Equity financing refers to raising capital through the sale of the company’s shares and/or other securities. In technology start-ups, the class of shares offered to investors is typically created as part of the financing and will be tailored to the investors’ needs. When issuing shares during any stage of funding, you must comply with applicable securities laws and should seek advice from legal counsel before proceeding.

Equity financing instruments used by early-stage investors

Early-stage investors tend to use warrants, convertible debentures and common shares for seed or first rounds of investing. Warrants are discussed below.  Sophisticated later-stage private investors traditionally use other types of equity instruments.

Warrants

Warrants represent an option to purchase a certain number of shares (common or preferred) at a future date at a fixed price, which can be the price of the current round of financing or set at a premium to the current price per share.

Warrants tend to be used in earlier-stage deals to compensate an investor helping you to raise startup financing (in lieu of or in addition to cash). Warrants can also be used in later-stage deals or strategic rounds to provide upside potential value to investors to encourage participation in a round of financing.

Unlike stock options, warrants tend to provide an option to purchase the most recent class of shares (rather than common shares). Warrants can also be issued to third parties while stock options are limited to employees, directors, consultants and advisors engaged in the business.

References

Canada Business. Retrieved April 9, 2009, from http://www.canadabusiness.ca.
VC Experts. Retrieved April 9, 2009, from .
Houston, T., Johnson, A., & Smith, E. (2006, September 15). Technology Startups: A Practical Legal Guide for Founders, Executives and Investors. Retrieved April 9, 2009, from Fraser Milner Casgrain website at http://www.techstartupcenter.com/