Acquiring equity capital is approached differently depending on the business’s ownership structure. Because equity capital is money invested by the owner, the type of ownership structure determines who can provide the equity capital and how it is obtained and invested in the business.
Sole proprietors must rely on their personal assets for capital if they want to retain ownership of the company. If owners are wealthy or the needed amount is small, they can invest more of their own money in the business.
If they do not have available cash, they will have to sell personal assets to raise the money. Other options are to mortgage personal property such as a home or obtain a personal loan using the collateral of owned assets such as automobiles, insurance policies, or other property.
Of course, when those funds are invested in the business by the sole proprietor, they are at risk and can be lost if the business is not successful. In addition, other personal assets that were not invested in the business can be lost if the business fails.
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If the sole proprietor cannot provide additional financing for the business and chooses to use equity capital, alternative sources will have to be considered.
When others provide equity capital, the form of business ownership will need to change. The sole owner of a business can obtain additional funds by
- forming a partnership and requiring the new partner to invest money in the business, or
- forming a corporation and bringing in additional equity and owners by selling stock.
When a business expands by creating a partnership, the partner is not required to invest money. A partner may be brought into a business because of his or her business expertise rather than the need for additional capital.
However, partners usually invest their personal resources in the business to balance the amount of money each owner has in the business and to spread the financial risk among the owners.
When a sole proprietorship is reorganized into a partnership, a formal partnership agreement must be created that identifies the financial contributions of each partner and how business profits will be shared. As with the sole proprietor, a new business partner will need to use personal finances to provide the required equity capital.
Those resources can be personal savings, income from the sale of assets, or personal loans and mortgages. And just as in the sole proprietorship, the money invested by each partner as well as any other personal assets that were not invested are at risk if the business fails.
If the assets of one partner are not adequate to cover the debts of a business, assets from other partners can be taken. When a sole proprietorship expands ownership by forming a partnership, the owner gives up individual control over management and decision-making.
The third way to raise equity capital is by forming a corporation and bringing in additional owners through the sale of stock.
The use of a corporate structure for a small business may be an effective way to raise equity capital because the amount of money that an individual needs to invest is usually much smaller than if a partnership is formed.
Also, stockholders are not involved in the day-to-day management of the business. Therefore the person who was the original owner may be able to continue as the primary manager of the business. Investors in corporations are protected financially; they can lose the money they have invested only if the business fails.