Equity securities are shares of stock held by investors as reported on a company's balance sheet. A company issues equity securities as a means to raise capital in the financial markets for a major event, such as an expansion or merger or for product development. By purchasing equity, shareholders are obtaining a partial ownership stake in that company. Equity issuance is an alternative to issuing bonds, which are a form of debt, in the public markets.
The first time that a company issues equity securities into the financial markets is known as its initial public offering (IPO). A company typically will raise large sums of money in this transaction, because investors often flock to new issues to obtain a piece of a promising opportunity. The number of equity securities issued in an IPO depends on financial documents filed by the company with the regulatory body in a region. A company is permitted to sell a certain number of shares within a particular price range on the day of its IPO. Once shares are issued in the public markets, the equity price will rise and fall depending on investor demand.
Typically, a company will not issue the whole of its available shares in one offering. Instead, a number of shares usually are reserved for a subsequent offering at a future date, known as a secondary or follow-on offering. A company's management team does this because they anticipate needing to raise capital again to fund future growth plans.
A downside to issuing equity securities in the financial markets is that the more shares that become available for investors to purchase, the more that existing shareholders see the percentage of their equity ownership diluted. For example, a large holder of equity securities might own a number of shares that represents 10 percent of a company's total shares available to trade. If the company decides to increase the number of total shares available for trading, that shareholder's equity ownership instantly decreases as a percentage of total outstanding shares.
If a company decides not to issue equity, debt securities are the other primary option. Debt securities are bonds issued into the public marketplace by a corporation or a government. By purchasing a debt instrument, investors become instant creditors to an issuer. The primary downside for issuing debt is even though selling bonds does not give shareholders part ownership of the entity, the issuer must make ongoing interest payments to those shareholders over the life of a contract.