Most business owners will know that growth and success require investment. But when the cost of that becomes larger than the business budget, some form of finance may be needed. Equity financing is one of the options available.
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Equity financing is one of the driving forces in some of the most consequential businesses of our time – think Google, Facebook and the like. The idea is that by selling shares in their company, business owners can raise the money they need to take their enterprise through the next stage of growth, while investors could reap a healthy return.
This method can be beneficial for all types of businesses, from start-ups through to more established companies, since there’s no interest to repay and the founders can focus on growth.
In this guide, we’re going to get stuck into the detail – uncovering how it all works, the different types of equity finance as well as weighing up the benefits and pitfalls. It’s important to note that any form of finance has inherent risks. If you’re concerned about your options in any way, you should seek independent legal or financial advice.
Equity financing involves raising capital by selling shares in your business. When you do this, investors receive a share of the company, along with voting rights and a portion of the profits and losses, in return for their funds. This method can be particularly beneficial for businesses with high-risk, high-reward investment needs, as it means you can split the risk among shareholders, all of whom have a vested interest in the company's success.
Equity financing is often used by:
By using equity financing, businesses can secure the capital needed for ambitious growth plans while aligning investor interests with their success. This approach not only provides a healthy injection of funds but also brings valuable expertise and networks from investors, contributing to the company's overall growth and sustainability.
While equity financing typically comes from angel investors or venture capitalists, it can also be funding from family, friends or the public.
In return for becoming shareholders, investors can provide the funds you need to take your business to its next level. Some investors will be more involved in decisions made within the company.
It’s possible to go through several rounds of equity financing. But remember anyone who owns more than half of the shares becomes a controlling shareholder – no matter who started the business.
William has started a new business. Up until now he has invested £100,000 of his own money, so he owns all the shares of the company.
While the start–up is showing a lot of promise, it’s in need of capital to grow. William finds an outside investor – his friend Helen – to supply the funds he needs. Helen agrees to pay £40,000 for 40% of the business' shares. This means that the company has now raised a total of £140,000 in capital, and William has a 60% stake of his business.
If you’re wondering how to raise equity financing, then you need to get to know the different types. Here are some of the options:
Angel investors are often wealthy individuals who tend to have some entrepreneurial experience themselves. They use their personal funds to help businesses in need of capital. They may also bring their knowledge, expertise and business contacts to the table.
Angel investors can even be found close to home, with many businesses turning to family members, close friends and professional contacts.
Venture capitalists are employed by venture capital firms to invest other people’s money into businesses. They tend to invest larger amounts than business angels, but take on fewer investments.
Venture capital firms may also be looking for a seat on your board of directors.
An IPO is when a business sells shares of its stock to the general public for the first time. This is also referred to as “going public”, as it marks the transition from a privately-held company to becoming a public company.
Mezzanine finance is a type of equity finance, but is also a type of debt finance. It blurs the lines between the two, making its own hybrid version of financing.
Mezzanine financing is where a business secures a loan, but the lender is able to convert this to an equity share after a set time frame. In plain English, it’s a loan which can be paid back if all goes well, but if it can’t be repaid then the lender can recover their costs by securing shares in the business. In some instances, it can even be agreed that some of the money will always need to be paid back as equity.
This method can be seen as more favourable than other equity finance options, as it offers a way to get the funds you need without giving up large shares in your business – if all goes well – allowing you to maintain as much control as possible, for longer.
Angel investors can even be found close to home, with many businesses turning to family members, close friends and professional contacts in order to get their enterprise started.
This form of investment is similar to venture capital. Both types of equity financing pool others’ money into companies in the hope of a positive return, however private equity investors tend to choose more mature and established companies. They’re also more likely to purchase a larger share of the company, such as 50-100%, and look to improve its profitability.
Large corporates will often invest in smaller firms as part of a wider strategy, which could result in funding for your business in exchange for equity.
This type of equity financing looks to raise a large number of smaller investments to generate capital. It can be done via specific crowdfunding platforms that give businesses the opportunity to pitch their product or service to catch investors’ attention.
Wealthy families with significant amounts of money will sometimes invest in smaller businesses in order to generate more income. By contributing cash in exchange for equity, they hope to see their investment grow as the business does.
National schemes such as the Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS) encourage investors to put capital into new and growing companies by offering tax reliefs to those who invest.
Business owners may choose Equity Financing over other forms of business finance for a variety of reasons.
Equity financing tends to be most suitable for younger businesses or start ups. That’s because at this stage it tends to have the most benefit for all involved. Cash flow tends to be tighter when you’re first starting out, so an injection of capital within the first few years can go a long way.
For the investor, a small percentage of a business during its infancy may well be worth a lot more once it matures. They’ll tend to choose businesses with high-growth potential that can multiply their investment as quickly as possible, and may expect hard work and perseverance in order to do so.
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In business, we sometimes have to turn to external help to get the funds we need. Generally speaking, financing options can be split into two camps: equity and debt.
As we now know, equity finance is all about raising the money you need by selling shares in your business. Debt finance is as you’d expect – borrowing money which needs to be repaid, along with interest.
They’re fundamentally different ways to get hold of capital, so it’s important to grasp their respective features and benefits so you can make the right choices for your business. Let’s dive into some of the details.
Both debt financing and equity financing are ways to help inject funds into business. The biggest difference between the two is what you have to give the lender.
With equity finance you need to be willing to give up some ownership of your business. In return for their money, the investor will become a shareholder. This means there isn’t a commitment to pay back what was originally invested, but it does give the investor a level of control.
Debt finance acts more like a household loan. A sum of money is released to you, within the arrangement of it being paid back under certain conditions, such as monthly with additional interest. This way, you don’t dilute your ownership of the business and instead pay back more than you borrow.
Weighing up which to choose is dependent on your current situation. Not everyone will be eligible for a loan, and therefore may have limited access to debt financing. Take start–ups for example, who have yet to prove that they are profitable – they may be seen as too risky for lenders, but could have better luck with equity finance if investors are more willing to take on the risk.
With so many options available when looking at business finance, it pays to think ahead about what’s right for you. Equity finance can look enticing, and be useful if your cash flow situation doesn’t permit big loan repayments. However, this opportunity will almost definitely result in a reduction of control.
Most business owners will know that growth and success require investment. But when the cost of that becomes larger than the business budget, some form of finance may be needed. Equity financing is one of the options available.
