Equity finance means the owner owns funds and finance. Usually, their owners operate small-scale businesses such as partnerships and sole proprietorships through their finances. Joint-stock companies use based on equity shares, but their management differs from shareholders and investors.
Merits of Equity Finance:
The following are the prices of equity finance:
(i) Permanent: Equity finance is permanent. There is no need to repay it unless liquidation occurs. Shares, once sold, remain in the market. If any shareholder wants to sell those shares, he can do so on the stock exchange where the company is listed. However, this will not pose any liquidity problems for the company.
(ii) Solvency: Equity finance increases the solvency of the business. It also helps in increasing the financial standing. In times of need, the share capital can be increased by inviting offers from the general public to subscribe for new shares. This will enable the company to face the financial crisis successfully.
(iii) Credit Worthiness: High equity finance increases creditworthiness. A business with a high proportion of equity finance can easily take loans from banks. In contrast to those under serious debt burden, they no longer remain attractive to investors. A higher proportion of equity finance means less money will be needed to pay interest on loans and financial expenses, so much of the profit will be distributed among shareholders.
(iv) No Interest: No interest is paid to any outsider in the case of equity finance. This increases the business’s net income, which can be used to expand the scale of operations.
(v) Motivation: As in equity finance, all the profit remains with the owner, motivating him to work harder. The sense of inspiration and care is greater in a business financed by the owner’s money. This keeps the businessman conscious and actively seeking opportunities and earning a profit.
(vi) No Danger of Insolvency: There is no borrowed capital, so no repayment has to be made in any strict lime schedule. This frees the entrepreneur from financial worries, and insolvency is not dangerous.
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(vii) Liquidation: In case of winding up or liquidation, no outsiders are charged for the business’s assets. All the assets remain with the owner.
(viii) Increasing Capital: Joint Stock companies can increase both the issued and authorized capital after fulfilling certain legal requirements. So, in times of need, finance can be raised by selling extra shares.
(ix) Macro Level Advantages: Equity finance produces many social and macro level advantages. First, it reduces the elements of interest in the economy. This makes people feel financial worries and panic. Secondly, joint-stock companies’ growth allows many people to share in their profit without actively participating in their management. Thus, people can use their savings to earn monetary rewards over time.
Demerits of Equity Finance:
The following are the demerits of equity finance:
(i) Decrease in Working Capital: If most of the business funds are invested in fixed assets, then the business may feel a shortage of working capital. This problem is common in small-scale enterprises. The owner has a fixed amount of money, and fixed assets consume a major proportion. So, less is left to meet the current expenses of the business. In large-scale enterprises, financial mismanagement can also lead to similar problems.
(ii) Difficulties in Making Regular Payments: In equity finance, the business person may feel problems in making payments of a regular and recurring nature. Sales revenues may sometimes fall due to seasonal factors. If sufficient funds are not available, then there would be difficulties in meeting short-term liabilities.
(iii) Higher Taxes: As no interest has to be paid to any outsider, the business’s taxable income is greater. This results in a higher incidence of taxes. Further, there is double taxation in certain cases. In the case of a joint-stock company, the whole income is taxed before any appropriation. When dividends are paid, they are again taxed from the recipients’ payment.
(iv) Limited Expansion: Due to equity finance, the business person cannot increase the scale of operations. Expansion of the business needs huge finance for establishing new plants and capturing more markets. Small-scale companies also do not have any professional guidance available to them to extend their market. There is a general tendency for owners to keep their business to such a limit to maintain effective control over it. As the owner finances the company, he is obsessed with fraud and embezzlement. These factors hinder the expansion of the company.
(v) Lack of Research and Development: In a business run solely on equity finance, there is a lack of research and development. Research activities take a long time, and huge finance is needed to reach a new product or design. These research activities are undoubtedly costly, but when their outcome is launched in the market, huge revenues are gained. However, the problem arises that if the owner uses his capital to finance such long-term research projects, he will face a crisis in meeting short-term liabilities. This factor discourages investment in research projects in a business financed by equity.
(vi) Delay in Replacement: Businesses that run on equity finance face problems during the modernization or replacement of the capital equipment when it wears out. The owner tries to use the current equipment as long as possible. Sometimes, he may even ignore the deteriorating quality of the production and keep on running old equipment.