What is Equity Financing?

Equity financing is a method of raising capital for an organization by selling shares of the organization to investors. Companies will often go through several rounds of equity financing as they grow and scale operations, using different equity instruments based on their specific needs. While equity financing is often critical to finance operating expenses during a company’s earliest stages, it can also be an effective financing tool for long-term growth initiatives in more mature companies.

There are two primary methods of equity financing:

1. Private placement of stock: sale of shares into the private, non-public capital markets to individual investors and/or private institutions (i.e., venture capital and private equity firms).
2. Initial public offering (IPO): sale of shares to the public in a new stock issuance.

Private Placement vs. Initial Public Offering

Source: Investopedia and Capstone Partners

When a business pursues private financing, it raises capital through the sale of equity, which can be structured in various ways:

• Common Shares: junior equity issued to investors in exchange for capital.
• Preferred stock: securities that are of higher priority than common equity. In other words, when the proceeds from the company’s profits are distributed, both lenders and preferred stockholders are paid before distributions reach common stockholders.
• Convertible preferred stock: a quasi-debt instrument that doesn’t require repayment when it is matured. Many startups use convertible equity/debt in their financing. Generally, the debt is a short-term note that converts to equity at a later date. The contractually set conversion ratio determines the number of common shares that each share of preferred stock may be converted into. This is preferred by angel investors and venture capitalists as the holder benefits from the advantages of preferred stock in the early stages of the company while limiting downside risk as shareholders can submit the preferred stock to the issuing company and receive a predetermined number of common shares.
• Equity warrants: give the investor the right to purchase a specific number of additional shares in the company at some future date, presenting an arbitrage opportunity for the investor. Warrants have a predetermined “exercise price” which is the price at which an investor has the right to purchase shares in the company. The figure below provides an example of the arbitrage opportunity presented to investors through equity warrants.

Equity Warrant Arbitrage Opportunity

Source: Capstone Partners

Private Placement

Private placement investors frequently include angel investors, crowdfunding platforms, venture capital and private equity firms, and corporate investors. Each type of investor possesses distinct qualities that business owners should consider when seeking funding.

Types of Private Placement Investors

Source: Corporate Finance Institute and Capstone Partners

Equity vs. Debt Financing

There are two primary options for capital raising: debt financing and equity financing. Businesses typically utilize a combination of debt and equity to fund growth as both classes have advantages at different stages in a business’s lifecycle. In debt financing, a business borrows money to be paid back to the lender, with added interest. Once the loan is paid back, the relationship between the business and its lender ends. Creditors typically look at businesses with lower debt-to-equity ratios more favorably, although the ideal amount of debt depends on the industry.

Advantages of Equity and Debt Financing

Source: The Hartford, Investopedia, and Capstone Partners

Case Study: Capstone Partners Advises UrbanStems on a $20 Million Series C Growth Capital Raise

In June 2021, Capstone Partners advised UrbanStems, Inc., an e-commerce floral arrangement and gifting delivery provider, on raising a $20 million Series C growth capital round in support of the company’s growth initiatives. The round was led by SWaN & Legend Venture Partners and DFE Capital Management, with follow-on investments from Motley Fool Ventures, Gordon Segal, Gaingels, PAN, and others.

With the new funding UrbanStems will continue to hire and grow its team, build on its leading gifting technology platform, and scale infrastructure to support the brand’s accelerated growth plans. The company has grown 500% since the Series B in 2018 and has advanced its position as a leader in the direct-to-consumer (DTC) floral and gifting space under the guidance of CEO Seth Goldman.

“Under Seth’s leadership, the UrbanStems Team has built a highly differentiated DTC gifting and floral platform providing a user experience that generates enduring customer relationships. We are confident their expertise in scaling DTC businesses and their approach to the floral and gifting market will result in continued rapid growth at UrbanStems,” commented Matt Huebner, Co-Head of Capstone’s Equity Capital Advisory Group.

We selected Capstone due to its promise of senior support and involvement. At every turn, especially in critical moments, the most senior members of their team gave their time and attention to the transaction.

Seth GoldmanCEO, UrbanStems

Important Considerations for Business Owners

It is critical that business owners identify their values and company goals before seeking funding from investors or lenders. Owners contemplating financing options may want to consider the questions outlined below.

1. What source of funding is most easily accessible for the company? Debt financing can be easier for a business to attain as it is more difficult to find an equity capital provider. However, private equity and venture capital investors continue to display a significant appetite for stakes in strong businesses serving growing markets. In addition, traditional debt financing is not available to early-stage companies. Venture debt, on the other hand, can be a viable method of raising capital for early-stage businesses and startups. Due to the elevated risk associated with venture debt, the lender receives the company’s warrants on common equity in lieu of collateral.
2. How important is it for principal owners to maintain complete control of the company? In equity financing, the business owner is selling shares of the company and often retains majority ownership, albeit diluted on a pro rata basis tied to the valuation of the company. When utilizing debt financing, the owner maintains complete ownership without dilution, except in situations where the debt provider also requires a small amount of equity warrants, which can often be the case.
3. What resources do the investors provide? Venture capital and private equity firms, along with large strategic acquirers, are experienced in improving businesses’ scale, management teams, operational efficiency, and profitability. In addition, these buyers may have strong connections in the market that can help form accretive partnerships and establish knowledge-sharing relationships.
4. Do the investors often make add-on investments in companies? Private equity acquirers often use add-on acquisitions to form synergies and increase the scale of portfolio companies. A business owner that seeks investment from a private equity firm should consider how add-on acquisitions would impact the business’s culture and performance.
5. Does the investor’s culture align with your brand? Cultural preservation may be important to business owners. Before seeking investment, business owners should consider the culture and track record of potential investors.
6. Do the investor’s goals align with your vision for your company?  It may also be important to a business owner that the company goals are left unchanged. Business owners should have a clear understanding of the investor’s aspirations before closing the deal.
7. Is now a good time to borrow? A business will want to consider the overall debt financing environment with respect to current interest rates to determine if now is the best time to borrow. The professionals on Capstone’s Debt Advisory Group closely follow leveraged finance market conditions and provide insights to business owners that are considering a debt capital raise.

Capstone Partners offers a full suite of services to help business owners achieve their goals, if you are considering a capital raise to support the goals of your company and would like professional guidance on finding an investor to help meet those goals, please contact us.

The senior professionals in our Equity Capital Advisory Group bring 50+ years of combined experience and have worked on capital formation transactions that exceed $3 billion in aggregate financing value. As a fully-dedicated group focused exclusively on the equity capital markets, the team has established a distribution channel comprised of diverse global investors, including the leading venture capital, private equity, family offices, and alternative investment firms.

Our Debt Advisory Group has developed established relationships with over 300 institutional lenders across the credit universe, including commercial banks, finance companies, credit opportunity funds, business development companies (BDCs), insurance companies, private debt funds, and family offices. The firm’s deep credit experience and entrenched relationships allow us to deliver tailored debt solutions and provide real-time market intelligence on current market terms, lending trends, and structural alternatives.