What is meant by equity financing?

What is Equity Financing?

Equity financing refers to the purchase of shares in a business by investors in order to provide funding for the organization. This is done to pay for working capital requirements, acquisitions, and fixed asset purchases. The different types of equity financing instruments that a firm can use include the following:

Common Stock

Common stock is the basic type of stock, giving its holder the right to share equitably in any dividends and in the final payout from the dissolution or sale of a business. The holder also has the right to vote for members of the board of directors, as well as certain other company decisions.

Preferred Stock

Preferred stock is a type of stock that usually pays a dividend, and which may contain additional privileges, such as a vote on whether the issuer can accept a buyout offer from a third party.

Convertible Debt

Convertible debt is a debt instrument such as a bond, that gives its holder the right to convert the debt into the stock of the issuer. The conversion feature is activated by the holder when the price of the issuer's shares makes the conversion profitable.

Warrant

A warrant is an instrument that conveys to its holder the right, but not the obligation, to purchase the shares of the issuing entity at a certain price and within a certain date range. Warrants are typically issued along with a stock sale, so that investors can profit from any upside in the price of the stock.

How Equity Financing Works

A business that is growing at a rapid rate will likely need to go through several rounds of equity financing. The usual progression of equity instruments sold is for early investors to buy preferred shares, since these instruments have more protective rights than common stock. These early investors are more likely to be angel investors, followed by venture capitalists. As the business becomes larger, institutional investors are more likely to buy common stock. If the firm has difficulty selling shares, it may need to offer warrants in a package with the shares sold, so that investors can participate in the upside potential of the shares.

When a business has reached a size large enough to qualify for listing on a public stock exchange, it typically converts all preferred stock to common stock, and then goes through the initial public offering process, after which its shares are registered with the Securities and Exchange Commission. At that point, the early investors can sell their shares to the investing public.

Conditions for Acquiring Equity Financing

A business is less likely to pursue equity financing when the stock market is depressed, since it can only obtain a lower valuation at this time, which means that a large percentage of the business must be sold in order to obtain a reasonable amount of financing. That is why most public companies only sell shares when the stock market is robust.

What is equity funding?

Equity finance is generally the issue of new shares in exchange for a cash investment.

Your business receives the money it needs and the investor will own a share in your company. This means the investor will benefit from the success of your business.

Benefits may include proceeds from an eventual sale or buyout, and any dividends your business decides to pay before that happens.

Equity funding

Equity investors can be anyone from the founder's friends and family to a large private equity house.

The most common types of equity investors include:

• Friends and family
• Angel investors and angel networks
• The crowd (through crowdfunding platforms)
• Venture capitalists
• Government funds
• Private equity funds
• Corporates (directly or through venturing arms)

Advantages of equity funding

If your business doesn't have the revenues or financial history necessary to successfully apply for a business loan, your other option is equity finance.

Investors recognise that their potential return on investment will be in the longer-term, with greater risk and uncertainty attaching to it.

Equity investors benefit from your business by receiving dividends and/or when they exit your business. This means you won't have to worry about making regular repayments. Not having to think about making repayments while your business establishes itself can be helpful and it also helps manage your cash flow.

The right equity investor should bring to your business more than just their money. Many will be well-connected through their previous investments or experience, and you can use their skills and experience to help grow your business.

Why choose equity funding?

• If you have little or no revenue
• Want to bring on board additional expertise, and
• Are happy to trade-off selling a stake in the company with potentially higher costs to achieve quicker and greater growth

For some businesses, the choice between equity and debt will be straightforward. For others, there will be elements of both that will be appealing and suitable. 

How we can help with equity funding

Our growth investments team actively invests in high-growth businesses across Scotland and provide advisory support to companies looking to raise funding through our financial readiness team.

We have a suite of investment funds and programmes we invest under.

Our model is to co-invest alongside a range of private sector investors (angels, angel syndicates, venture capitalists, private equity and corporate investors) into ambitious Scottish companies with high growth potential.