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What is equity financing and how does equity financing work?

Equity financing is a business funding method where the company’s owner sells the company’s share for upfront capital, these could be for short-term bill payments or long-term business growth. 

The sources of funding could be either private equity holders or IPO(initial public offering), and the cost of shares are determined through companies valuation, worth or partial owners of the company. Giant Companies like Google, Meta, etc. have secured huge funding through IPO.

How does equity financing work? Stages of equity financing (with pros & cons)

Equity financing mostly works for startups and SMEs as they are well experienced and have a hold of the market which makes them very suitable for going to the next stage.However the concept revolves around the exchange of investment and getting major stakes or ownership which comes with an offer given by investors and owners.

Every business has to cross different stages of funding,which evolves as the company grows which will also need different equipped instruments as each stage is crossed during the success journey.

What is buyout? (Equity Financing)

If investor has a certain percentage of stake in business through the sale of equity,the only way to eliminate the investor is by repurchasing the shares which is also called buyout process, although the repurchase would be way expensive than what was initially invested .

Pro and cons 

Pros  Cons 
Large amounts can be raised for long term commitment without repayment obligations or regular payment to investors Dilution in ownership and control. Raising equity is a length and relatively complex process
Higher equity increases creditworthiness of the company and can raise additional funds on favorable terms Equity shareholders expect higher returns compared to other sources
Advantage of risk sharing and added value by inducting investors on board Cost is higher as dividends are paid out of profits after tax  

Stages of Equity financing 

  • Pre-Seed Funding: Initial capital from family, friends etc. to kickstart the venture. Difficult to access bank  loans & institutional funding at this stage. Used largely for firming up business plans, concept finalization, initial inventory, essential machinery etc.
  • Seed Funding: Often provided by Angel investors usually structured as convertible notes or equity. Used largely for firming up the concept and build a product or service line
  • Early Stage Investment (Series A & B): Series A usually referred to the first round of institutional funding of a venture. Used largely for funding operations for initial 1 or 2 years towards product development & marketing, building management capability etc.      Seed Funding & Series A/B funding is applicable for high growth and high risk businesses and involves a highly intensive due diligence process and negotiations on the dilution, pricing, exit strategy apart from the business due diligence.
  • Later Stage Investment (Series C, D etc.): Subsequent rounds of venture capital funding. Used for growing existing product or service, adding new products, marketing etc.
  • Mezzanine Financing (PE Funding): Typically  provided by private equity firms structured as Equity or Debt or Convertible instruments. Funding for growth typically few years before the listing/IPO. Typically PE investors  would like to exit within 3-5 years of investment
  • SME Listing:  A platform set up by BSE for entrepreneurs and investors which enables listing of SMEs from the unorganized sectors and raise Equity Capital for their growth and expansion 

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