Notes

Learn how proprietorships and partnerships can raise equity financing. This lesson touches on the process of attracting investors and capital, with examples, and attracting capital specifically as a partnership.
Attracting Investors
Let's face it: running a small business requires a lot of effort. Sometimes, effort isn't enough. You've also got to think of a way to raise capital, or the resources necessary to let you do business. Often, this is in the form of money, but could also include machines, property, or even a special ability or skill. After all, it's hard to have a business designing mobile apps if you don't have a computer!

However, small businesses are usually sole proprietorships or partnerships, which makes raising capital quite challenging. After all, you can't just sell stocks like a corporation. That doesn't mean that raising capital is impossible, though!

In this lesson, we're going to look at how sole proprietorships and partnerships can raise capital through equity financing. Equity financing refers to raising the value of the business by directly investing in the company.

Attracting Capital
First, let's start with how a sole proprietorship might raise some capital. Remember that a sole proprietorship is when one person owns a company with no separation between their business and their personal funds. This is what makes attracting capital sometimes challenging for a sole proprietorship; no one is going to invest in your business when they know that you can legally decide to fly to the Caribbean for the week with their money! However, that doesn't mean it is impossible.

The most common way that sole proprietorships are financed is by being funded through the sole proprietor herself. This is part of what makes starting up a small business so risky for so many people! This is not the only way that a sole proprietorship can raise financing, but it is almost the only way it can do so through equity. Gifts or grants from friends and family could theoretically count, but these are rare. Loans, on the other hand, are debt financing, when money is infused into the business by taking on debt to be repaid in the future.

Example
Let's take a look at an application development company that has exactly one employee - you. You've got a great idea for a new app, but you need a new tablet to test it on. More often than not, that means you've got to dip into your savings to buy the tablet.

Now, that purchase is still an equity investment because it does raise the value of your company. If your company was worth $200,000 before purchasing a $500 tablet, it is now worth $200,500. Hopefully, that new app idea will help make your company even more profitable!

Attracting Capital as a Partnership
But what about raising capital for a partnership? In this case, in addition to the ways a sole proprietorship might attract capital, there are some other options available. Because a partnership splits up ownership and profits among a group of people, there can be more hands in the pot. A partnership can also grant stakes in your company to new partners in order to raise capital.

Note that I did not say 'shares' because anyone can buy or sell a share. Stakes in a partnership, however, do not come with that freedom. Often, a partnership will seek out a silent partner who is willing to put up capital for expenses but then stays out of the daily operations of the business.

It should be noted that, technically speaking, a sole proprietorship could seek out a silent partner to raise equity financing. However, since the trade-off here is most often money for a stake in the company (sometimes as high as a 50% stake), taking on even a silent partner will, by definition, turn a sole proprietorship INTO a partnership. For this reason, if a business owner wants to remain a sole proprietorship, granting stakes to potential partners isn't an option.

Partnership Example
Your app development company has now grown into a partnership. You handle all the front-end graphics, while your partner does all the back-end coding. You agree to split profits 50-50. However, it has become clear that you need equity (cash) to purchase new tablets and phones on which to test your latest apps. Apparently, some phones running a popular operating system do well with your app, while others don't.

Now, you and your partner could pool your money together, or you could seek out a silent partner who is willing to put up the money necessary to buy those tablets and phones. The catch is that you both have to sacrifice some level of ownership in the firm to him. As a result, you each may now get 45% of the profits, but this silent partner gets 10% without having to do any of the work.

Lesson Summary
In this lesson, we saw how sole proprietorships and partnerships were able to attract equity financing in order to increase their capital, or the resources required to do business (many times, that means money). Since these two types of businesses can't sell stock, they have to resort to other methods. Equity financing refers to raising the value of the business by directly investing in the company.

A sole proprietorship is when one person owns a company with no separation between their business and personal funds, while a partnership splits up ownership and profits among a group of people. Also, remember that a silent partner contributes money to and receives a share of the profits from a company, but gets no voice in how the company is run.

To raise equity financing, a sole proprietor has relatively few options available. They can finance a purchase themselves, get a gift from a friend or family member, or get a loan. A loan, however, would be an example of debt financing, when money is infused into the business by taking on debt to be repaid in the future. In any event, the money adds to the firm's equity. A partnership, however, has the option of granting stakes in the business to an additional partner (silent or not) in exchange for additional capital, raising the overall equity value of the company.