When companies sell shares to investors to raise capital, it is called equity financing.
The benefit of equity financing to a business is that the money received doesn’t have to be repaid. If the company fails, the funds raised aren’t returned to shareholders.
In exchange for this benefit, the business must give them a percentage of ownership in the company—which may also include some decision-making control. The business also shares a portion of its profits with its equity investors out of its earnings after tax (EAT).
Equity financing is almost always counterbalanced with some type of debt financing. Debt financing costs less and leaves the company with more control.
More about equity financing
Privately owned small and medium-sized companies can find it hard to get equity financing because the liquidity of their shares is low. This makes investors difficult to attract.
To make investment in the company more enticing, businesses often have to lower their share prices, generating less equity, increase the dividend payments and/or offer a greater percentage of ownership for each share held.
Companies also have to make a number of decisions about equity financing, including the types of shares to offer (common, preferred or voting), pricing, who to sell to (family, friends, angel investors or venture capitalists), and their policy for paying dividends to investors.
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