What is equity financing and how does it work?

Saturday 18th June 2022

What is equity finance?

Equity finance is a way for a company to raise investment capital by selling a stake in its business in the form of shares.

How does equity financing work?

Investors buy shares in the company, this can be to anyone (including friends and family through to venture capitalists). The investors who buy the shares will now own a stake in the business. The money does not have to be repaid but the investors will now receive a share of the company profits in the form of dividends. Investors can also make money by selling their shares at a higher price to other investors in the future. Equity finance can be raised at any stage of a company’s growth.

What are the advantages and disadvantages of equity financing?

Advantages of equity finance

  • It is available to businesses that are finding it difficult to apply for a business loan.
  • Gives freedom from debt as there is no obligation to repay the money, thereby reducing the financial burden for the business and helping with cash flow.
  • A successful business will attract good investors hoping to cash in.
  • Investors may continue to invest as the business grows.
  • Some equity investors bring experience, contacts and connections which can be helpful.

Disadvantages of equity finance

  • Raising equity can be costly and time consuming leaving less time for business activities.
  • Legal and regulatory rules must be complied with when raising finance this way.
  • A percentage of company profits have to be given to investors.
  • Potential investors may want to see detailed background information on the business.
  • Complete control of the business is lost; investors will need to be consulted prior to making any significant business decisions.
  • Information on progress must be provided regularly for investors to see.