If you’re an SME, there will come a point where growth moves to the top of the agenda. However, growth doesn’t come easily, especially for smaller businesses that may not have access to a range of funding solutions or strong cashflows.
For these SMEs, equity is a great option to secure the funding required for growth. Through it, you can raise substantial sums without placing the burden of loan repayments and interest on your business, as is often associated with debt finance.
However, it’s not a matter of just clicking your fingers and receiving equity funding. There are important considerations to make before you commit, and it’s crucial to find the right funder relationship for your needs. Different sources of equity will have different strengths, access to unique expertise, and criteria of what is expected from any SME that varies depending on the funder.
In this blog, we have explored the five most common sources of equity finance which can support SMEs and how they work so that you can make the best choice for your business.
Angel investment
Angel investment is a form of equity that sees a high net-worth individual invest their money into a business, with the aim of generating a return on their investment as that business grows.
There are many benefits to angel investment. Typically, you could raise funds of between £10,000 to £500,000 from a single angel, or this can could be substantially with an angel syndicate. These investors also tend to be seasoned business professionals, meaning they can contribute valuable expertise and advice to your SME to help guide your growth and success.
However, there are also concerns you must be aware of. Firstly, as with most investment forms, you need to be willing to commit to a long-term relationship with your angel. Return on investment is generally expected in the three to eight year time frame, and you will need to have an exit plan in place that outlines when they will step away from the business. During this time, and depeding on the terms agreed between you, they may be able to influence your business and your decisions.
On top of this, there is time and effort associated with finding and securing angel investment. You will need to have a winning proposition that persuades investors to back your business, supporting evidence (such as a business plan and other financial documentation) will need to be available ready. You will also need to create and deliver a pitchdeck to investors, which takes time to perfect and patience to find an interested party.
Another factor to bear in mind that you will need to share any distributable reserves with any other shareholders throughout the duration of the investor relationship. It is important to establish the right relationship with your investor from day one and whether you want a hands-on investor, whose is willing to work alongside you and other investors and lenders to help you boost your funding level.
Crowdfunding
Crowdfunding is an alternative source of equity that sees multiple people contribute smaller amounts of money, which is pooled together, and invested into a business. In the case of equity crowdfunding, each person who contributes receives a share in proportion to their investment in a company. They have the same aims and objectives as an angel investor, but are very much a hands-off and silent partner, but will still share in a distributable reserves and capital appreciation.
Equity crowdfunding commonly happens with early-stage, unlisted ventures. There are many online platforms dedicated to helping SMEs crowdfund. To win over substantial funding, you will need to have a strong case that makes people want to back your business. Examples include having a charitable or local impact, offering a niche product that customers couldn’t get elsewhere, or finding another way to provide value to potential contributors. High growth is the key to most successful funding rounds, but equally there are platforms where being the first to obtain the product or service is reward enough.
You’ll also need to generate enough buzz to interest people, such as through social media promotion, and ideally need to have raised a third of your total investment need in advance of launching your crowdfunding campaign.
While not every business will succeed with crowdfunding, it’s an excellent way to drum up support and get people engaged with your company. It’s also an ideal alternative solution for those who don’t wish to pursue traditional forms of equity fundraising.
Venture capital
Venture capital is aimed at early-stage and scale-up businesses that offer high growth potential. An enterprise accepted for venture capital financing will be provided a substantial funding line from one or more venture capitalists alongside hands-on guidance that can shape the company’s future and optimise it for success.
The main advantage of venture capital is that it has a more high-risk status to it which may assists SMEs that would struggle to get finance from more traditional routes. The pay-off is that a high return on investment will be expected to make the risk worthwhile, usually at least 25% internal rate of return.
Again, you will need to convince a venture capital firm to invest in you, which means having a compelling pitchdeck, including a commercially viable offering, high growth potential, sound management and meeting the specific VC’s investment criteria. Receiving an investment from a VC firm is tough – the acceptance rate has been reported to be as low as 1 in 2000.
Another factor to consider is that venture capital investment tends to happen over a set period of time, usually seven to ten years. This can cause pressure for the VC to exit the business within this timeframe, the company will need to look for replacement funding sources at this juncture.
Stock market
Another option might be to raise equity for your company via listing on a stock exchange. If you wish to pursue this option, you must be a publicly listed company and fulfil specific requirements.
One benefit of listing your business on a stock exchange is that it creates a clear market valuation for your company which can help you to track your worth. It’s also a great way to secure capital for expansion. It will heighten the profile of your business, which will enable you to attract further investment.
However, it does subject you to more scrutiny and reporting requirements as well as the need to seek approval to publish information that might affect the price of your shares. There are also high costs associated with stock exchange listing, which you need to account for.
EIS/SEIS
SEIS and EIS represent a mechanism that encourages investors (angel, crowdfunding or venture capital) to take risk and invest in start-ups.
The Seed Enterprise Investment Scheme (SEIS) is aimed at very early-stage companies, and Enterprise Investment Scheme (EIS) is aimed at more developed, but still early-stage companies.
Both schemes work by offering tax relief to investors who choose to support applicable businesses, thereby making SME investment more attractive. The SEIS can provide businesses with a maximum of £150,000, while the EIS could help you gain up to £12 million. It’s also possible to move from the SEIS to the EIS as your qualifying criteria changes.
The primary consideration to make for either scheme is that your business qualifies. There are several criteria you need to meet before the tax relief can be given.
However, if you are eligible, it can be a great way to attract investment by making the risk more worthwhile for investors, and is therefore worth investigating for most start-ups.
Conclusion
There are now many equity solutions for SMEs in the market, meaning more companies should be able to access the funding they need to scale. However, it’s essential to make sure you choose the right choice for your requirements.
Understanding the various equity funding sources can help you pinpoint an option that works for your business while offering the substantial financial support you need to fulfil your growth ambitions.
If you are looking to bring equity finance into your business, we can put you in touch with suitable sources from our extensive network of contacts.