Equity investment is where you raise capital by selling pieces of your business in the form of shares. If the business does well, the investors will share in your success but if the business does badly then the investors accept that they won’t get their money back.
- Equity investors become co-owners and share in the fortunes of the business. If you raise a lot of equity, your shareholders may gain some control of your business through voting rights.
- Early on, many small businesses ask family and friends to be equity investors. Make sure it’s clear to them that they may lose their money.
- Venture capitalists and angel investors tend to invest in high-growth, entrepreneurial start-ups
- It’s important to get the terms of the investment drawn up by a solicitor since they can be non-standard and complex
How does equity investment work?
Before you approach people to invest in your business, you need to have a clear case for why you need funding and how much you need. Potential investors will want to know details about your past business activities and your plans for the future. Importantly, they will want an exit strategy: an idea of how and when they can expect to see a return on their investment. Some investors will be looking for a steady but reliable return. Others will be willing to take a risk but will be looking for a big reward.
If you’re not seeking investment from friends and family, there are a few options. You can look to angel investors and venture capitalists, who have money to invest in businesses that they believe have the potential to grow rapidly. You can also consider crowdfunding platforms, which offer the chance for many people to invest in your company.
Once you’ve found equity investors, you need to draw up a shareholders’ agreement with the help of a solicitor. This sets out the shares you’re selling to the investor, the price they’re paying and the responsibilities on either side. When the investor pays your business the money, you hand over a portion of the company to the investor in the form of shares. This usually involves issuing a share certificate and filing a form with Companies House. Depending on your agreement, the investor may then have some say over how the company is run.
In the future, the investor can get a return on their investment by selling their shares. This would usually be a private sale but could be on the stock market if the company is floated with an ‘initial public offering’ or IPO. You may also pay your shareholders dividends from your profits.
How much does equity investment cost?
One of the main advantages of equity investment is that you’re not paying interest rates or fees to lenders. Instead, you’re receiving money in return for a portion of your business.
However, there are some hidden costs. Most importantly you are selling a stake in the business and this means you will not benefit from any gains in value it makes in the future. If your business skyrockets then selling equity at a low valuation could be the most expensive decision you ever make. There can also be a high cost to closing an equity round, both in time investment and legal fees.
The amount you can raise from equity investment will depend on how much investors believe your business is worth, and how much of your business you’re willing to sell. To get an idea of your likely valuation you can benchmark yourselves against others in a similar industry. However, your valuation will ultimately come down to what the investors you meet are prepared to pay and they can be quite turbulent for young businesses.
A tech start-up has built a prototype and established a customer base, but the founders need investment to progress the business and launch their product. The founders approach a number of people as potential equity investors, including a successful former colleague of the CEO. Valuing the business at around £500,000, the former colleague agrees to invest £50,000 of her own money for shares worth 10% of the business. It’s also agreed that she will act as an adviser as the business continues to grow.
Frequently Asked Questions
Where can I find an equity investor?
It’s often sensible to look to friends, family, former colleagues and contacts first. Remember that even if the person investing in your business is someone you know well, it’s still important to get a proper agreement drawn up.
The next place to look may be private investor networks and websites that help match businesses with investors. Make sure you’ve got a well-polished business plan and you can sell your idea convincingly, as you’ll have to work hard to persuade people to invest. Try to project your future financials as accurately as possible, or at least quantify any uncertainty.
How much can I raise from equity investment?
This is a difficult question to answer, as it depends how much your business is worth and how much of your business you’re willing to part with. However, equity investors don’t tend to deal in small change so you’re likely to be looking for at least £10,000 but often much more. Although it may be tempting to raise as much capital as you can from equity investment, remember that selling shares also means ceding some control of your business. It may also be worth raising a smaller round now, then raising again once you’ve made progress and your valuation has increased.
It can be really difficult to put a value on your business, especially when you’re at an early stage. You need to think about how much money you predict your business will generate in the next few years, and also look at other businesses in the market to see how much they’re selling for.
Alternatives to Equity Investment
Relying on equity may mean you lose control of your business too quickly. It’s often better to fund safe investments with debt and only use equity for high-risk but high-return ideas. For instance, a retailer might use a credit facility to buy stock that they’re confident they can sell but use equity to invest in a TV advertising campaign given the uncertain return. It’s also important to understand that equity investment is likely to only be a realistic fundraising method for ambitious, high-growth business. Equity investors won’t get excited if you’re starting a lifestyle businesses predicted to generate only modest revenue. In these cases a startup loan or grant may be more appropriate.