Equity finance means the owner, own funds, and finance. Usually, small-scale businesses such as partnerships and sole proprietorships are operated by their owners through their own finance. Joint-stock companies operate based on equity shares, but their management is different from shareholders and investors.
Merits of Equity Finance:
Following are the merits of equity finance:
(i) Permanent in Nature: Equity finance is permanent in nature. 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 problem 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 in which equity finance has a high proportion can easily take loans from banks. In contrast to those under serious debt burden, they no longer remain attractive for investors. A higher proportion of equity finance means that 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, so it gives him the motivation to work more hard. The sense of inspiration and care is greater in a business financed by the owner’s own money. This keeps the businessman conscious and active to seek opportunities and earn 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 makes the entrepreneur free from financial worries, and there is no danger of insolvency.
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(vii) Liquidation: In case of winding up or liquidation, there are no outsiders charged on the business’s assets. All the assets remain with the owner.
(viii) Increasing Capital: Joint Stock companies can increases 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 Tree of financial worries and panic. Secondly, joint-stock companies’ growth allows a great number of people to share in its profit without taking an active part in its management. Thus people can use their savings to earn monetary rewards over a long time.
Demerits of Equity Finance:
Following are the demerits of equity finance:
(i) Decrease in Working Capital: If the majority 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 businesses. The owner has a fixed amount of capital to start with, and fixed assets consume a major proportion. So less is left to meet the current expenses of the business. In large scale business, financial mismanagement can also lead to similar problems.
(ii) Difficulties in Making Regular Payments: In equity finance, the businessman may feel problems in making payments of regular and recurring nature. Sales revenues sometimes may 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, then they are again taxed from the income of recipients.
(iv) Limited Expansion: Due to equity finance, the businessman cannot increase the scale of operations. Expansion of the business needs huge finance for establishing new plant and capturing more markets. Small scales businesses also do not have any professional guidance available to them to extend their market. There is a general tendency that owners try to keep their business in such a limit to keep affective control over it. As the owner himself finances the business, he is very obsessed with fraud and embezzlement. These factors hinder the expansion of the business.
(v) Lack of Research and Development: In a business that is 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 eventually, when their outcome is launched in the market, huge revenues are gained. But the problem arises that if the owner uses his own capital to finance such long-term research projects, he will be facing a problem 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 at the time of 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 keeps on running old equipment.
