Private Capital Investing

CHAPTER 3Equity Products

INTRODUCTION

Equity capital is capital raised by a company in exchange for an ownership interest in the firm. Equity as a financial instrument has the following defining features:

• it refers to an investment in a company's share capital, via the purchase of shares of the company, entitling the holder to a pro-rata ownership of the business;
• the rights of the shareholder are defined by the company laws and by the commercial laws of the countries where the company is located;
• in case of default, there is no protection in terms of security;
• it involves an indefinite, open-ended commitment with no automatic right to return of capital;
• unlike debt securities, there is no contractual obligation entitling regular payments to holders;
• if the company performs well, shareholders will benefit from dividend payments and capital appreciation (the so-called upside of the business).

Therefore, the advantages of equity financing are: 1) no repayment is necessary; 2) longer-term funding can provide long-term support where the returns are not certain; 3) availability of assets for other funding is not restricted; and 4) there are fewer limitations on the use of funds and business operations.

The disadvantages of equity financing are: 1) ownership and control are diluted; 2) the original owners must share the upside; 3) sources of equity financing are limited; 4) it is more expensive to raise; and 5) investors require very high returns.

As a byproduct of the features described ...