- Equity is a term generally used to describe funds that belong to the owners of the business
- While the term can be used to refer to the same funds in sole trader partnerships and other form of businesses it is generally used to refer to funds belonging to shareholders in a company
- In this instance we are specifically using the term to refer to share capital
- Equity financing involves raising funds by issuing shares in the company.
- These shares represent ownership in the company, and investors who purchase them become shareholders. The company may issue shares through an initial public offering (IPO), private placement, or other methods.
Features of equity financing:
- Shares represent ownership in the company
- No obligation to repay the investment
- Investors may receive dividends if the company is profitable and decides to distribute them
- Shareholders have voting rights and may participate in company decisions
- Equity financing does not increase the company’s debt
Situations where equity financing may be most appropriate:
- Startups and early-stage companies that have not yet established creditworthiness or do not have sufficient assets to use as collateral for debt financing
- Companies with high growth potential that need significant funding to finance their growth
- Companies that are not able to obtain debt financing due to poor credit ratings or other factors
Benefits of equity financing:
- No obligation to repay the investment, which can provide financial flexibility for the company
- Can provide access to significant funding for companies with high growth potential
- Shares sold in an IPO can provide liquidity for existing shareholders
- Can increase the company’s visibility and prestige, which can be beneficial for attracting customers, partners, and employees
- Can bring in new shareholders who may have valuable industry knowledge or connections
Drawbacks of equity financing:
- Shareholders have voting rights, which can dilute the control of existing shareholders
- Dividends paid to shareholders can reduce the company’s profits and limit its ability to reinvest in growth
- Selling shares in an IPO can be expensive and time-consuming
- The company may be required to disclose significant information about its operations and financials, which can limit its ability to keep information confidential
- Investors may have different objectives than the company’s management, which can lead to conflicts.
