Equity Financing

AAA

DEFINITION of 'Equity Financing'

The process of raising capital through the sale of shares in an enterprise. Equity financing essentially refers to the sale of an ownership interest to raise funds for business purposes. Equity financing spans a wide range of activities in scale and scope, from a few thousand dollars raised by an entrepreneur from friends and family, to giant initial public offerings (IPOs) running into the billions by household names such as Google and Facebook. While the term is generally associated with financings by public companies listed on an exchange, it includes financings by private companies as well. Equity financing is distinct from debt financing, which refers to funds borrowed by a business.

INVESTOPEDIA EXPLAINS 'Equity Financing'

Equity financing involves not just 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.

For example, angel investors and venture capitalists – who are generally the first investors in a startup – are inclined to favor convertible preferred shares rather than common equity in exchange for funding new companies, since the former have greater upside potential and some downside protection. Once the company has grown large enough to consider going public, it may consider selling common equity to institutional and retail investors. Later on, if it needs additional capital, the company may go in for secondary equity financings such as a rights offering or an offering of equity units that includes warrants as a “sweetener.”

The equity-financing process is governed by regulation 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. An equity financing is therefore generally accompanied by an offering memorandum or prospectus, which contains a great deal of information that should help the investor make an informed decision about the merits of the financing. Such information includes the company's activities, details on its officers and directors, use of financing proceeds, risk factors, financial statements and so on.

Investor appetite for equity financings depends significantly on the state of financial markets in general and equity markets in particular. While a steady pace of equity financings is seen as a sign of investor confidence, a torrent of financings may indicate excessive optimism and a looming market top. For example, IPOs by dot-coms and technology companies reached record levels in the late 1990s, before the “tech wreck” that engulfed the Nasdaq from 2000 to 2002. The pace of equity financings typically drops off sharply after a sustained market correction due to investor risk-aversion during this period.

RELATED TERMS
  1. Inventory Financing

    A line of credit or short-term loan made to a company so it can ...
  2. Financing

    The act of providing funds for business activities, making purchases ...
  3. Diluted Founders

    A slang term often used by venture capitalists to describe the ...
  4. Debt Financing

    When a firm raises money for working capital or capital expenditures ...
  5. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs ...
  6. Mezzanine Financing

    A hybrid of debt and equity financing that is typically used ...
Related Articles
  1. Financing Basics For First-Time Homebuyers
    Home & Auto

    Financing Basics For First-Time Homebuyers

  2. Stock Basics Tutorial
    Investing Basics

    Stock Basics Tutorial

  3. How Mortgage Refinancing Affects Your ...
    Credit & Loans

    How Mortgage Refinancing Affects Your ...

  4. The Road To Creating An IPO
    Investing Basics

    The Road To Creating An IPO

comments powered by Disqus
Hot Definitions
  1. Due Diligence - DD

    1. An investigation or audit of a potential investment. Due diligence serves to confirm all material facts in regards to ...
  2. Certificate Of Deposit - CD

    A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate ...
  3. Days Sales Of Inventory - DSI

    A financial measure of a company's performance that gives investors an idea of how long it takes a company to turn its inventory ...
  4. Accounts Payable - AP

    An accounting entry that represents an entity's obligation to pay off a short-term debt to its creditors. The accounts payable ...
  5. Ratio Analysis

    Quantitative analysis of information contained in a company’s financial statements. Ratio analysis is based on line items ...
  6. Days Payable Outstanding - DPO

    A company's average payable period. Calculated as: ending accounts payable / (cost of sales/number of days).
Trading Center