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Advantages and Disadvantages of Equity Funding in an Indian SME

Apohan Corporate Consultants Pvt. Ltd. > Financial Strategy > Advantages and Disadvantages of Equity Funding in an Indian SME

Advantages of Equity Funding

The biggest advantage of equity capital is that it could be available even in the worst circumstances of a business.

Equity funding is provided based on the the intrinsic potential of the business and merit of the offer. Request for equity funding may not be rejected only because a certain rule book doesn’t permit to do so. There is no fixed guaranteed, permanent, periodic return on equity funding. Hence, the business has no tension of of monthly repayment of any interest amount. More importantly, the capital provided need not be returned at any point of time in the future to the investor. There is no requirement of any guarantee or any security. Practically there is no limit on what is the the maximum amount that can be availed.

There is no risk to the corporate assets or personal assets of the original promoters even if the business fails. This is because the equity investors joins on profit sharing and ownership sharing basis.

If the investor joins in management of the company, his experience in financial management it and corporate management may come handy and the business may become very professional. Equity funding is very useful in preparing the growth projects when sufficient amount of fund is not provided by a bank.

Equity funding is also very useful when a business suffers a one time misfortune and has potential to turnaround and excel again. The organic growth of business through internal accruals is very slow and equity funding provides avenues for rapid growth of a business.

There is no specific term of equity funding and hence even if the growth initiatives are delayed, even if the projects take longer than usual, there is no question mark on the existence of the company.

Disadvantages of Equity Funding

Unlike bank loans, equity funding is provided after a hectic due diligence of the business. The investor satisfies himself assessing the technical, marketing, business development, intellectual property,  brand value, legal, financial, corporate, regulatory, human resource, contractual, etc aspect in detail through a hectic due diligence.

This is because once the equity is provided the investor has to be here all the risks of the business without any recourse. Hence, it is very difficult for an unprofessional, incompetent business without any profitability or growth potential to get equity funding form third-party unrelated investors.

From the perspective of the previous shareholders, investment dilutes their ownership and control of the company. They have to share all the fortunes with the new investors in a fixed proportion.

If the parties have not entered into a professional shareholding agreement and if they have not defined the roles and responsibilities of each of the individuals, equity funding may bring in friction in the board of directors and shareholders of the company.

The decision making in the company may not be smooth. Apohan provides corporate management services to businesses to draft professional shareholding agreements and implement a decision making mechanism. Disharmony in the board or among shareholders is not the intrinsic demerit of equity funding, but it is indication of incompetent management.

Generally, the cost of raising equity fund is higher and the time frame required to complete the process is longer.