Equity Financing: Meaning, how it works and more

Businesses all over the world have ownership divided into shares. The share of a business offers an ownership stake of that entity to an investor. Such a share entitles the investor to certain rights and responsibilities to the company. The investor can also sell, or trade the share in whatever way that he pleases, as the shares act as a private property of the investor. 

Equity financing is a vital topic in the world of finance as it relates to the offering of a company’s shares to its shareholders in exchange for investment in the company. This article offers all there is to know on equity financing, how it works and others.

What is equity financing?

Equity financing is the branch of financing that deals with the company raising capital from investors in exchange for a part of the company, called shares issued to the said investor. 

Equity financing is a method of generating money through the issuance of stock in a firm. As compensation for their investment, investors adopt this strategy to purchase a share of a company’s stock. When corporations borrow money from lenders with the promise to pay it back with interest, is not financing with equity. Start-ups and small enterprises frequently utilize equity financing to raise funds for their operations. Investors find equity financing appealing because, if the business expands and becomes lucrative, they receive returns on their investment. In addition, shareholders in a corporation have a voice in how decisions are made from time to time.

How equity financing works

Equity financing acts as a form of fundraising for businesses. The financing method entails great due diligence and checks by professionals on the records of the company. 

It begins with the corporation making calls for the purchase of its shares, subsequently, the corporation’s board of directors would then pass a resolution offering the said shares to the investor. The resolution follows a letter offered by the company to the investors informing them of the shares issued.

Types of equity financing

There exist two major types of equity financing in the market today. These are:

1. Private equity financing

Investors that participate in private equity financing make investments in privately held businesses. Private equity firms often invest in businesses with strong development potential. Under this type of equity financing, investors make investments in well-established businesses with a proven track record of profitability and a capable management group. 

Private equity firms often make investments in privately held businesses. They invest in these businesses with the intention of either selling them to another business or making them publicly traded through an initial public offering (IPO). Private equity firms frequently play an active role in the management of the companies they invest in and typically own a substantial ownership position in such businesses.

2. Public equity financing

Public equity financing is a kind of equity financing in which businesses offer the general public shares of their own through a stock exchange market. 

Businesses often choose public equity financing to access a wide range of investors for their shares. The public gets access to the quoted shares traded on the stock exchange and can purchase such shares on the floor of the stock market. The Securities and Exchange Commission’s inspection of publicly listed corporations can have an impact on their stock price and reputation.

Pros of equity financing

  1. Absence of debt obligations: Unlike debt financing, equity financing exempts businesses from making ongoing debt payments, which in turn maintains the credit record and borrowing capacity of the startup or small business for a greater project. For businesses that are just getting started or who have a tight cash flow, this might be advantageous. 
  2. Easy access to capital for businesses: Equity financing may provide businesses access to significant sums of money that they can utilise to finance their expansion and growth. This money might go towards expanding into new markets, purchasing new equipment, or hiring more employees. This advantage is a major benefit that attracts corporations to adopt equity financing. 
  3. Increased partnership: equity financing offers increased strategic partnerships to businesses, especially startups and small companies. These businesses can have access to a wide range of expertise that can support their business growth in the long and short run. For instance, a startup having a well-known investment banker can get support for their accounts, which can boost sales in the organization. 

Cons of equity financing

  1. Ownership dilution: the possibility of the founder of the business offering shares to investors dilutes the founder from fully owning the business. The issuance of at least a share from a founder to an investor offers the investor all rights to question and demand rights about the company.
  2. More expensive: Compared to debt financing, equity financing is more expensive and demanding. Equity financing offers the investor control and further rights in the business, the investor is also entitled to dividends when declared by the company, all these make the debt financing most attractive compared to the equity financing.
  3. Profit sharing: Having to share the profits of the business through dividends when declared is again another disadvantage of the equity financing method. Most times the dividends paid by the company to the investor surpass the investor’s investment in the long run, opting for debt financing would have saved the business the stress of continuous dividend sharing to the investor.

Conclusion

Equity financing is one of the most sought-after financing methods by investors. What draws investors to this form of financing is the possibility of a flexible investment that mitigates risks while offering corporations the needed investments to grow. 

Nonetheless, the shares of the company are a strong part of its existence and could be used to raise funds for the business in the long and short run. This article has provided all the information there is to know on equity financing in the global corporate world.

Frequently Asked Questions

Is venture capital a part of equity financing?

Yes, venture capital is a vital part of equity financing.

Is the Initial public offer (IPO) part of equity financing?

Yes, IPOs are significant parts of equity financing. 

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Richard Okoroafor

Richard Okoroafor

Richard is a brilliant legal content writer who doubles as a finance lawyer. He brings his wealth of legal knowledge in corporate commercial transactions to bear, offering the best value that exceeds expectations.

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