What is equity financing?

Broadly speaking, there are two main types of capital in the business world- debt and equity. Characteristically, they are very different and therefore have different effects on a business as it grows and develops. Equity financing, in simple terms,is the method of raising capital by selling company stock to investors (shareholders), who in return for their investment will receive ownership interests in the company.

How it works?

Most businesses usually use some form of equity financing. Figures from the Bank of England show, that nearly 61% of businesses are launched with either personal capital or that of friends and relatives, which is a kind of an equity arrangement where friends and family take a stake in the business. Typically, equity financing involves the sale of the company’s stock wherein a portion of the ownership of the company is given up to investors in exchange for cash. The proportion of the company that will be sold in an equity financing depends on how much the owner has invested in the company and what that investment is worth at the time of the financing.

Here’s an example of how an equity financing would work. An entrepreneur initially invests £600,000 in the startup of a company and therefore owns all of the shares of the company. However, as the company grows and requires further capital, the entrepreneur seeks an outside investor for equity financing. If the investor is willing to pay £400,000 and agrees to a share price of £1.00 (i.e. that the original £600,000 invested is still worth £600,000), then the total capital in the company will be raised to £1,000,000. The entrepreneur will then control 60% of the shares of the company, having sold 40% of the shares of the company to the investor through an equity financing.

In most countries, the equity financing process is governed by regulation imposed by a local or national securities authority. These regulations require an equity financing to be generally accompanied by an offering memorandum or prospectus, which would contain information on the company’s activities, details on its officers and directors, use of the financing proceeds, risk factors, financial statements and so on.

Formal equity finance is typically availed through a number of different sources, such as business angels, venture capitalists or the stock markets. Private venture capital partnerships, industrial venture capital pools, investment banking firms and individual private investors(angel investors) are the more popular forms of equity financing used to finance high-risk, high-return businesses.

Why is equity financing important?

Equity financing is beneficial to businesses in two ways. In the early stages of a company’s growth, particularly when the company does not have sufficient cash flow or hard assets to act as collateral, equity financing can provide the necessary capital from investors who are willing to take risks along with the entrepreneur. On the other hand, for a company that is established with significant assets and cash flow, an equity financing such as a public offering in the capital markets can raise substantial capital for the business. While equity financing enables an owner to gain debt-free financing, they should be aware that subsequent rounds of equity financingwould require them to dilute some portion of their ownership as well.

Attract Capital, an internationally reputed independent advisory firm, has two decades of experience in the private capital markets. In addition to our advisory services,we also provide bespoke funding solutions including Acquisition Financing, Mezzanine Debt and Direct Loan Solutions. We can help you arrive at the right capital raising solution for your business.