Equity finance is a form of business funding where, in exchange for much-needed funds, you give up equity or shares in your business.
It sounds simple but there are a number of questions that you need to be aware of the answers of if you are going to be ready to seek finance to fund the growth of your business.
- What are the types of equity finance available?
- What are the main sources of equity capital?
- Why choose equity finance?
- How does equity finance work?
- Do I need to repay anything to the investor?
- What are the other benefits of equity finance?
- Where can I find out more about equity finance?
What types of finance are there?
Types of equity finance are tied up with the business lifecycle and depend very much on what stage your business is at.
Seed capital – Occurring at the first stage of the business lifecycle this is usually funding in the region of £10,000 to £30,000, higher than a basic grant and designed to get a business off the ground.
Venture capital – usually the next step up the ladder as your business grows and develops. Involves more money and the participation of investors in the business and their involvement in running the business and making business decisions.
Growth capital – When your business is more established you will no doubt seek to grow it further. You may need funding to acquire new premises, employ new staff or acquire new expertise or purchase new machinery. This will also require more funds and tie your investors further into your business.
Capital for established businesses – Businesses at this stage are mature companies that are successfully cemented their position in the marketplace. Growth is controlled. They are perceived to be less of a risk so finance is most likely to come from banks and government grants as well as profits and investors.
Sources of equity finance
Equity crowdfunding – You can list your business on a crowdfunding platform such as CrowdCube and Seedrs. This lets individuals make micro investments, each buying a tiny amount of equity in your business. Together the investments all add up to a larger amount of capital investment.
Angel investors – Usually wealthy individuals, angel investors typically invest at the start of a business or in more established SMEs looking to expand. Angel investors can bring contacts, expertise and support to the table in addition to providing funds.
Private equity – Sitting between angel investors and more expensive venture capital, private equity tends to invest in small-to-medium businesses looking to grow and capitalise on their success.
Why choose equity finance
The biggest advantage of equity funding is that the money doesn’t have to be paid back, only a share of profits. If your business fails, you won’t have to repay investors.
Equity financing is useful when other funding avenues are impractical or the amounts too small. If you can’t bootstrap or the business requires lots of money simply to get off the starting blocks, then equity funding is a viable option.
How does equity financing work?
The first step is to value your business. You can’t pluck a figure out of the air and hope for the best. Investors will want to understand how you arrived at the value of your business. Tot up the value of assets and business activity, such as future orders and income, and then subtract liabilities and debts to get a value.
You can also value your company based on its potential, such as forecasting profitability based on growth.
You need to value your business competitively to woo investors but it’s important to strike the right balance. Undervaluing your start up means sacrificing too big a share of future profits. Overvalue it and investors will be reluctant to put money into your business.
For example, by valuing your start-up at £200,000 you could offer a percentage – say, 25% – in exchange for £50,000 of investment. Convince an investor that your business is potentially worth more – say, £400,000 – then you’d get £100,000 for the same 25% stake. Once your business starts making a profit, the investor will receive 25% of dividends and future exit of the business for as long as they hold their share of equity.
Do I need to repay anything to the investor?
The big advantage of equity finance is that it never has to be repaid and there is no interest rate paid on the money. Equity investments are true risk capital as there is no guarantee of the investor getting their money back. The investment is not tied to any particular assets that can be redeemed from the business and, should the business fail, an equity investor is less likely to get their original investment back than other investors.
The return from an equity investment can be generated either through a sale of the shares once the company has grown or through dividends, a discretionary pay out to shareholders if the business does well.
However, the reason that firms will give you cash in this form is that they will take a share of the business in return.
What are the other benefits of equity finance?
You can use equity finance to grow and fund further investment in your business. Your investors will also be able to supply expert advice to help you run your business and give you access to their contact database which you can leverage to unlock new growth opportunities.
Are there any sources where I can find out more about my equity finance options?
There are a number of industry bodies that can provide you with a wealth of information including:
Call one of our experts on 0203 327 0567 to find out about equity finance options to suit your own business goals or email [email protected].