Executive Summary
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Equity capital or financing is funding raised by a business in exchange for a share of the ownership.
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Equity financing enables firms to obtain money without incurring debt, or without needing to repay a specific amount of money at a particular time.
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There are four stages of equity investment: seed, early-stage, expansion, and late-stage financing.
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Equity capital sources differ in terms of timing, amount provided, type of firm funded, extent of due diligence, contract type, expectations of timing and payback, and monitoring of business decisions.
Introduction
Entrepreneurs may require both debt and equity financing, and often start their firms by financing growth through equity. Equity capital is money invested in the venture with no legal obligation on the entrepreneur to repay the principal amount or to pay interest on it; however, it requires sharing the ownership and profits with the funding source, and possibly also paying dividends to equity investors.
After value has been built, entrepreneurs may consider debt financing, which involves a payback of the funds (with interest) for use of the money. In short, debt places a burden of repayment and interest on the entrepreneur, whereas equity capital forces the entrepreneur to relinquish some degree of ownership and control.
The stages of equity financing are depicted in Figure 1. In the first stage, known as the seed stage, entrepreneurs tend to raise capital from their own savings, though they may also seek informal investment from family, friends, business angels, and public sources. Entrepreneurs may then choose to pursue formal equity capital through rounds of early-stage, expansion, and late-stage financing. This may be followed by an initial public offering (IPO) and, finally, raising of finance from public markets and banks. Summary details of the financing stages are as follows:
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Seed financing is the initial funding to develop a business concept, for example by expenditure on research, product development, and initial marketing to reach early-adopter customers. Companies that receive seed funding may be in the process of incorporation, or may have been in operation for a while.
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Early-stage financing is sought by companies that have completed the product/service development stage and test marketing but require additional financing to expand.
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Expansion financing is provided when the company is poised to grow rapidly. The funds may be used to increase production capacity, marketing, or product development, and/or provide additional working capital.
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Late-stage funding refers to pre-IPO investments to strengthen a company’s positioning and to gain endorsements from top venture capital (VC) firms as the company prepares to list.
At any stage, equity investment can come from informal or formal sources. However, it is more usual to access informal sources in the seed and early stages, and formal sources in the expansion and late stages.
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