Equity Financing Definition:
Equity financing is the strategy for raising capital by offering companies stocks / shares to investors, public, money lenders, institutions etc. Generally those who receive the shares or stocks are known as shareholders of the companies.
For instance: A startup might require different rounds of equity financing to address liquidity issues. They may jump at the chance to go for convertible preference share as type of equity finance, and as the firm reports growth year on year, it might think to go public. Once organization chooses to go public, financial investors (like: Venture Capitalists) can utilize the chance to sell their stake to retail investors, institutional at a premium rate. If organization requires additionally huge money, it can go for public offer as well.
At the point when an organization goes for equity financing to meet its liquidity needs, for enhancement or extension reason, it needs to set up a plan where money related details of the organization are specified clearly. Equity financing is somewhat different than debt financing, but final goal of raising liquidity are relative same for both equity and debt financing.
What is Equity Finance?
Equity (Owner’s Equity) = Assets – Liabilities.
Let us take the equity finance example to understand.
If somebody owns a car worth INR 15,000, but owes INR 5,000 loan against mortgaging car, then the car’s is of INR 10,000 value of equity. Equity can be negative if liabilities exceed assets. Under liquidation procedures of any company, the equity is what stays after all the liabilities have been paid up.
Example of Equity Financing:
Let us take an equity financing examples to get more cleared. End goal of any company is growth. An organization will require an extra capital, which it might attempt to acquire in one of two ways i.e. either debt or equity. Equity finance includes the offer of the organization’s stock and giving a part of the responsibility for organization to financial institutions or investors in return for extra capital. The extent of the organization that will be sold in an equity financing relies upon how much the proprietor of the company has invested and what that investment is worth to finance. For example, a business person who invests INR 500,000 in the startup of an organization will own all the shares of the organization.
With the growth of the company, it requires additional capital for investment; the business person may look for alternative sources like: a venture capitalist, angel investor, etc. For example financial investor will pay INR 400,000 and agrees to an offer share price of INR 1.00 (i.e. that the first INR 600,000 contributed is as yet worth INR 600,000), at that point the aggregate capital in the organization will be raised to INR 10,00,000. The business owner will at that point control 60% of the shares of the organization and sold 40% of the shares of the organization through an equity finance to the investors.
Sources of Equity Financing:
There are various sources of equity financing. Here we are going through some of the sources of equity financing as follows:
- Institutional Investors.
- Corporate Investors.
- Venture Capital Firms.
- Angel Investors.
- Crowd Funding.
You can apply for equity finance to any of the above sources of equity financing. Apart from this there are numerous sources of equity financing. We would suggest you to contact your chartered accountant who can provide you the complete information about it. After collecting all the information, once should also check for debt financing option. Upon then a business person should be in better position to take the decision on equity finance and can select the right type from sources of equity financing.
Importance of Debt Financing:
In the beginning stage of an organization’s growth, especially when the organization does not have adequate incomes, income or assets as collateral for debt finance. Equity financing can draw in capital from beginning stage investors who are willing to take risk to start a business.
Correspondingly, when an organization is built up and has resources and income or has the guarantee of touchy development because of new advancements or new markets, it can raise generous capital through an equity financing, for example, a public offering in the capital markets. In light of the organization’s stock value, a part of the organization is sold to the new investors or financial institutions. For the business person, financing from equity is a technique to raise capital for the organization before it is gainful in return for diluted control and ownership of the organization.
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» e-Learning Chapter 3: Advantages and Disadvantages of Debt Financing
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