Categories
A Guide to Equity Financing
Funding a company can be tough - and it’s rare to do it alone. Having the capital needed to invest in the future while maintaining strong cashflow to keep business operations running means there is a constant need for cash.
When looking to inject cash from outside the business, there are two main methods: debt financing (loans), or equity financing. But what is equity financing and how can you access it? Here at Clifton Private Finance, we’ve written this guide to explain it all.
Table of Contents
What is Equity Financing
Equity Financing vs. Debt Financing
Equity Financings - Understanding Terms
The Different Types of Investors
The Advantages of Equity Financing
Why do Investors Invest?
Preparing for Equity Financing
Equity Financing Pros and Cons
Equity Financing Advice
What is Equity Financing
Equity financing is the broad term that refers to selling part of your company to another in exchange for capital.
There are many reasons to consider equity financing, as we’ll see later in this guide, and there are several places you can go to find an investor. But in all cases, when you sell shares for capital, it’s called equity financing.
Equity Financing vs. Debt Financing
When looking for cash to help your company expand and keep running, there are two main options:
- Equity financing - selling shares in the company for money.
- Debt financing - borrowing the money with an agreement to pay it back.
The first clear difference between the two is that with debt financing, there’s an obligation to pay the money back - equity financing has no such condition. By contrast, with equity finance, you sell on part of your company for the investment - in this way you may have to share the decision-making too, as the investor becomes a part owner.
Other differences include:
- Interest - Almost all debt financing comes with fees or interest; additional money you must pay for the service provided by the lender. This means you are always ‘out of pocket’ compared to capital raised through equity financing.
- Experience - When you obtain equity finance, in many cases, you also gain the expertise of the investor and their team.
- Debt Service Strain - The debt repayment obligation can put a stress on business cash flow and restrict future opportunities.
- Future Credit Opportunities - Equity finance doesn’t limit future applications for credit, where piling debt upon debt soon becomes impossible.
Equity Financings - Understanding Terms
There are a number of equity finance terms that can seem confusing - a little explanation goes a long way.
Equity
Equity refers to the size of an investor’s stake in a business or asset. If you own a business outright, you have 100% equity; whereas if it is shared equally with another, you each have 50%.
Equity finance is called that because it is finance provided in return for equity in the business.
Stock and Shares
When discussing investment, the terms shares and stocks come up a lot. In real terms these mean the same thing; equity held in a company. If an investor has invested in a company, they are said to have ‘shares’ or ‘stock’ in that company.
‘Shares’ is more usually used in the UK, while ‘stocks’ is a more prevalent term in the US. While there are some subtle differences between the two terms at a high-level, they can commonly be used synonymously. At Clifton Private Finance, we use ‘shares’ to refer to the amount of equity held by an individual or company in a business.
Dilutive and Non-Dilutive
Dilutive refers to financing that dilutes the ownership of a company through the sale of shares. Non-dilutive is financing that does not affect the level of equity held in a company.
Equity finance is an example of dilutive financing. A bank loan is non-dilutive financing.
Exit Strategy
An exit strategy is a plan, conceived prior to entering an investment, for the investor to realise their investment and leave the arrangement should certain conditions be met. Often, in making an arrangement for equity finance, the investor will have an exit strategy in place.
Exit strategies help set goals for the business, but can also be seen as limiting, as they push the company in a certain direction to accomplish the exit goal.
The Different Types of Equity Finance Investors
There are multiple avenues to find investment:
Angel Investors
An angel investor is an individual investing their own money in businesses during the early stages - startups or other young companies.
As an angel investor (sometimes called business angel) is using their own money, they are able to make a decision on their investment based on a number of more personal reasons; thus angel investors may invest in a company that they like rather than simply work with the numbers (although those numbers are still of utter importance!).
Angel investors often also bring their own experience and network of connections to the business, offering support in whatever way they can.
Attracting an angel investor is typically about the personality of the business leader as much as it is the business idea - the line ‘I invest in people’ is often cited by angel investors.
Angel investors typically invest sizeable-but-smaller amounts, often £100,000 or less, to fund engaging startups that they see as potentially profitable. Due to the personal level of their investment, they are often willing to take more risks in their investment than other investors. You can approach multiple angel investors to secure larger sums by working together.
Venture Capitalists
Venture capitalists (VCs)s are companies that invest substantially in businesses that have rapid growth potential. VCs represent a number of private investors and are looking to make impressive returns on the power of their investment. Unlike angel investors, they care less about the business leader and are more dedicated to crunching the numbers.
As the caretakers of multiple investment funds, venture capitalists are less likely to take significant risks on their investment and are keen to see strong business planning and comprehensive forecasts that indicate a solid likelihood of success. In exchange, VCs have access to far higher funds of capital than most angel investors, investing multiple millions of pounds into companies.
Venture capitalists often have an exit strategy of bringing the company to an IPO level, at which point they liquidate their shares for considerable profit.
Individual Investors
Private investors or individual investors are those people you approach directly asking for funding. They are often friends or family of the company directors who are offered an opportunity to invest in a new startup or growing firm.
Because of the personal relationship of many individual investors, each situation is unique, with a negotiation between the two parties regarding size of investment vs. equity provided.
Many individual investors have little understanding over the finer nuances of the business or business management, and it is likely they will not want to get involved in the running of the business or long-term decisions. They are also unlikely to have any strong business connections or bring any other similar skills to the company, unlike angel investors or venture capitalists.
It is essential to put comprehensive contracts in place when obtaining individual investment, clearly detailing the terms for both parties and avoiding any later issues.
Initial Public Offering (IPO)
An initial public offering (IPO), or ‘going public’, is the term given to a company that sells shares to the public on the stock market. It is a considerable undertaking that occurs later in a company lifetime, turning it from a privately owned venture into a full listed publicly-owned company.
An IPO can raise significant levels of capital for businesses, fuelling impressive expansion.
While public investors do not receive significant equity per share, the control and ownership of the company will move from a personally-run business to a more democratically-run shareholding, where shareholders can vote on major decisions.
The IPO stage is often considered the exit strategy for many earlier venture capital, individual and angel investors.
Crowdfunding
While not always a direct form of equity financing, one other similar route for investment lies with crowdfunding. Through online crowdfunding platforms, businesses can promote their company to public individual investors.
Done well, crowdfunding can be an excellent avenue for companies to boost their capital investment.
Latest Business Financing Case Studies
Below is a snapshot of our latest case studies, in which we broker finance solutions for businesses of all shapes and sizes, negotiating the best rates and terms and advising on the correct finance routes:
The Advantages of Equity Financing
When looking for capital, why would you choose equity financing? The following are some of the more common reasons to look for equity financing over other options:
Starting a Business
Very few businesses can start from scratch with no capital investment whatsoever, and if you’re not wanting to lean heavily on a business loan then investment capital and equity financing can provide exactly what you need.
More than that, however, angel investors and venture capitalists bring a lot to a fledgling business in terms of experience and connections. Having someone alongside to help you with the many early pitfalls of running a business can be a huge advantage as you will both avoid making mistakes and have specialists on hand to undertake some of the difficult areas of business.
Marketing specialists, accountants, legal advice and more are often brought alongside that early stage equity finance.
Loans are Difficult to Get
Without an established credit rating or strong personal finances, debt financing can be difficult to get in the early stages of a startup - especially those who present themselves as risky on paper. Banks and traditional lenders are stringent with their risk analysis and see things in a different way to investors.
Angel investors, especially, may perceive your company strategy from a very different perspective and be willing to come on board where lenders are more wary.
You Simply Don’t Want the Debt
Starting a business in debt can be a significant worry to many entrepreneurs, who prefer to have a better financial standing while they develop on their ideas, perhaps with a view to building a strong credit history for preferential debt financing in the future.
This can be especially true with companies who are projecting a tighter level of cash flow and are looking for capital without an ongoing repayment obligation.
You Have Your Own Exit Strategy
Not all entrepreneurs start a business with the desire to be in that company for life. Many look at a company in the same way as a venture capitalist - with a desire to build the business up enough to make it viable for an IPO before selling up and moving on to the next idea.
If this is your strategy, then working alongside investors with a similar viewpoint can be incredibly successful, as a shared goal and open-minded attitude to equity can lead to rapid and efficient success.
Why do Investors Invest?
When you are looking to obtain equity financing, it’s important to understand how the equation works from the other side of the table. With an insight into the investor perspective, you are far more likely to be able to present yourself accordingly. Consider the following:
- Investors are in it to make money - No matter how passionate you are about your business idea, all an investor really cares about is ‘will this work, and will I make money?’. They are rarely altruistically looking to improve your life. Money is the simple truth, so look at your business realistically and understand how it benefits the investor.
- Angel investors invest in people - You may think it’s your business idea that is the selling point, but often it’s you that they care about. If you show that you’re the type of person who can realistically and objectively run a business, with the skills and passion to lead a team, and a clear eye on the prize, then you’re more likely to obtain investment, no matter what your business idea is.
- Investors often need to widen their portfolio - A diverse range of investments spreads the risk for investors and increases their long-term security. It may seem sensible to approach investors who have similar businesses under their umbrella, but often the opposite is true and offering a branch in a different sector is appealing.
- Investors want to have a positive impact - While investors are not selfless, many do have a secondary desire to benefit their industry, the country, and even the world as a whole. Innovation and growth businesses can be enticing for these reasons.
Preparing for Equity Financing
So, you want equity financing? What do you need to do to secure funding?
Accounts and Paperwork
The first step towards equity financing is to have a realistic and comprehensive understanding of your business, the industry you are in, and the competition.
Undertake thorough market research to develop a detailed-yet-concise business plan, work with an accountant to ensure your figures and company valuation are realistic and even conservative, and make sure all the paperwork is in order to back up your claims.
How you present your business to an investor is vital, and turning up with less than 100% understanding of how your business will make money is futile.
Approaching an Investor
No two investors are the same, so research the investors who might be a suitable fit for your company. Be professional and confident - it’s essential that you never come off as desperate or begging, and equally that you are not arrogant or condescending.
If you believe in yourself and your proposal, then so will they.
Equity Financing Pros and Cons
Pros
- No repayment.
- Better cashflow.
- Alternative risk assessment to loans.
- Additional advice and experience from investors.
- Access to investor network.
Cons
- Equity financing is dilutive and lowers your control of the company.
- Major decisions may need to be shared.
- Profits are shared with investors.
- Ultimately may be more expensive than a loan.
Advice for Equity Financing from Clifton Private Finance
At Clifton Private Finance we work with both lenders and investors across the UK to provide the best business financing for our clients.
Call us today to learn more about equity financing and discuss your requirements on 0203 900 4322 or book in time to speak that suits you.
