Equity financing is the process of raising capital through the sale of shares. Companies raise money because they might have a short-term need to pay bills or they might have a long-term goal and require funds to invest in their growth.
By selling shares, they sell ownership in their company in return for cash. Equity financing comes from many sources; for example, an entrepreneur’s friends and family, investors, or an initial public offering (IPO). Industry giants such as Google and Facebook raised billions in capital through IPOs.
While the term equity financing refers to the financing of public companies listed on an exchange, the term also applies to private company financing.
Equity financing is distinct from debt financing, which occurs when a business borrows funds.
Types of Equity Financing
Equity financing involves the sale of common equity but also the sale of other equity or quasi-equity instruments such as preferred stock, convertible preferred stock, and equity units that include common shares and warrants.
A startup that grows into a successful company will have several rounds of equity financing as it evolves. Since a startup typically attracts different types of investors at various stages of its evolution, it may use different equity instruments for its financing needs.
Later, if the company needs additional capital, it may choose secondary equity financing such as a rights offering or an offering of equity units that includes warrants as a sweetener.
How Equity Financing Is Regulated
The equity-financing process is governed by rules imposed by a local or national securities authority in most jurisdictions.
Such regulation is primarily designed to protect the investing public from unscrupulous operators who may raise funds from unsuspecting investors and disappear with the financing proceeds.
Equity financing is thus often accompanied by an offering memorandum or prospectus, which contains extensive information that should help the investor make an informed decision on the merits of the financing.
The memorandum or prospectus will state the company’s activities, information on its officers and directors, how the financing proceeds will be used, the risk factors, and financial statements.
Companies seek equity financing because they might have a short-term need for funds or they might need to finance a long-term growth strategy.
Companies raise capital through equity financing by selling common equity, preferred stock, convertible preferred stock, and equity units that include common shares and warrants.
- A startup that grows into a successful company will have several rounds of equity financing as it evolves.
- An IPO occurs when a private company decides to issue stock to the public.
- Equity financing is heavily regulated by national and local government.
Investor appetite for equity financing depends significantly on the state of the financial markets in general and equity markets in particular.
While a steady pace of equity financing is a sign of investor confidence, a torrent of financing may indicate excessive optimism and a looming market top.