Equity Capital definition
Most businesses will look to gain some additional funding at some point in its lifespan. Equity financing offers businesses the chance to either benefit from external investments or try to make money by investing in a business with growth potential – and many of the biggest brands we know today have used equity financing at one time or another.
- Read more: What is Cash Flow?
Equity Share Capital Definition
Equity capital or equity share capital is the money that is invested into a company in exchange for stock or a share of the business. Start-ups or companies that are looking for financial support can use equity financing to help with the core funding of their business.
Equity financing can be a great way to raise funds without cutting business expenses, taking on additional debt or sacrificing the business owner’s personal funds. Many small businessowners make money by letting out a portion of their office space, sub-contracting employees to other companies, and even investing in stocks themselves. This is incredibly risky, of course, and often leaves businesses in a worse position than they were before.
Equity financing carries less risks for a company in need of cash because it does not stand to lose money in the short term as a result. It is also less of an immediate financial burden than a bank loan because in the event of liquidation or insolvency, the company is not responsible for repaying any capital given by external investors.
For the same reason, this process can be incredibly risky for the investors who are placing their trust in the success of the beneficiary’s business. Investors can reap huge rewards if the business they support goes on to grow in value, which is why those looking to capitalise by buying a company’s shares must have confidence in their product and its value in the marketplace.
If investors seek a more secure moneymaking opportunity than equity financing, they could get involved in debt financing. This works in a similar way, with businesses giving assets (but not a share in ownership) to investors in exchange for capital, but the business must eventually repay any money given by investors – with interest. In this regard, debt financing should be considered a form of loan.
This is much less of a gamble for investors, who stand to benefit whether the business they support succeeds or not. For businessowners, however, high interest rates on their newfound capital can worsen their financial situation, particularly if the business was struggling to keep up with core funding requirements beforehand. High interest rates can result in a company paying back significantly more than they initially benefitted from, increasing the chance of insolvency.
However, if a company has a lucrative business model and simply needs some extra capital to get its product onto the shelves, or to carry out a marketing campaign to boost sales, debt financing could be the way to go.
Many businesses will take advantage of debt financing at one time or another, as it is significantly less expensive than equity financing in the long run. Businesses that receive support from investors are not tied into giving away a portion of their revenue every year, and do not have to relinquish any control over their company.
Why choose equity financing over debt financing?
Ultimately, equity financing is likely to be far more expensive for a business than debt financing. So why opt for it? Here are a few advantages of equity financing:
- Businesses aren’t locked into an agreement which requires them to keep up fixed monthly payments, which take money out of the company’s cashflow and increases the profit needed to break even
- It’s a long-term arrangement – investors who put their money into a business do not expect to benefit from their investment from the get-go
- It doesn’t require a good credit score, so could be a good alternative for those who cannot implement debt financing
- Debt financing often imposes limitations on the business, meaning that it cannot later apply for other financing options
Equity Capital Markets Definition
Equity capital markets are where investors and businesses meet to exchange capital. The complex nature of equity financing means that there are various categories within the Equity Capital Market itself.
The equity capital market is divided into two main part – the primary equity market and the secondary equity market.
The primary equity market is itself split into two sub-categories. The first is the private placement market, a risky and illiquid market in which businesses can directly trade with investors without being publicly listed. The second is the primary public market, which deals with initial public offerings (IPO), where businesses are listed on the stock exchange and trade for the first time, and secondary public offerings (SPO), where listed companies make new exchanges.
The secondary equity market concerns the selling and buying of existing shares, and also encompasses two categories. The first deals with the stock exchanges, a central space where businesses that are listed on the stock exchange hand over their shares. The second is the over-the-counter market (OTC), a network of entities who trade together without using a Stock Exchange as a middle-man. Whereas each stock exchange has its own set of criteria with which listed businesses must comply, the OTC market is much more flexible.
Venture Capital and Private Equity Definition
Many people get confused between venture capital and private equity. Both terms describe money that is invested into businesses in the hope of raising capital, but in practice they function in quite different ways.
While venture capital tends to be used to support start-ups or relatively young businesses in emerging areas such as the technology industry, private equity is more commonly invested into older and more established businesses and traditional industries. Private equity is also associated with larger-scale deals, with investors buying out most or all of the business’s shares.
If businesses or investors are interested in benefitting from equity financing, they should be sure to carry out extensive research into the market and choose the right path for their situation. While some options are riskier than others, there is certainly potential to significantly grow the capital you start out with.