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Equity financing often catches the eye of Australian startups and growing small businesses, promising the capital you need to step up to the next level. From venture capital to angel investors, more founders are considering selling shares in the business as a way to fund growth. But like any big business decision, it’s important to look before you leap. While equity finance has its advantages, it brings with it a unique set of challenges and risks that every business owner should consider.
If you’re weighing up how to fund your business – whether you’re just getting started or ready to grow – keep reading to understand the key disadvantages of equity financing in Australia. Being fully informed will help you decide if it’s the right fit for your journey, and if not, what alternatives might suit you better.
What Is Equity Financing?
Before we dive into the disadvantages, let’s quickly recap what equity financing means. Equity financing is when you raise funds by selling off partial ownership in your business – in other words, you give investors shares in exchange for their money rather than taking on debt.
This might come from private investors (like angel investors), venture capital firms, or even friends and family. In the case of larger or more mature companies, it could mean listing on the ASX and selling public shares. For most small businesses and startups in Australia, though, it’s usually a private transaction between founders and a handful of external investors.
If you want a deeper understanding of how this works and the types of funding available, our key guide on Equity vs Debt Financing explores the pros and cons of both.
Why Do Businesses Seek Equity Finance?
The advantages of equity financing can be attractive, especially when you’re facing cash flow constraints or want to expand quickly:
- No Repayments: You don’t need to make regular loan repayments or pay interest – the capital is “free” in the sense there’s no set payback, though you are giving away future profit.
- Shared Risk: Investors share the risk. If your business doesn’t succeed, you’re not left with a mountain of debt.
- Investor Support: Investors (especially VCs and angels) often bring not just money but expertise, networks, and credibility.
- Better Cash Flow: Since you’re not making repayments, you have more cash available to invest in growing your business.
But it’s not all upside. The equity financing disadvantages often become more apparent further down the line. Let’s take a closer look.
What Are the Disadvantages of Equity Financing?
Below, we break down the main disadvantages that Australian businesses face when raising funds through equity finance, and why it’s essential to balance the short-term benefit of extra cash with the long-term consequences.
You Give Up Some Ownership and Control
One of the biggest drawbacks is dilution – when you sell shares, you give up a slice of ownership in your business. This means sharing decision-making power and, at times, even the overall direction of your business.
It’s not just about profit – major decisions could require shareholder approval, and you may need to consult or even get agreement from your investors on strategy changes. In some cases, investors might even demand board seats or veto rights. For founders with a big vision or creative companies that value autonomy, this can quickly feel restrictive.
Potential for Conflict and Disputes
More shareholders means more opinions, priorities and – sometimes – personal interests. It’s not uncommon for shareholder disputes to arise about dividends, business direction, or how to respond to market change.
If disagreements get out of hand, they can drain your time, money and energy. Strong shareholders agreements can help clarify each owner’s rights and responsibilities, but you’ll still need to invest significant time in relationship management.
Profit Sharing – Future Returns Are Divided
With equity financing, you’re not just sharing control, you’re also sharing the future financial upside. If your company does well, you’ll be splitting profits (through dividends or eventual sale proceeds) with your investors. Over time, this can add up to far more than the value of a loan’s interest.
For example, if you sell a significant portion of your business to raise $300,000, and that business is worth $5 million ten years later, the price of that capital has become much higher than the sticker upfront.
Loss of Confidentiality
Investors will want to see your accounts and have ongoing access to financial and operational information. What was once a private business is now subject to more scrutiny and, potentially, less confidentiality around your trade secrets, business plans, or financial health. This is especially relevant if you have to provide regular investor reports, board meeting minutes, or business forecasts.
Longer, More Complex Fundraising Process
Compared to taking on a simple business loan (or even using your personal savings), raising equity finance is a longer and much more complex process. You’ll need a well-prepared business plan, detailed financial forecasts, and possibly even audited accounts.
Add to that the legal and compliance requirements – due diligence, negotiating term sheets, preparing shareholder agreements and company constitutions, registering new shares with ASIC, and managing disclosure obligations. You’ll also have to pay for lawyers, accountants, and possibly other advisors throughout this process.
Dilution of Existing Shareholders
Bringing in new investors usually means the percentage ownership of existing shareholders (including founders and employees with shares) decreases unless they “top up” their investment. Dilution is not just a matter of pride – it can affect the balance of power and future negotiating ability as well.
No Guarantee of Further Investment
It’s a common misunderstanding that once you’ve attracted investors, future capital will be easy to secure. In reality, each new round of funding is a new negotiation. If your company doesn’t achieve rapid growth, you may struggle to get the next round of investment on good terms. You could face tougher conditions or even end up giving away further control at a lower valuation.
Exit Pressure and Timeframes
Investors usually want to see a return on their investment within a set period, through either a sale, merger or public listing. This ‘exit pressure’ can push the business towards decisions or strategic changes that “fit” investor timelines, but not necessarily the long-term interests of founders or staff.
This can limit your ability to run the business as you see fit, or pursue more organic, sustainable growth. It can also be a source of significant stress if the business isn’t in a position to exit within the expected timeframe.
Heavier Compliance and Reporting Burden
When you have multiple shareholders (especially institutional or sophisticated ones), you will need to comply with increased recordkeeping, reporting and corporate governance obligations. For example, running annual general meetings (AGMs), preparing regular financial statements, and maintaining up-to-date company registers with ASIC.
For companies considering an eventual listing on the ASX, the regulatory and compliance expectations only increase. This is in stark contrast to running a sole trader or even a simple proprietary limited company with only one or two owners.
Are There Alternatives to Equity Financing?
If the disadvantages above feel like a poor fit for your business or goals, it’s worth considering the alternatives:
- Debt Financing: Loans, overdrafts, or lines of credit let you raise funds without giving up ownership – though you’ll be taking on repayment obligations.
- Government Grants: There are grants available for different industries, especially if you’re working on innovation, exports, or employing people.
- Bootstrapping: Growing slowly, using your own funds or reinvesting profits, is still a valid path – especially if you want to retain full control and avoid external pressure.
- Crowdfunding: Particularly for consumer-facing or social-good businesses, raising capital from the public can be a flexible alternative – but it comes with its own legal requirements.
Every alternative has pros and cons – understanding them is key for strategic planning. Whichever path you take, ensure you create a detailed business plan and are clear on your cash flow forecasts before you approach any funders.
What Legal Documents and Compliance Steps Are Needed for Equity Funding?
If you decide to pursue equity financing, getting your legal documents and compliance steps right from the start is crucial. Here are the documents and agreements most equity-funded businesses will need:
- Shareholders Agreement: Outlines ownership structure, voting rights, exit processes, and how disputes are handled. This is essential for preventing (and resolving) conflicts. Learn more in our shareholders agreements guide.
- Company Constitution: Sets out the rules governing the company – from director powers to meetings and share issues. It works alongside the Shareholders Agreement.
- Term Sheet: The initial, non-binding document that sets out the framework for the investment – valuation, type of shares, rights and expectations.
- Share Subscription Agreement: The formal contract for new investors to purchase shares in your company. More on this in our Share Subscription Agreements guide.
- Disclosure Documents: Depending on the type of investors (retail, sophisticated, or through crowdfunding), there may be mandatory disclosure and compliance requirements under the Corporations Act 2001.
- Employment Agreements and IP Assignment Deeds: Investors will expect employee contracts to include IP assignment clauses, ensuring all intellectual property created by the team belongs to the company.
Making sure these documents are tailored to your situation can save you major headaches later, especially if the company becomes valuable or if a shareholder wants out unexpectedly. Our Shareholders Agreement service can help you get it right.
What About Australian Regulations and Compliance?
Equity financing in Australia is governed primarily by the Corporations Act 2001. If you issue new shares, there are strict rules around who can invest, disclosure, company records, and ongoing reporting. Key compliance requirements include:
- ASIC Registration: All changes in shareholding and issuance of new shares must be recorded and reported to ASIC (Australian Securities and Investments Commission).
- Shareholder Register: You must accurately maintain registers of members, share classes, and rights attached to each class.
- Disclosure Documents: For most private companies, you can only raise up to $2 million from no more than 20 investors in any 12-month period before full prospectus requirements apply, unless your investors are “sophisticated” or “professional”.
- Ongoing Reporting: Annual returns, financial reports (in some cases), and maintaining corporate records as required by law.
Not sure if you’re compliant? It’s wise to get advice from legal experts with experience in Australian equity funding to avoid costly compliance breaches. See our guide to capital raising requirements for more information.
Frequently Asked Questions About Equity Finance Disadvantages
Will I Lose Control of My Business if I Use Equity Financing?
You may not lose total control, but you will be required to share decision-making power with your investors. The more equity you sell, the less direct control you’ll retain. Creating clear agreements and thinking carefully about the percentage you’re selling is essential.
How Can I Protect My Interests?
Have clear and strong shareholder agreements, and ensure all parties know their rights and responsibilities. Carefully consider which decisions require unanimous approval and which can be made by the board or majority shareholders. Our guide on shareholders agreements covers this in more detail.
Is It Possible to Buy Back Shares from Investors in the Future?
Yes, but only under certain conditions and usually at a price set by agreement or market value. There can also be legal restrictions on share buy-backs, and it’s important to set these out in the original agreements to avoid disputes (learn more about transferring and selling shares in our guides).
Key Takeaways
- Equity financing can empower your business to grow, but it comes with significant disadvantages around loss of ownership, future profit sharing, and increased reporting and compliance requirements.
- Carefully consider the impact on control – once you take on shareholders, you will need to share strategic decision-making.
- Make sure you have a robust business plan, accurate financials, and all essential legal documents before seeking equity finance.
- Understand your ongoing compliance and reporting requirements as a company with multiple shareholders in Australia.
- Alternatives such as debt financing, bootstrapping, grants, and crowdfunding might fit your goals better if control and simplicity are priorities.
- Getting legal advice early – especially regarding agreements, company structure, and ASIC compliance – can save you time, money, and stress down the track.
If you’d like a consultation on raising equity or structuring your business funding, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.
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