What is Equity Financing?

Lea LeBlanc on September 24, 2021

Equity financing is a method of capital raising via the selling of stock. Businesses grow money for a variety of reasons. They may need cash to meet immediate financial obligations or have a longer-term objective and require capital to invest in their development. By selling shares, a business essentially sells its ownership in exchange for cash.

Equity funding may originate from various sources, including friends and relatives of the entrepreneur, financiers, or an initial public offering (IPO). An initial public offering (IPO) is how private businesses sell shares of their company to the public in a new stock issuance. Public share offering enables a business to obtain money from the general public. Industry titans such as Google and Facebook raised billions of dollars via initial public offerings.

While the phrase “equity financing” is often used to refer to the funding of publicly traded businesses, the term is also applied to private company financing.

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What is Equity Financing in SaaS?

SaaS equity financing is the process of acquiring money in return for a stake in a business. When it comes to equity financing, various options are available, including funding from high-net-worth individuals, a venture capital firm (investment in a company with the potential for long-term growth), or private equity (investment in a business that is not publicly listed).

The amount of ownership provided to an investor is decided by the stage of business investment (series A, B, etc.). Also, it depends upon the firm’s success and the amount of money that the company is looking to acquire.

SaaS equity financing is usually sought after a business has operated for a while and established a solid foundation as this affects their overall equity. Typically, the critical components of this foundation are monthly recurring revenue (MRR) or annual recurring revenue (ARR). Another financial factor to examine is the amount of churn a business suffers every month as this reflects the company’s capacity to develop and retain connections — or to lose them. It is ideal to have a low churn rate and a high MRR/ARR.

Equity financing is usually not considered by a business seeking capital to remain afloat early in its life cycle as the investment is considerably more significant. Additionally, getting SaaS equity financing is much slower, often taking six months or more. This is usually where venture debt funding comes into play, loan-based financing returned via earnings or another kind of monthly payment. Debt financing is preferable for sales and marketing acceleration since it has a lower long-term cost and enables the company to expand quicker.


What is the difference between Equity Financing, Loans, and Venture Capital Funding?

When a business wants to obtain money, it may choose from various financing options: equity financing, debt financing, and venture capital funding.


1. Equity Financing

While equity financing imposes no extra financial strain on the business, the drawback is very significant. The primary benefit of equity financing is no obligation to return the funds raised.


2. Debt Financing (Loan)

Debt financing requires borrowing money. The primary benefit of debt financing is that the company owner keeps complete control of the enterprise, unlike equity financing. Creditors prefer a low debt-to-equity ratio, which helps the business if it ever requires more debt funding.


3. Venture Capital Funding

Venture capital funds invest in high-growth prospects in startups and other early-stage companies on a pooled basis. Hedge funds invest in high-growth, high-risk businesses. Consequently, they are accessible only to experienced investors who can tolerate risk, illiquidity, and lengthy investment horizons. Venture capital funds provide seed money or “venture capital” to new businesses seeking rapid development, most often in high-tech or developing sectors.


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When should you be thinking about Equity Financing?

When you need a stable funding source with no required dividend payments and retained earnings, you should consider equity financing.

Each of these will be described in-depth:


1. Stable Source of Finance

Equity finance is the long-term answer to a business’s financial requirements. No business’s primary emphasis or goal can be just financial management. A product manufacturing company’s goal will be to produce high-quality products and to reach the appropriate customer. A service provider business will guarantee that the services it provides are of the highest quality. Equity financing gives management the leverage necessary to maintain a laser-like focus on their primary goals. It frees management from the difficulties associated with obtaining money repeatedly, as with other forms of funding, such as debt. Debt is acquired and repaid over time.


2. No Requirement to Pay Dividends

Equity financing for a new business is similar to receiving divine gifts. The primary constraint for a startup business is the unpredictability of financial flows. Due to the absence of a set duty to pay dividends, the equity financing method provides breathing room for management. A business may opt to pay no dividends or pay them at a reduced rate depending on its cash flow situation.


3. Earnings Retained

By bringing equity financing on board, a business may create an internal source of funding. Earnings generated by a business utilizing capital can be maintained to cover increasing working capital and other financial needs. It eliminates the additional complications associated with obtaining money from other sources. Additionally, if the funds are invested in initiatives that provide greater returns than those accessible to equity owners, the firm accomplishes its goal of maximizing shareholder wealth.


When is it a good idea to not do Equity Financing?

An offering of equity financing does not always imply approval of your business model. Businesses that fall into specific attractive categories have a simpler way of acquiring funding—even if the money is unsuitable for their company.

This section explains two distinct developmental pathways and how entrepreneurs can determine if equity financing will benefit or hurt their company in the long run. The two pathways are:

  • Businesses continue to expand sustainably and intentionally through non-dilutive capital and reinvestment of income from paying consumers.

  • They are given venture money, give up a significant amount of stock, and make an exponential growth risk.

Those who follow the first route will likely see consistent and predictable development, eventually resulting in an exit.

Those who choose the second choice face a far more risky future with a 75% failure rate—and no plan B or alternative result.

Typically, they take venture capital and celebrate it in the same way that most companies do. They modify their steady, sustainable development plans to meet the venture capital firm’s expectations and expand quickly. They increase recruiting, spend in sales and marketing, and then sit back and watch their revenue grow.

If revenue growth does not materialize at a suitable rate, it becomes simpler to see the foundation’s flaws. Eventually, the entrepreneur is compelled to sell, debt and venture investors are compensated, and ordinary shareholders often get nothing.

The reason things may go wrong is that money alone cannot address all of a startup’s problems; it can even worsen them.

To determine if your company would profit from equity financing, follow these three steps:

  • Conduct an honest evaluation of your business’s development potential.

  • Determine if your issue is one of customer acquisition or market size.

  • Examine the underlying indicators to determine whether you need to spend more money.

Baremetrics for great Financial Reporting

The financial indicators that you want to track for your organization are industry and business-specific. Metrics relating to assets such as equipment and logistics will be important for heavy industrial companies. Not so much for SaaS.

You’ll need to create a unique financial model for each company that outlines precisely the KPIs you’re focused on. Consider this financial model for SaaS, which you can download and use straight in Sheets. Baremetrics interfaces with Google Sheets, making it simple to feed data directly into your financial model.

Furthermore, the names and definitions of metrics vary per industry. For instance, the Quick Ratio is used to compare the assets and liabilities of a brick and mortar commodities business. The Quick Ratio has a different meaning in SaaS. The SaaS Quick Ratio compares growth in MRR due to new customers, expansions, or reactivations against churn losses.

Each product or tool will uniquely gather data about your metrics. It is up to the analyst to choose a tool compatible with the manner their measurements will be measured. When tracking financial KPIs for a SaaS business, it’s critical to concentrate on the fundamentals. Then, you must focus on performing the fundamental measures properly.

Every company should begin with these measures as their primary set of financial measurements and add supplementary computations. Baremetrics offers a variety of financial metrics that can help a SAAS company grow.

The financial measures include the following:

  • Monthly Recurring Revenue (MRR)

  • Annual Run Rate (ARR)

  • Net Revenue 

  • MRR Growth Rate 

  • Other Revenue  

  • Quick Ratio

  • Active Subscriptions

  • New Subscriptions

  • Plan Quantities 

  • Upgrades

  • Downgrades 

  • Failed Charges

  • Refunds

  • Coupons 

  • Average Revenue Per User (ARPU)

  • Lifetime Value (LTV)

  • New Customers

  • Active Customers 

  • Churned Customers

  • Reactivations

  • User Churn 

  • Revenue Churn

  • Net Revenue Churn

  • Churned Subscriptions

If you want to get these metrics without running any calculations in your own Google Sheets, join up for Baremetrics here. Begin your free trial and instantly examine your first 26 financial measures.

Moreover, check out the Baremetrics Academy for more information on financial metrics for SaaS!

Lea LeBlanc

Lea is passionate about impactful businesses, good writing, and the stories founders have to tell. When she’s not writing about SaaS topics, you can find her trying new recipes in her tiny Tokyo kitchen.