Equity Financing Definition

Equity financing allows a company to raise money by selling shares of the business to investors. If you’re not sure if equity financing is the right solution for your business, check out our funding guide to evaluate your options.

Equity Financing Definition

The definition of equity financing is the process where 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. 

Sources of Equity Financing

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.  

What are the different types of equity financing instruments?

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. 

Equity Financing’s Benefits

What are equity financing’s main advantages? There are two big ones. 

Easier to Obtain than Debt Financing

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. 

Access to Guidance

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.

Equity Financing’s Disadvantages

Profit-Sharing

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.

Investor Input on Decision Making 

Along with shares goes 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 take on a large percentage of company ownership. 

Highly Regulated

Another thing to keep in mind is that the sale of equity is regulated under securities laws. These laws protect investors from dishonest companies and individuals and maintain fairness in the market. 

Because of regulatory disclosure requirements, you will need to offer potential investors a memorandum or prospectus so that they can make informed decisions. The memorandum or prospectus will:

• List the company’s officers and directors 
• Offer financial statements
• Describe the company’s activities 
• Explain how the financing will be used 
• Disclose any risk factors

It’s always best to consult with an attorney before offering any form of security.

Equity Financing Examples

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. 

Many people also try to buy stock during highly anticipated IPOs such as the ones for Facebook, Uber, and Rivian. 

Summary

Equity financing is a way to raise capital by selling equity in a company to investors. It can be a great way to get more cash flow, but you may also have to give up some control of your business.

We Can Help

If you need cash, but you don’t have all your records in order, check out our accounting basics guide. When you use us to form your limited liability company or corporation, you receive a free accounting consultation with one of our experts. This can help you get all your finances organized and taxes figured out before seeking equity financing from investors.