Introduction

Equity financing is a cornerstone of modern business growth, enabling companies to raise capital by offering ownership in the company in exchange for funding. Equity financing allows companies to attract investors who share in both the risks and rewards of the business. This financing approach is critical for businesses at various stages, from early startups seeking to establish themselves to mature companies looking to expand operations or diversify their portfolios.

A prominent real-life example of equity financing is Amazon’s journey to becoming a global powerhouse. In its early days, Amazon relied on venture capital to fund its growth, securing $8 million from Kleiner Perkins Caufield & Byers in 1995. Later, in 1997, the company went public through an Initial Public Offering (IPO), raising $54 million by offering shares to the public. As Amazon grew, it also issued Seasoned Equity Offerings (SEOs) to further finance its expansion and fuel innovation. [Footnote 1]

Through this topic, we will explore key aspects of equity financing, including its various forms, the role of venture capital, the significance of IPOs, and the function of seasoned equity offerings.

The key learning outcomes for this topic include:

• Understand the Types of Equity: Explore various forms of equity, including common, preferred, convertible, and private vs. public equity.
• Appreciate the Role of Venture Capital: Recognize how venture capital supports startups and early-stage businesses through funding and strategic involvement.
• Examine the Importance of IPOs: Learn how Initial Public Offerings (IPOs) raise capital and enhance market visibility for companies.
• Analyse the Impact of SEOs: Evaluate how Seasoned Equity Offerings (SEOs) support corporate growth and strategic initiatives post-IPO.

Learning Outcome 1: The many different kinds of equity

As explained in the previous topic, equity represents ownership in a company and forms the foundation for raising capital to fuel growth and operations. Businesses utilize various types of equity to meet diverse funding needs and strategic goals. These types include:

• common equity: the basic ownership shares with voting rights.
• preferred equity: which provides fixed dividends and priority in liquidation
• private equity: held by a select group of investors or
• public equity: traded on stock exchanges and accessible to the general public.

Each type serves distinct purposes, from early-stage funding to corporate expansions, reflecting the dynamic nature of equity financing.

1.1 Common vs. Preferred Equity

Common equity and preferred equity are two primary forms of equity that companies issue to raise capital. While both represent ownership in a company, they differ significantly in terms of rights, benefits, and risks.

Common equity (also known as common shares) represents the basic ownership in a company and held by common shareholders. These shareholders typically have the right to vote on key corporate matters, such as electing the board of directors. In case of liquidation, common shareholders receive assets only after all debts and preferred shareholders are paid (that is they are residual claimants on the firm’s assets). Common shareholders benefit directly from the company’s growth, as their returns are tied to stock price appreciation and dividends. These two forms of return: share price increase and dividends are the main reason why investors invest in equity. However, there is risk involved in investing in equity as returns are not guaranteed, and in the cases of financial distress or bankruptcy, common shareholders may receive nothing and lose their entire investment in the company.

Preferred equity (also known as preferred shares or preference shares) is a hybrid form of equity that combines features of both equity and debt, offering specific privileges over common equity. These privileges include priority in dividends, at a fixed dividend rate such as 8% of the par value, and priority in liquidation, should the company encounter bankruptcy. However, most preference shares have limited or no voting rights and hence restrict preference shareholders’ involvement in business operations. A major advantage of preference shares over common shares is fixed dividends provide a more predictable income stream. However, preferred shareholders typically do not benefit from the company’s growth to the same extent as common shareholders, as their returns are fixed.

The below table summarizes key differences between these two types of equity.

From an investor point of view, common equity is ideal for investors seeking high growth and a voice in corporate decisions, while preferred equity suits those prioritizing stable returns and lower risk.

1.2 Private vs. Public Equity

Private equity represents ownership stakes in private companies that are not publicly traded on stock exchanges. It is typically held by a limited number of private investors, such as institutional investors or high-net-worth individuals. As the companies are private, shares are not easily bought or sold; and private equity investments often require long-term commitments before investors can realize their return.

A major source of private equity is private equity funds. These private equity (PE) funds are investment vehicles that pool capital from institutional investors, high-net-worth individuals, and sometimes sovereign wealth funds to invest in privately held companies. These funds are managed by private equity firms and are designed to achieve substantial returns by taking ownership stakes in companies and actively managing them to increase value over time. Investments are normally held for 5–10 years, during which the PE firm works to increase the company’s value. PE funds realize returns through methods such as selling the company, conducting an IPO, or merging with another company. The focus of PE funds is primarily:

• Venture Capital: investments in startups or early-stage companies
• Growth Capital: investments in established companies seeking growth capital.
• Buyouts Capital: investment in underperforming companies that require restructuring

A well-known example is Blackstone Group, one of the largest private equity firms globally, which has used its funds to acquire and transform businesses worldwide. In Australia, one of Blackstone’s largest investments is Crown Resorts which it acquired in 2022 for $A8.9 billion. [Footnote 2] The aim of Blackstone in this investment is to improve the management of the company and generate returns for its investors.

Most PE funds operate as limited partnerships (LPs) comprising of two types of partners:

• General Partners (GPs): The private equity firm manages the fund, selects investments, and oversees portfolio companies. These GPs may contribute a small share of capital of approximately 10% and receive a 20% share of the profits plus a management fees.
• Limited Partners (LPs): Institutional investors or individuals who provide the majority of the capital but have limited liability and no active role in management. LPs typically contribute the majority (90%) of the capital and receive the majority of the profits (80%) as a return on their investment.

The structure of a PE fund is illustrated graphically below

Private equity funds play a vital role in the financial ecosystem by providing critical funding and expertise to businesses, driving innovation and growth in startups and rescuing and restructuring struggling companies to restore profitability.

While offering potentially high returns, these funds are generally accessible only to sophisticated investors due to the high-risk, long-time horizon, and significant capital requirements involved.

Public Equity represents ownership in companies that are publicly traded on stock exchanges such as the Australian Securities Exchange (ASX). For these listed companies, shares are distributed among a broad base of public investors which comprise of both institutional and retail investors and can be freely bought and sold on the stock market, offering high liquidity. Due to the broad investor base, publicly listed companies are subject to strict regulatory and reporting requirements imposed by the stock exchanges as per the listing rules. Public equity offers liquidity, transparency, and accessibility, making it a suitable option for a wider range of investors.

The table below provides a summary of the key differences between private and public equity.

1.3 Life cycle analysis of equity financing

The firm life cycle refers to the stages a business typically goes through as it grows, matures, and evolves over time. Each stage is characterized by distinct challenges, opportunities, and financing needs, influencing the firm’s strategy, operations, and access to capital. Understanding the firm life cycle helps businesses anticipate and adapt to changes, ensuring sustainable growth and long-term success. The key stages of the firm life cycle are:

• Start-Up Stage: The business is in its infancy, focusing on developing a product or service, building a customer base, and establishing a market presence. In this stage, the company has a high level of risk, limited resources, and uncertainty about market acceptance.
• Growth Stage: The firm experiences rapid revenue and market expansion, scaling operations to meet growing demand. The major challenges for the company during this phase is to manage growth, hire talent and expand its infrastructure while maintaining the quality of its products and services.
•  Maturity Stage: The firm reaches a stable position, with consistent revenues, established market share, and operational efficiency. During this stage, the company is still growing but at a much slower rate. It faces competition and pressure to innovate.
• Decline or Renewal Stage: The firm faces stagnation or decline due to market saturation, outdated products, or operational inefficiencies. Alternatively, it may pursue renewal through innovation or diversification to remain relevant in the marketplace.

As a firm progresses through its life cycle, it has varying funding needs and can access different types of equity tailored to its evolving needs and growth stages. The type of equity available to the company at different stages in its life is presented in the table below.

Footnotes

1. For more details, see https://www.fundable.com/learn/startup-stories/amazon
2. For more details, see Where I’m putting the money: Blackstone’s Australian investments