Equity financing means the owner, equity and finances. Small-scale businesses, such as associations and sole proprietorships, are generally operated by their owner through their own finances. Stock companies operate on the basis of capital shares, but their management is different from that of shareholders and investors.
Equity Finance Merits:
The following are the merits of equity finance:
(i) Of a permanent nature: Equity financing is permanent in nature. There is no need to return it unless clearance occurs. The shares once sold remain in the market. If any shareholder wishes to sell those shares, he can do so on the stock exchange where the company is listed. However, this will not cause any liquidity problem for the company.
(ii) Solvency: Equity finance increases the solvency of the business. It also helps to increase the financial situation. In times of need, the share capital can be increased by inviting offers from the general public to subscribe for new shares. This will allow the company to successfully face the financial crisis.
(iii) Credit solvency: High equity financing increases creditworthiness. A business in which equity financing has a high proportion can easily obtain a loan from banks. Unlike those companies that are under a serious debt load, they are no longer attractive to investors. A higher proportion of equity financing means that less money will be needed for interest payments on loans and financial expenses, so much of the profit will be distributed to shareholders.
(iv) Without interest: No interest is paid to any third party in the event of equity financing. This increases the net income of the business that can be used to expand the scale of operations.
(v) Motivation: Like equity finance, all profits stay with the owner, motivating them to work harder. The sense of inspiration and caring is greater in a business that is financed with the owner’s money. This keeps the entrepreneur aware and active in seeking opportunities and making a profit.
(vi) Without Danger of Insolvency: Since there is no borrowed capital, no repayment is required on any strict schedule. This frees the entrepreneur from financial worries and there is no danger of insolvency.
(vii) Settlement: In the event of dissolution or liquidation, there is no third-party charge on the company’s assets. All assets remain with the owner.
(viii) Capital Increase: Public limited companies may increase both the issued capital and the authorized capital upon compliance with certain legal requirements. Therefore, in times of need, financing can be obtained by selling additional shares.
(ix) Advantages of the macro level: Equity finance yields many macro-level and social benefits. First it reduces the elements of interest in the economy. This turns people into a tree of financial worries and panic. Second, the growth of corporations allows a large number of people to participate in their benefits without taking an active part in their management. Therefore, people can use their savings to earn monetary rewards for a long time.
Capital Finance Demerits:
The following are the demerits of equity finance:
(i) Decrease in Working Capital: If most of the business’s funds are invested in fixed assets, then the business may experience a shortage of working capital. This problem is common in small-scale companies. The owner has a fixed amount of capital to start with and most of it is consumed in fixed assets. So there is less to cover the current expenses of the business. In large-scale businesses, poor financial management can also lead to similar problems.
(ii) Difficulties in making regular payments: In the case of capital financing, the entrepreneur may have problems making regular and recurring payments. Sales revenue can sometimes drop due to seasonal factors. If sufficient funds are not available, it will be difficult to meet short-term liabilities.
(iii) Higher Taxes: Since no interest has to be paid to any third party, the taxable income of the company is higher. This translates into a higher incidence of taxes. In addition, there is double taxation in certain cases. In the case of corporations, the entire income is taxed before any appropriation. When dividends are paid, they are taxed again with the recipients’ income.
(iv) Limited Expansion: Due to equity financing, the entrepreneur is unable to increase the scale of operations. The expansion of the business needs a large financing to establish a new plant and capture more markets. Small-scale companies also do not have any professional guidance available to expand their market. There is a general trend that owners try to keep their business within that limit in order to maintain affective control over it. Since the business is financed by the owner himself, he is very obsessed with the possibilities of fraud and embarrassment. These factors make it difficult to expand business.
(v) Lack of research and development: In a business that is run solely on equity financing, there is a lack of research and development. Research activities take a long time and large funding is needed to come up with a new product or design. These research activities are undoubtedly expensive, but eventually, when their results are released to the market, huge revenue is earned. But the problem arises that if the owner uses his own capital to finance long-term research projects, he will have trouble meeting short-term obligations. This factor discourages investment in research projects in a company financed by capital.
(vi) Delay in Replacement: Businesses that run on equity financing face problems when modernizing or replacing capital equipment when it wears out. The owner tries to use the current equipment as long as possible. Sometimes he can even ignore deteriorating production quality and continue to use old equipment.
