Equity financing involves raising capital by selling ownership shares or stocks in a company, giving investors a stake in the business in exchange for funding.
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Last Updated: December 17, 2025
Equity financing allows a company to raise money by selling shares of the business to investors. But how, exactly, does equity financing work? And what are its advantages and disadvantages? This guide explains the basics of equity financing to help small business owners make wise, strategic decisions about this funding method.
Equity financing refers to the process by which investors purchase shares in a business to provide capital to the company. Essentially, equity financing’s business definition means a company sells an ownership interest to raise cash. It’s a popular type of business funding.
Both private and public companies can take advantage of equity financing, meaning both types of entities can sell ownership interests. Private placements of stock may go to friends, family, angel investors, crowdfunding platforms, venture capital firms, private equity firms, or corporate investors. If a company is ready to go public, it may make an initial public offering (IPO) of stock.
Public companies sell stock to the public on one of the major stock exchanges.
A business owner seeking to raise equity can sell common stock, preferred stock, convertible preferred stock, or warrants. Members of the public tend to purchase common stock, while angel investors or venture capitalists may request preferred or convertible preferred stock.
What are equity financing’s main advantages? There are two big ones.
Companies can raise cash through equity financing or debt financing. A small business or startup may not qualify for large loans, so equity financing offers them a way to raise money. One of equity financing’s advantages is that it doesn’t inflict a financial burden on the company. Debt, on the other hand, imposes a liability that needs to be repaid.
When companies are able to obtain equity financing from angel investors or venture capital firms, they also gain the expertise of these experienced professionals. Additionally, the investors may grant the companies access to their professional and financial networks, which can be a tremendous benefit.
Of course, there are some disadvantages to equity financing. There are three primary drawbacks.
A downside to equity financing is that the company must share a percentage of its profits with investors. This makes equity financing more expensive than debt financing in most cases.
A shareholder has an ownership interest in the company. As a result, company management has to consult with the company’s investors on major decisions. This is particularly true when professional investors acquire a significant stake in a company’s ownership.
Another thing to keep in mind is that the sale of equity is heavily regulated by securities laws. These laws protect investors from dishonest companies and individuals, helping maintain fairness in the market.
Due to regulatory disclosure requirements, corporations are required to provide potential investors with a memorandum or prospectus detailing the business, enabling them to make informed investment decisions. The memorandum or prospectus will:
It’s always best to consult with an attorney before offering any form of security.
One of the most well-known examples of equity financing is the television show Shark Tank, in which entrepreneurs seek equity financing from wealthy investors. On Shark Tank, already-successful entrepreneurs pitch their companies to the Sharks, each hoping to make a deal that will give them money to grow their companies. In return, the Sharks negotiate for a stake in the company, which can give them some impact on company decision-making, a share of the company’s profits, and so on.
Many people also try to buy stock during highly anticipated IPOs such as the ones for Facebook, Uber, and Rivian. While these investors often have a smaller impact on company decisions (since so many shares are offered), these scenarios are still a type of equity financing.
Equity financing is a way to raise capital by selling equity in a company to investors. It can be a great way for small businesses to get more cash flow, but an entrepreneur may also have to give up some control of their business.
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Before a business owner can seek equity financing, they need to create a company that’s worth investing in. That’s where ZenBusiness can help. Their business formation services can help entrepreneurs start a new limited liability company or corporation, and their Worry-Free Compliance service makes it easy to keep that company compliant with state requirements. They’ve also got an accounting basics guide to help entrepreneurs start their bookkeeping on a solid foundation.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. For specific questions about any of these topics, seek the counsel of a licensed professional.
Written by ZenBusiness Editorial Team
The ZenBusiness Editorial Team has more than 20 years of combined small business publishing experience and has helped over 850,000 entrepreneurs launch and grow their companies. The team’s writers and business formation experts are dedicated to providing accurate, practical, and trustworthy guidance so business owners can make confident decisions.
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