What is Equity Financing?

//What is Equity Financing?
What is Equity Financing? 2017-10-04T07:25:11+00:00

Definition: Equity financing is a method of raising capital by issuing additional shares to a firm’s shareholders, thereby changing the previous percentage of ownership in the firm. In other words, it’s the process of raising funds from investors.

What Does Equity Financing Mean?

What is the definition of equity financing? Firms raise capital through equity financing by selling the ownership of their shares. An ownership stake can be given to friends and family for small businesses or to the public through an initial public offering (IPOs) for large-cap firms, leaders in their industry. The main advantage of equity financing is that firms do not have to pay back the capital or interest associated with it like debt financing.

Instead, the shareholders participate in the firm through owning the firms’ shares and exercise a certain extent of control over the business decisions. Furthermore, because equity investors invest their money to the firm, they undertake the risk of business failure, expecting a higher return on investment. Therefore, they are looking for growth opportunities. Generally, equity financing is preferred when a firm is in its early stages seeking to raise funds and increase its cash flows.

Let’s look at an example.

Example

Jonathan Petersen invests $500,000 in a startup technology company with a strong growth potential to acquire 10,000 of the firm’s 200,000 total shares outstanding.

After a year, the technology company grows and needs additional capital. The firm’s management decides to raise the funds by issuing new stocks and giving a percentage of ownership to more investors in exchange for cash.

Jonathan agrees to invest $300,000 at a share price of $60, thereby getting another 5,000 shares. Before the stock issuance, Jonathan controlled the 5% of the company (10,000 shares of the firm’s 200,000 total shares outstanding). After the equity financing, Jonathan controls the 7.5% of the company (15,000 shares of the firm’s 200,000 total shares outstanding).

Summary Definition

Define Equity Financing: Equity financing is the process of acquiring capital from shareholders to fund new expansions and operations.