In this free finance guide, we'll review the basics of how and why companies raise cash, or capital. These concepts are covered in more detail in our finance training in New York.
Financing
When you think of the word finance, what likely comes to mind is car financing, or financing a home purchase, etc. Car or home financing is simply how one plans to pay for those purchases.
Finance is how companies pay to make investments (like capital improvements, acquisitions, etc.) and maintain daily operations. Companies may use cash on hand or cash generated by operations, although using those funds still has an opportunity cost. However, many companies need additional cash, and this is where debt and equity financing comes into play.
Debt Financing
Debt financing includes loans from a bank or bond offering (see below for more detail on bonds). When taking on debt financing, a company borrows money and promises to repay the principal (original borrowed amount) and interest.
The interest rate can be fixed or variable (based on certain interest rate benchmarks like SOFR), and the principal must be repaid on the maturity date (some debt financing allows for early repayment without penalty - it varies). Debt often has a lower required return than equity because creditors have priority over shareholders, but its cost and availability depend on credit risk, terms, and market conditions.
Why might a company choose equity instead of additional debt? And what exactly is equity financing?
Equity Financing
When a company raises capital by issuing equity, it is selling shares to investors for cash it can use to finance its operations and investments. The existing shareholders now own less of the company, but the company has the cash it needs to execute its plan.
Companies can raise equity through private or public issuances. Let's start with the widely-known Initial Public Offering or IPO. In an IPO, a company sells its shares for the first time to the public, meaning anyone can buy the shares.
Listed shares can trade on exchanges, although liquidity and price can vary. After an IPO, companies can sell additional shares to the public in what is called a Secondary Offering. Companies can raise equity on the private markets, often through venture capitalists or angel investors.
Another form of financing is preferred stock, which is a hybrid of debt and equity. Preferred stock typically has specified dividend rights and priority over common stock. Terms vary: dividends may be fixed or floating, and some issues have no maturity date. Preferred stockholders are not entitled to the same dividend or voting rights as common stockholders.