What is Equity Financing?

Equity financing is the process to raise funds for a business by issuing shares (selling stock) in the market.

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How Does Equity Financing Work?

When a company needs funds beyond what is available from operations, it generally has two options: 1) issue debt instruments (or take a loan), or 2) sell an ownership an ownership interest in the company. The latter is known as equity financing. Equity financing varies in scope and size. Entrepreneurs raise million and even billion of dollars in funding through selling an equity interest at various stages of their business's lifecycle. When the company is incorporated and it issues shares for the first time, the process of raising funds for the first or selling shares for the first time is referred as subscription or subscribing. Later, the startup may raise funds by selling equity to friends and family investors, angel investors, or later-stage venture capitalists. Once the company reaches the maturity stage, it may have the potential to raise capital by selling its shares to the public through a direct public offering (DPO) or through an Initial Public Offering (IPO). Equity financing may entail the sale of common equity (or common shares) or the issuance of preferred stock with special rights for the investor. The founder of a business entity generally receive common shares or some form of founders shares. The same is true for early-stage, friends and family investors. Angel investors and venture capitalists generally require some form of preferred share. The most common characteristics of the preferred shares are liquidation preferences, conversion right, redemption rights, anti-dilution protection, and registration rights. These shares rarely entail dividend rights, as it is rare of a startup company to have profits or to issue dividends. All available funds are used for growth.

How Equity Financing Is Regulated

Equity markets are regulated by the Security and Exchange Commission (SEC) to protect investors from fraudulent practices. This is the main function of Security and Exchange Commission to make certain that companies selling their shares publicly make full and accurate disclosures to potential investors. It is also worth noting that securities exchanges engaged in selling public securities also have very extensive requirements for companies listing their securities for sale.