If you have a company, whatever the business model and area of activity, financial resources are necessary to keep the operation running .
We can say that there are basically two ways to finance a company’s activities: equity and third-party capital.
Each of them has its advantages and characteristics. Therefore, it is important to understand the current situation of your business to make the right choice.
In this article, we will look in detail at what equity and third-party capital are, their advantages and how to make the most appropriate decision for your investments.
Equity and third-party capital: what is it?
Understanding the peculiarities of the two different types of capital is essential to decide which path to follow in financing your company’s activities.
Equity
Equity capital is the investment made by the partners of a company using their own resources, be it money, assets or other goods.
This kind of funding, which is a component of the business’s equity, may originate from the business’s profit, shareholders, or the entrepreneur himself.
When the company has investors with equity participation (angel investor, seed investor or venture investor), the capital contributed by them also counts as equity.
Another point is that, when the owners assume the risk of the operation, they do not commit to paying regular interest and are only remunerated if the business is profitable.
Third party capital
Third-party capital is a resource obtained externally, through loans, financing or other forms of credit, with previously defined terms and rates.
The company’s liabilities and obligations include this kind of capital. The payment of the loan is not related to the company’s performance and must be repaid with interest, even if the business does not perform well..
What are the advantages of equity?
Among the main benefits of equity, we can highlight the following points:
Investments without accumulating debts
With equity, you don’t need to resort to loans or financing, which means you won’t accumulate debt.
This provides a sense of security as you don’t have to worry about future payments or the possibility of not being able to meet your financial obligations.
More time to invest
By using your own capital, you have more time to invest. There is no pressure to pay back loans or meet financing deadlines.
This allows for a more strategic approach, making it possible to wait for better business opportunities.
More freedom to apply capital
With your own capital, you have complete freedom to decide how to apply the resources to your investments.
There are no restrictions imposed by third parties, which allows for greater flexibility in decision-making.
Member incentive
The investing partners will be the main stakeholders in making the business successful, since they profit from it.
Therefore, their contributions are not usually just financial, but they also involve the exchange of knowledge, as well as new visions and experiences to boost the company.
What are the advantages of third-party capital?
Anyone who thinks that taking out a loan is always a businessperson’s second option is mistaken. There are several advantages to using third-party capital, as we will see below:
Interest may be lower
Even though taking capital from third parties involves the payment of interest, these costs may be lower in relation to the profitability of some types of investments.
In some situations, it is possible to obtain returns greater than the interest costs, which makes third-party capital a viable option.
Predictability
With third-party capital, you can organize your payments on a fixed schedule.
With this predictability, it becomes easier to have good financial management and a healthy cash flow, without major unforeseen events.
Autonomy
You have decision-making authority over your firm when you use loans to fund it. The lender will not have the right to have a say in the direction of your business.
What are the disadvantages of equity?
Conflicts
When capital comes from partners, differences of opinion may arise regarding the use of resources and the running of the business itself.
Loss of autonomy
Since shareholders have the right to participate in company decisions, it is necessary to consult them when making certain decisions.
Profit distribution
Over time, the distribution of profits to shareholders may exceed the interest that would be charged on a loan.
What are the disadvantages of third-party capital?
Interest charging
Even if your business is not making a profit, once you choose to use third-party capital, payment must be made on the agreed date and with interest accrued.
High risk reputation
Companies with a lot of debt are seen as high risk by potential investors and you may have difficulty raising this type of capital in the future.
Commit cash to debts
Having immediate access to resources is very convenient. However, it is important to keep in mind that, over time, part of the money that comes into the company will be used to pay off debt and not to grow the business.