Equity financing involves money that is borrowed to finance the firm’s assets. Group of answer choices True False
The correct answer and explanation is:
Correct Answer: False
Explanation:
Equity financing does not involve borrowing money. Instead, equity financing refers to the process of raising capital by selling shares of a company to investors. These investors become partial owners of the business and share in its profits or losses. This is fundamentally different from debt financing, which involves borrowing money that must be repaid over time, typically with interest.
When a firm uses equity financing, it raises funds by issuing common or preferred stock to individuals or institutional investors. These investors provide money in exchange for ownership stakes, and they assume the risk of the business. If the business performs well, investors can earn returns through dividends and capital gains. However, if the business performs poorly, they may lose some or all of their investment. Importantly, the company is not required to repay the equity funds as it would with a loan.
Equity financing is commonly used by startups and growing companies that may not have the credit history or collateral required for loans. It can also be attractive to firms that do not want the burden of interest payments or fixed repayment schedules associated with debt. However, one trade-off is the dilution of ownership and control, since issuing more shares means spreading ownership among more parties.
In contrast, debt financing involves raising money through loans or by issuing bonds. The company must repay the borrowed funds with interest, and lenders do not gain any ownership in the company. Because of these differences, the statement that equity financing involves borrowed money is incorrect.
Equity financing contributes to the firm’s capital structure, but it does so by bringing in new owners, not by taking on debt. This distinction is essential in understanding how companies fund their operations and grow.