how equity financing works
equity financing involves the sale of common stock and other equity or quasi equity instruments such as preferred stock convertible preferred stock and equity units that include common shares and warrants this action can affect existing shareholders and impact the ability to reach new shareholders a startup that grows into a successful company will have several rounds of equity financing as it evolves since a startup typically attracts different types of investors at various stages of its evolution it may use other equity instruments for its financing needs for example angel investors and venture capitalists generally the first investors in a startup favor convertible preferred shares rather than common stock in exchange for funding new companies because the former have more significant upside potential and some downside protection once a company has grown large enough to consider going public it may consider selling common stock to institutional and retail investors later if the company needs additional capital it may choose secondary equity financing options such as a rights offering or an offering of equity units that includes warrants as a sweetener equity financing is distinct from debt financing with debt financing a company assumes a loan and pays back the loan over time with interest equity financing involves selling ownership shares in return for funds types of equity financingthese are often friends family members and colleagues of business owners individual investors usually have less money to invest so more are needed to reach financing goals these investors may have no relevant industry experience business skills or guidance to contribute to a business often these are wealthy individuals or groups interested in funding businesses they believe will provide attractive returns angel investors can invest substantial amounts and provide needed insight connections and advice due to their industry experience typically angels invest in the early stage of a business s development venture capitalists are individuals or firms capable of making substantial investments in businesses that they view as having very high and rapid growth potential competitive advantages and solid prospects for success they usually demand a noteworthy share of ownership in a business for their financial investment resources and connections in fact they may insist on significant involvement in managing a company s planning operations and daily activities to protect their investment venture capitalists typically get involved early and exit at the ipo stage where they can reap enormous profits a more well established business can raise funds through ipos selling company stock shares to the public due to the expense time and effort that ipos require this type of equity financing occurs in a later stage of development after the company has grown investors in ipos expect less control than venture capitalists and angel investors crowdfunding involves individual investors investing small amounts via an online platform such as kickstarter indiegogo and crowdfundr to help a company reach particular financial goals such investors often share a common belief in the company s mission and goals equity financing vs debt financingbusinesses typically have two options for financing when they want to raise capital for business needs equity financing and debt financing debt financing involves borrowing money equity financing involves selling a portion of equity in the company while there are distinct advantages to both types of financing most companies use a combination of equity and debt financing the most common form of debt financing is a loan unlike equity financing which carries no repayment obligation debt financing requires a company to pay back the money it receives plus interest however an advantage of a loan and debt financing in general is that it does not require a company to give up a portion of its ownership to shareholders with debt financing the lender has no control over the business s operations once you pay back the loan your relationship with the lender ends companies that elect to raise capital by selling stock to investors must share their profits and consult with these investors when they make decisions that impact the entire company debt financing can also restrict a company s operations limiting its ability to take advantage of opportunities outside of its core business in general companies want a relatively low debt to equity ratio creditors look more favorably on such a metric and may allow additional debt financing in the future if a pressing need arises finally interest paid on loans is tax deductible as a business expense loan payments make forecasting for future expenses easy because the amount does not fluctuate 3