What is Equity Financing?

Published by Thomas Herold in Corporate Finance, Investments, Laws & Regulations

'Equity Financing' is explained in detail and with examples in the Laws & Regulations edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Equity Financing refers to raising capital via selling shares within the enterprise itself. This comes down to selling an ownership stake in the corporation in order to come up with much needed funds for business enterprises. This type of financing could cover a wide array of different activities in both scope and scale. It might be only several thousand dollars which an entrepreneur raises from his family and friends. It could also be enormous IPOs initial public offerings that amount to literally billions of dollars and come from such household favorite names as Facebook and Google.

The phrase is most often applied to mega financing of major public companies which are listed on a stock exchange. This could also cover financing of private companies too. Equity financing is more or less the opposite to debt financing. In debt financing, funds will be borrowed form a business to be paid back at a later date and time.

There is more to Equity Financing than only selling common shares of stock. It might also involve other forms of equity (such as preferred stock) or even semi equity instruments like convertible stock shares or equity units which come with either warrants or common shares. Startup companies that evolve into highly successful firms often go through a few rounds of such Equity Financing as they grow and mature. These startups commonly attract varying types of investors at the different points in their growth. They will often rely on differing equity instruments for the various financing needs which arise throughout the newer company’s history.

Consider an example to better understand the concept. Venture capitalists and angel investors are two different investors who are commonly the initial investors in startup companies. They generally prefer convertible preferred shares of stock instead of common shares of stock for their early rounds of funding. This is because those convertible shares offer a much higher possibility for upside potential as well as a little bit of downside protection.

After the firm has expanded enough to think about going public, they might begin to sell common shares of stock equity to retail and institutional investors. It might be that later they decide they require additional capital. At this point, they might go out for secondary equity financing. This could include rights offerings or even offering various equity units which include warrants to sweeten the deal.

Financing via equity has rules and regulations which govern it. National securities regulators such as the SEC Securities Exchange Commission have the jurisdictional authority. This is intended to safeguard the investing public from any unscrupulous practices and operators who simply trick investors out of their funds then vanish. This is why such equity financing will usually come alongside a prospectus or at least an offering memorandum.

These provide a huge amount of useful information which assists the investors in taking highly informed decisions on the merits of the company and its financing offers. This data will usually cover the activities of the firm, provide information on the directors and other officers, explain the uses for the financing proceeds, offer financial statement disclosure, and revel the various risk factors.

The appetite which investors display for the various equity financing offerings heavily depends on the equity markets status as well as the financial market demand. When there are steady equity financing deals in the works, this represents an evidence of high investor confidence. Too many financing deals might mean that optimism is exuberant and a top in the market is coming.

When the Initial Public Offerings of dot coms and technology firms touched incredibly high record levels at the end of the 1990’s, the writing was already on the wall. From 2000 through 2002, NASDAQ crashed and burned in a slow motion but extremely painful train wreck from which it needed more than a decade to recover. The speed and frequency of equity financing fell off substantially after this sustained correction in the markets because investors quickly became risk averse in the wake of the massive market selloff.

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The term 'Equity Financing' is included in the Laws & Regulations edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.