Equity finance

Introduction

Equity finance is a way of raising share capital from external investors in return for handing over a share of the business. This may take many forms including a share of future profits, but is most frequently associated with sharing the ownership of the business to some degree. Equity finance is normally restricted to limited companies.

The two main providers of equity finance for private businesses are venture capitalists and business angels.

What is equity finance and is it right for your business?

Equity finance is capital invested in a business for the medium to long term in return for a share of the ownership and, sometimes, an element of control of the business.

Unlike lenders, equity finance investors don't normally have rights to interest or to be repaid at a particular date. Their return is usually paid in dividend payments and depends on the growth and profitability of the business.

Because equity investors share the risks your business faces, equity finance is often referred to as risk capital.

Is it right for your business?

Different forms of equity finance suit different business situations. For example, venture capital is most often used for high growth businesses destined for flotation on the stock market - with shares available to the general public - or sale.

Business angels can offer investment, particularly in the early or growth stages of development, in return for equity.

Because of the risk to their funds, investors expect a higher potential return than for safer, more secure investments. Risk capital is likely to be most suitable where:

  • the nature of a project deters debt providers, eg banks
  • the business will not have enough cash to pay loan interest because it is needed for core activities or funding growth

Questions to ask yourself include:

  • Are you prepared to give up a share in your business and some control? Investors expect to monitor progress and many seek involvement in significant decisions.
  • Are you and your key people confident in the business' product/service? Does it have a unique selling point that singles it out?
  • Do you have the drive to grow the business?
  • What industry experience and knowledge does your management team have? Is there a variety of skills?

Types of Equity Investors

Business angels

Business angels (BAs) are wealthy individuals who invest in high-growth business in return for equity. Some BAs invest on their own, whereas others do so as part of a network, syndicate or investment club of BAs. In addition to money, BAs often make their own skills, experience and contacts available to the company.

BAs typically invest in businesses with:

  • an investment need of between £10,000 and £250,000 - most initial investments are less than £75,000
  • the potential for high return - BAs are not averse to high risk
  • good early stage development or expansion
  • a presence in a particular sector

The advantage of using a business angel is that they often make an investment decision quickly, without complex assessments. However, it's still a good idea to draw up a professional and tailored business plan.

Most business angels can bring valuable first-hand experience of either working in a small business or running their own business venture. They're also likely to have local knowledge, as they tend to focus their investments within a small geographical area.

The disadvantage of business angels is that they don't make investments very regularly and may not be actively looking for an opportunity, so they may be difficult to find. While you may decide to approach an agency to help you with this, business angels will place a lot of emphasis on your relationship and how well you can work together directly. Tracking down the right investor may take longer than expected and can typically take several months.

Venture capital

Venture capital is also known as private equity finance. Unlike business angels, venture capitalists (VCs) look to invest large sums of money in return for some of your business' shares.

VCs typically invest in businesses with:

  • a minimum investment need of around £2 million
  • an ambitious but realistic business plan
  • a product or service that provides a unique selling point or other competitive advantage
  • large earning potential and offering a high return on investment within a specific time frame, eg five years
  • sound management expertise - although VCs tend not to get involved in the day-to-day running of the business, they often help with a business' strategy
  • a proven track record - for this reason start-ups are generally not considered by VCs for investment

The advantages of securing a VC are that they can provide large sums of equity finance and bring a wealth of expertise to your business. Also, if you successfully attract a VC to your business, you're likely to find it easier to secure further funding from other sources.

The disadvantage is that securing a deal with a VC can be a long and complex process. You'll be required to draw up a detailed business plan, including financial projections for which you're likely to need professional help. Support from your local Business Link/Business Gateway may be available for this. Also, if you get through to the deal negotiation stage, you'll have to pay legal and accounting fees whether or not you're successful in securing funds.