Equity financing pertains to generating capital through the sale of company shares. When investors buy shares, they also believe in the right to own the company. You get money when you sell any equity asset, like common stock, preferred shares, share warrants, etc.
There are many places where you can get equity investment. For instance, a startup may be able to get the money they need from their friends and family, professional investors, or an initial public offering (IPO).
An IPO is the process private companies use to give the public shares of their business in the form of new stock. A business can get money from people who want to invest by selling public shares. IPOs allowed big companies like Google and Meta (formerly Facebook) to raise billions of dollars.
Sources of Equity Financing
In the early stages of a business, equity investment can come from angel investors, crowdfunding sites, venture capital firms, or corporate investors. IPOs are the last way that shares can be sold to the public.
1. Venture Capital Firms
A group of investors called venture capital firms put money into businesses they think will overgrow and go public in the future. Compared to angel investors, they put more money into businesses and get a more significant company share. This method is also known as private equity investment.
2. Initial Public Offerings (IPOs)
An initial public offering (IPO) is a way for companies that have been around for a while to get money. IPOs are a way for businesses to earn money by selling shares to the public so they can be bought and sold on the capital markets.
3. Angel Investors
Some wealthy people buy shares in businesses that they think will be able to make more money in the future. These people are called angel investors. Most of the time, the people bring business knowledge, experience, and ties to the table, which is suitable for the company in the long run.
4. Crowdfunding Platforms
Fundraising sites let many regular people put small amounts of money into a business. People put their money into these businesses because they believe in their ideas and think they will make money back in the future.
Contributions from the public are added up to meet a goal amount.
5. Corporate investors
Corporate donors are big businesses that put money into small companies to get them the money they need. Most of the time, the investment is made so the two companies can work together strategically.
Advantages of Equity Financing
Brow are some of the advantages of equity financing:
The Ability To Get Money From Business Ties, Management Skills, And Other Sources
Equity financing also has some benefits for the people running the business. Some investors want to be involved in the day-to-day processes of a business and want to help it grow for personal reasons.
Because they have been successful in the past, they can be beneficial by giving you business contacts, management advice, and access to other sources of cash. Many seed investors and venture capitalists will help businesses in this way. It is vital when a company is first starting.
Alternative Funding Source
The best thing about equity financing is that it allows businesses to borrow money. Startups that might not be able to get big bank loans can get the money they need from seed investors, venture capitalists, or crowdfunding sites. This financing is safer than debt financing since the business doesn’t have to repay its owners.
Most investors think about the long term and don’t expect to get their money back right away. This way, the company can use its sales money to grow the business instead of paying off debt and interest.
Disadvantages of Equity Financing
1. Investors need to be able to own a piece of your business: Some business owners are afraid they will lose control over how their business is run because investors own a part of the company after they put money into it.
2. You have to give investors a cut of your income: Companies may share their gains with their investors, which may be worth it for the money and knowledge they bring.
3. Longer Processing: Companies may need to go through several investment rounds to get the money they need, which can take longer than getting a loan.
4. You give up some power over your business.
How Equity Financing Works
Sell common stock and other equity or quasi-equity instruments like preferred stock, convertible preferred stock, and equity units that include ordinary shares and warrants. This is what equity finance is all about. This move could affect current shareholders and make it harder to get new ones.
An early-stage business that grows into a big success will go through several equity investment rounds. At different points of its growth, a startup may attract different types of investors, so it may use other equity instruments to get the money it needs.
Angel investors and venture capitalists, often the first to put money into a new business, prefer convertible shares to common stock when they want to fund new companies. This is because convertible preferred shares have more upside possibility and some downside protection.
If a business has gotten big enough to consider going public, it might sell common stock to big and small investors.
Later, if the business needs more money, it could use secondary equity financing choices, like a rights offering or an offering of equity units with warrants as a bonus.
Equity Financing vs Debt Financing
Two main financing types businesses can use to get the money they need are equity and loans. When you use debt funding, you borrow money. To get equity financing, you have to sell a piece of your company’s stock. Even though each type of financing has its benefits, most businesses use a mix of equity and debt funding.
Debt Ownership
Getting a loan is the most popular way to borrow money. Debt financing means a business has to pay back the money it borrows plus interest. This is different from equity financing, which doesn’t require repayment.
One good thing about loans (and debt financing in general) is that companies don’t have to give up any of their assets to the lenders. When a business gets debt financing, the lender has no say over how it runs. You no longer owe the lender money after you pay it back.
If a business decides to sell stock to investors to get money, they have to share their profits with those investors and talk to them before making choices that affect the whole business.
Differences in Operations and Costs
Debt financing can also make it hard for a business to do certain things and take advantage of chances unrelated to its principal business. Most of the time, firms want their debt-to-equity percentage to be low. Creditors are more likely to give money if this measure is used, and they may agree to more debt financing in the future if there is an urgent need.
Last, loan interest can be written off on your taxes as a business cost. Because the amount of loan payments doesn’t change, planning for future expenses is easy.
Types of Companies to Use Equity Financing
Equity financing isn’t always the best way for a business to get money because it comes with less risk than loan financing. There are times when it might be wise for a business to look for stock funding:
Companies Seeking Acquisition
People who own businesses have a better chance of selling them when the companies grow and expand. This gives people who want to buy the business confidence that it will make money for them.
So, before putting their business on the market, owners might look for stock investment to help them reach their growth goals.
Very Early-stage Businesses
Since new businesses don’t have much of a track record for money, it may be harder for them to get a bank loan than for companies that have been around longer.
There’s a good chance they can get a lot more money through investments than through loans, even if the loan goes through. It’s possible for tech startups in their early stages to have a lot of intellectual property but not many physical assets that could help them get a loan.
When a business isn’t making any money, funding can help it get started and pay for research and development.
Businesses That Want To Buy Another
When one business buys another, they usually get the money they need from several places. This is also true when the management of a business buys out the owner and keeps running the company themselves.
This is called an MBO (management buy-out). When these happen, stock financing might help a business or its leaders reach their goals.
New and Developing Companies
Companies may need to raise a lot of money to reach their growth goals when they plan to grow for a long time. Sometimes, they may need more money than they could get from a loan.
For instance, a business might want to enter a new market, make new goods, or grow. In this case, stock financing would let them get the money they need without making loan payments, which might slow their growth.
Conclusion
Companies often need money from outside sources to keep running and plan for future growth. Intelligent people will consider the best mix of debt and stock financing to save money when making a business plan.
There are several places where equity funding can come from. No matter where it comes from, the best thing about stock financing is that it doesn’t have to be paid back and gives a business extra money it can use to grow.
