Guide to equity finance

What is equity finance?

Equity finance is money that is raised through surrendering shares of the company in exchange for investment. Equity investors do not usually have to be repaid at a particular date, which makes this a good way for start-ups to raise finance. The return for the investor will depend on the success of the business, meaning there is a risk they’ll never see their money again. Because of this, you must convince your investors that your business will succeed. The following guide will help you to determine whether equity finance is right for you.

Advantages of equity finance

The main advantages of equity finance are:

· Unlike a bank loan, finance raised through equity will not incur interest or fees

· Your investor will have an interest in the success of your business, and will therefore contribute skills, knowledge and contacts.

· Investors will only see a return if your business is doing well, so the risk is theirs and not yours.

· The investor will be interested in the long-term success of the business so that they can eventually sell their ownership at a profit. This means they are likely to provide follow-up funding to promote further growth.

Disadvantages of equity finance

The main disadvantages of equity finance are:

· Depending on the amount of investment you secure, you could be giving up a considerable share of your business.

· You will be giving up some control over the business, and may lose some of your power when it comes to decision-making.

· There is the possibility that an influential investor could change aspects of the business culture in a way that you dislike.

· The process of raising equity finance will take a considerable amount of time and effort, and your business may suffer as a result.

· The agreement can be expensive in the short-term, as you will usually be required to seek assistance from lawyers and financial advisers.

Different types of investors

There are two main kinds of equity investors, business angels, and venture capitalists.

Business Angles are organisations or individuals who invest money in a business, in return for a share of ownership. A family member or friend could be a business angel, They will be involved in decision-making and will have a significant role in the overall organisation of the firm. Business angels will usually consider applications for financing for a wide range of industries, however they must have the potential for high return. An advantage of using a business angel is that they are likely to have local knowledge, as they will generally invest in businesses within the same geographical area. Unfortunately, business angels can be difficult to find, as they don’t regularly seek investment opportunities. A business angel will usually place a great importance on their relationship with the business owner, so finding the right investor may take some time.

Venture Capitalists are organisations that invest large sums of money in exchange for a share of ownership (equity). Typically they will invest a minimum of around £2 million, and specialise in firms who are developing new and innovative technology. Venture capitalists will invest in businesses with a large earning potential and a high return on investment, usually within a specific timeframe. Because Venture Capitalists like to invest in businesses with a proven track record, this type of finance is not usually offered to start-ups. Venture capitalists do not usually have input into the daily operation of the business, but may influence the overall business strategy. While venture capitalists can bring a large amount of finance and expertise to your business, the process of securing a deal can be long and complex. They will usually require detailed financial projections, and you are likely to incur legal and accounting fees during the negotiation stage.

Are you ready for equity finance?

Before you approach an investor for equity finance, you should ask yourself the following questions:

· How much money do I need?

· Am I willing to give up a portion of my business to secure the finance?

· Am I willing to lose some power of decision-making with regards to business operation?

· Does the business have a unique selling point that will make it a viable investment?

· Are my business plans realistic?

Pitching your plan

If you decide to go forward and seek equity finance after asking yourself these questions, then you will need to prepare your investment pitch. You will need to give potential investors the following details:

· The amount of finance required

· The share of the business that you are proposing to give up

· The timescale of investment

· The likely return that they could expect on their investment

Of course, they will also need details about the business, so you should be prepared to give them:

· Financial details, both historical and forecast

· Details of suppliers and customers

· Details of products and services you offer

· Business polices and procedures

When presenting your business plan or pitch to an investor, you should:

· Be open with the investor about your business prospects and not present them with an unrealistic vision for the future.

· Show your personality. Your investor will only offer finance to someone they trust, and to someone they feel they will work well with.

· Show the investor that you are passionate about your business, and they will be more likely to share your enthusiasm.

Links

For more information on equity finance, visit businesslink.co.uk

For a list of local business angels networks, visit the British Business Angels Association (BBAA) website.

To locate venture capital companies, visit the British Private Equity and Venture Capital Association (BVCA) website.

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