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.

VIDEO

Loading the player...
RELATED TERMS
  1. Inventory Financing

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

    The amount of capital "paid in" by investors during common or ...
  3. Debt Financing

    When a firm raises money for working capital or capital expenditures ...
  4. Pre-Money Valuation

    A slang phrased that refers to the value of a company's stock ...
  5. Mezzanine Financing

    A hybrid of debt and equity financing that is typically used ...
  6. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs ...
RELATED FAQS
  1. How does additional equity financing affect existing shareholders?

    Additional equity financing dilutes existing shareholders. There are two types of candidates for equity financing. One is ... Read Full Answer >>
  2. What are the benefits for a company using equity financing vs. debt financing?

    Most companies use a combination of debt and equity financing, but there are some distinct advantages of equity financing ... Read Full Answer >>
  3. What are the types of share capital?

    Share capital refers to the funds a company receives from selling ownership shares to the public. A company that issues 1, ... Read Full Answer >>
  4. What is the best form of equity financing for a start-up company?

    Raising capital during the startup phase of a business can present challenges to an entrepreneur. Debt financing is difficult ... Read Full Answer >>
  5. What are some advantage of raising capital through private placement?

    Small businesses face the constant challenge of raising affordable capital to fund business operations. Equity financing ... Read Full Answer >>
  6. What resources are available to an entrepreneur to raise capital?

    The greatest challenges an entrepreneur faces throughout the various stages of owning a business are directly related to ... Read Full Answer >>
  7. What are some examples of Cash Flow from Financing (CFF)?

    The cash flow statement is a financial statement showing the net change in cash for a company in a given period. Entries ... Read Full Answer >>
  8. How is venture capital different from other kinds of equity financing?

    Small businesses have a variety of options for raising capital for the purpose of funding growth operations or start-up costs. ... Read Full Answer >>
  9. What is the difference between asset-based lending and asset financing?

    In the most common usage, the terms "asset-based lending" and "asset financing" refer to the same thing. Asset-based lending ... Read Full Answer >>
Related Articles
  1. Investing

    What is Equity Financing?

    Companies that are short on cash may need financing to pay for short-term needs or long-term capital expenditures.
  2. Home & Auto

    Financing Basics For First-Time Homebuyers

    If you're looking to get your first mortgage, there are many financing options available.
  3. Investing Basics

    Stock Basics Tutorial

    If you're new to the stock market and want the basics, this is the tutorial for you!
  4. Credit & Loans

    How Mortgage Refinancing Affects Your Net Worth

    Find out how to determine whether refinancing will put you ahead or even more behind.
  5. Investing Basics

    The Road To Creating An IPO

    Through an Initial Public Offering, or IPO, a company raises capital by issuing shares of stock, or equity in a public market. Generally, this refers to when a company issues stock for the first ...
  6. Investing Basics

    Understanding Off-Balance Sheet Financing

    For anyone who was invested in Enron, off-balance sheet (OBS) financing is a scary term. Off-balance sheet financing means a company does not include a liability on its balance sheet. It is an ...
  7. Entrepreneurship

    The Basics Of Financing A Business

    From debt financing to equity financing, there are numerous ways to fund a business startup. But which is the best?
  8. Retirement

    IPO Basics Tutorial

    What's an IPO, and how did everybody get so rich off them during the dotcom boom? We give you the scoop.
  9. Investing Basics

    What are Ordinary Shares?

    Ordinary shares are any type of shares that are not preferred and don’t pay any type of predetermined dividend amount.
  10. Charts & Patterns

    How to Analyze Pharma Stock Fundamentals

    What you need to know about analyzing the fundamentals of pharma stocks.

You May Also Like

Hot Definitions
  1. Fiduciary

    1. A person legally appointed and authorized to hold assets in trust for another person. The fiduciary manages the assets ...
  2. Expected Return

    The amount one would anticipate receiving on an investment that has various known or expected rates of return. For example, ...
  3. Carrying Value

    An accounting measure of value, where the value of an asset or a company is based on the figures in the company's balance ...
  4. Capital Account

    A national account that shows the net change in asset ownership for a nation. The capital account is the net result of public ...
  5. Brand Equity

    The value premium that a company realizes from a product with a recognizable name as compared to its generic equivalent. ...
Trading Center