What is Equity Financing?

Equity financing refers to the sale of company shares in order khổng lồ raise capital. Investors who purchase the shares are also purchasing ownership rights lớn the company. Equity financing can refer to the sale of all equity instruments, such as common stock, preferred shares, nội dung warrants, etc.

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Equity financing is especially important during a company’s startup stage to finance plant assets & initial operating expenses. Investors make gains by receiving dividends or when their shares increase in price.

Major Sources of Equity Financing

When a company is still private, equity financing can be raised from angel investors, crowdfunding platforms, venture capital firms, or corporate investors. Ultimately, shares can be sold to lớn the public in the form of an IPO.

1. Angel investors

Angel investors are wealthy individuals who purchase stakes in businesses that they believe possess the potential lớn generate higher returns in the future. The individuals usually bring their business skills, experience, và connections to lớn the table, which helps the company in the long term.

2. Crowdfunding platforms

Crowdfunding platforms allow for a number of people in the public to lớn invest in the company in small amounts. Members of the public decide khổng lồ invest in the companies because they believe in their ideas & hope to lớn earn their money back with returns in the future. The contributions from the public are summed up to reach a target total.

3. Venture capital firms

Venture capital firms are a group of investors who invest in businesses they think will grow at a rapid pace và will appear on stock exchanges in the future. They invest a larger sum of money into businesses & receive a larger stake in the company compared khổng lồ angel investors. The method is also referred to as private equity financing.

4. Corporate investors

Corporate investors are large companies that invest in private companies khổng lồ provide them with the necessary funding. The investment is usually created khổng lồ establish a strategic partnership between the two businesses.

5. Initial public offerings (IPOs)

Companies that are more well-established can raise funding with an initial public offering (IPO). The IPO allows companies to raise funds by offering its shares to lớn the public for trading in the capital markets.

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Advantages of Equity Financing

1. Alternative funding source

The main advantage of equity financing is that it offers companies an alternative funding source to lớn debt. Startups that may not qualify for large bank loans can acquire funding from angel investors, venture capitalists, or crowdfunding platforms to lớn cover their costs. In this case, equity financing is viewed as less risky than debt financing because the company does not have lớn pay back its shareholders.

Investors typically focus on the long term without expecting an immediate return on their investment. It allows the company to reinvest the cash flow from its operations khổng lồ grow the business rather than focusing on debt repayment and interest.

2. Access lớn business contacts, management expertise, and other sources of capital

Equity financing also provides certain advantages khổng lồ company management. Some investors wish khổng lồ be involved in company operations và are personally motivated khổng lồ contribute khổng lồ a company’s growth.

Their successful backgrounds allow them to lớn provide invaluable assistance in the khung of business contacts, management expertise, and access khổng lồ other sources of capital. Many angel investors or venture capitalists will assist companies in this manner. It is crucial in the startup period of a company.

Disadvantages of Equity Financing

1. Dilution of ownership & operational control

The main disadvantage khổng lồ equity financing is that company owners must give up a portion of their ownership và dilute their control. If the company becomes profitable and successful in the future, a certain percentage of company profits must also be given to shareholders in the form of dividends.

Many venture capitalists request an equity stake of 30%-50%, especially for startups that lack a strong financial background. Many company founders and owners are unwilling to dilute such an amount of their corporate power, which limits their options for equity financing.

2. Lack of tax shields

Compared khổng lồ debt, equity investments offer no tax shield. Dividends distributed lớn shareholders are not a tax-deductible expense, whereas interest payments are eligible for tax benefits. It adds to the cost of equity financing.

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In the long term, equity financing is considered khổng lồ be a more costly khung of financing than debt. It is because investors require a higher rate of return than lenders. Investors incur a high risk when funding a company, & therefore expect a higher return.

Learn More

CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers khổng lồ the next level. To lớn keep learning and developing your knowledge base, please explore the additional relevant resources below: