Equity Finance

I got asked by a student what Equity Finance was today in class. I gave a pretty awful explanation...

My explanation tried to make the link between what equity means and how that might be used to finance the business...

Think of equity as the amount left when you take liabilities away from the assets of a business. Now think of Equity finance as when you sell shares in your business in return for shareholders owning part of your equity. The new shareholders get entitled to dividends or a share in the profits and the original owners lose some control of the business.

Now you can raise equity finance by issuing share to existing shareholders (Rights Issue) which means you avoid having to bring in new shareholders as a LTD company.

You might also decide to issue shares to new shareholders on the stock exchange either by floating your business for the first time to become a PLC or as an existing PLC. This is the way to get the largest amount of investment however there are risks involved. Plus it puts you under a lot of external and internal scrutiny  just look at Facebook and the negativity around their share prices of late!

Another way might be to keep (retain) profits in a business rather than issue dividends to your shareholders. This might not be popular with them but if it is being used to fun growth and invest in the business in return for larger future profits then shareholders will likely be happy enough to accept that.

Remember business have a legal obligation to deliver the maximum possible value/return to shareholders!

Tutor 2 U also has a round up on Equity Finance and if you look on the right hand side after reading the article they have links to a lot of additional information on the other sources of finance for businesses. Remember to focus on SME's for the moment...