Equity funding: does your business need or want?

Guy Rigby, head of entrepreneurs at Smith & Williamson, takes a closer look at your options if external equity funding is your route to growth

It’s often assumed that raising external equity is a prerequisite to business success. In many cases, this couldn’t be further from the truth

Most businesses start with very limited funding, typically provided by the founder, or by family and friends. ‘Keeping it in the family‘ is generally the preferred choice – you get to keep your potentially valuable equity, along with the choices and freedom that brings. Many entrepreneurs fear any loss of control and strive to retain as much of their shareholding as possible

However, cash constraints or growth opportunities may make it either necessary or desirable to raise additional funding. If this cannot be found through lending or other non-equity sources, then raising external equity may be your only option

On top of this, many entrepreneurs realise that they can create far greater wealth by giving away equity in exchange for both money and expertise. As the saying goes, 50% of something is worth a lot more than 100% of nothing. Although it may feel expensive, there are many benefits to be achieved from equity funding. Investors are naturally less risk-averse than banks and the day-to-day financing costs can be low

Ownership determines outcomes

Don’t underestimate the impact that external equity can have on your business. Your investors are there to make a profit and will generally have the right to a say in its management, including how much money you are allowed to earn and how you will spend their valuable resources. Equity investment will involve ceding elements of control to the investor.

So, as a general rule, if you want to run your business for life and make your own choices, try to avoid taking third party equity. This kind of investment typically means an exit at some point in the not too distant future, with varying levels of involvement along the way.

Timing is everything

Timing is vital when raising external equity. Where you are in your evolutionary process will be key to determining when you go looking for capital, as well as who you approach to raise it. Don’t leave it until the last minute – this won’t impress your potential investors, who will want to approach their investment in a measured and structured way. In the unlikely event that an investor is prepared to accelerate his investment process to meet your challenging timetable, you are likely to end up paying the price in terms of the level of equity you have to offer or the value at which you offer it.

So, you should think long and hard before taking the external equity route and, if you do, make sure you adopt a long-term, planned approach. The smartest way is to prepare and act well before the funding becomes a necessity.

Venture Capital and Private Equity

The private equity world comprises myriad investors and funds that make equity investments directly into privately owned businesses.

Venture capital (VC) is a subset of private equity. It is normally provided to early stage businesses with high growth potential, typically after the establishment of the business but before it has achieved scale. Venture capital investment, whether by business angels or funds, therefore carries high risks and offers the potential for extremely high rewards.

Private equity investors, on the other hand, tend to invest in more mature, established businesses, sometimes taking control of the business or sometimes providing growth capital in exchange for a minority interest. Private equity is often used for expansion, including ‘roll-out‘ and ‘buy-and-build‘ strategies.

At the lower or early stage end of the market, business angels tend to dominate the scene, as venture capital and private equity firms don’t want to spend their time and resources assessing smaller investments. This is often where the so-called ‘equity gap’ comes in, with angel investors typically investing from £10,000 at the lower end to £500,000 at the upper end and smaller venture capital and private equity firms often not wishing to make investments of less than £1-£2m.

So should you opt for a business angel or a venture capital firm?

If you’re lucky enough to have the choice, your intended pace of growth is likely to sway your decision. If you’re looking to grow fast and boldly and need a very significant cash injection, a VC is likely to be most beneficial. If you’re looking to grow in your own time with less pressure and less investment, a private investor may be preferable. In some cases, too much money can bring unwanted stresses and strains, so make sure you’re ready for the challenge.

If you would like to discuss the subject covered in this article or you want to sound out someone about raising finance for your business call Guy Rigby on 020 7131 8213 or email him at guy.rigby@smith.williamson.co.uk.

A date for your diary

Later this year we will be hosting an event focusing on how to grow your business using external equity funding. “Inside Private Equity” will be held in London in November.

If you are interested in attending please register your interest at http://www.smith.williamson.co.uk/inside-private-equity.

Disclaimer

By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

Smith & Williamson Limited

Regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. A member of Nexia International.

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