Question

Which of the following statements is incorrect regarding equity funding?

a)Equity investors are very demanding
b)Angel investors are a common source of equity funding
c)Equity investors expect to get their money back, along with a substantial capital gain, through the sale of their stock
d)Equity investors fund the majority of the plans they consider
e)Equity funding is not a loan

Answer 1

The incorrect statement about equity funding is that 'Equity investors fund the majority of the plans they consider.' These investors are very selective and most proposals are rejected. Equity funding involves acquiring partial ownership, not loan repayment, and venture capitalists typically have better insights into small firms due to their substantial ownership and active management role.

Step-by-step explanation:

The statement that is incorrect regarding equity funding is that 'Equity investors fund the majority of the plans they consider.' Equity investors, such as venture capitalists and angel investors, are selective and fund only a small portion of the businesses they review. They are indeed demanding and seeking substantial capital gains from the sale of stock, but the vast majority of funding proposals are rejected after careful consideration due to the high risk involved. Equity funding is not a loan because it does not require repayment like a traditional loan, but instead offers investors partial ownership in a company.

Very small companies tend to raise money from private investors like angel investors or venture capitalists because it is challenging and costly to issue public shares through an Initial Public Offering (IPO) due to regulatory and financial constraints. On the other hand, small, young companies might prefer an IPO to borrowing from banks or issuing bonds because they want to avoid mandatory interest payments which can strain cash flows, especially when their earnings are reinvested for future growth. Venture capitalists tend to have better information about a small firm's potential for profits due to their active role and substantial ownership in the company, which reduces informational asymmetry.

From a firm's perspective, a bond is similar to a bank loan in that it is a form of borrowing that requires regular interest payments. However, they are different in terms of the structure of repayments, the level of control retained by the company, and the way these instruments are traded. For equity calculation, if Fred bought a house for $200,000 and put down a 10% down payment, his equity would be the down payment amount, which in this case is $20,000.