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What is Equity Financing?
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Posted On: Monday December 29th, 2003 at 12:00am EST
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Equity capital generally is composed of funds that are raised by a business in exchange for an ownership interest in your company. This interest can be in the form of ownership of common or preferred stock or instruments that convert into stock. In addition to taking an ownership interest in your company, equity investors may also participate as a member of the company’s board of directors and take an active role in managing your company. However, in comparison to debt financing, which must be repaid over time, equity financing does not have to be repaid.
Equity capital can be raised from family or from friends. However, it is most often raised from high-net worth individuals investors, commonly known as "Angel Investors" or from venture capital or private equity firms, also known as "Venture Capitalists (VC)." Generally, both angels and venture capital firms are looking for: early stage companies that can’t yet obtain bank financing; a return on their investment of at least 30-40%; and a clear strategy to be able exit the investment within 3-7 years and obtain this return.
What makes a company attractive for equity investment?
Industry – Typical companies that receive equity investment are high-growth companies, with the potential for a high rate of return, in the technology industry. These companies generally have the ability to be a market leader and often to capitalize on the "first mover advantage" – being first in a growing marketplace or industry sector.
Clear Exit Strategy – Angel investors and venture capitalists are attracted to companies that have a clear exit strategy, allowing them to obtain the return on their investment. Often known as a "liquidity event", this includes an initial public offering; private placement, acquisition or merger with another company or management-led buyout. In general, investors are looking to exit an investment within 3-7 years.
Financial Return – Equity investors are attracted to companies that clearly demonstrate the likelihood of significant financial returns. In general, these investors would like to see profit margins of more than 50%.
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