Raising equity funding

Is equity funding right for your business?

Interested in equity funding but don't know where to start?

As a first step, you can watch this video with our finance expert Gary Torbett. He introduces some key aspects of equity funding, including risk, business plans, exit strategies and how to handle investors.

What is equity funding?

Equity funding is when your company issues shares in exchange for a cash investment.

By owning shares in a company, investors hope to gain from your company's profits through the payment of dividends. They also hope their shareholding will increase in value. If this happens, they can benefit financially through the sale of the business or through a listing on the stock exchange in the future.

When you give up shares in return for investment, you need to relinquish some ownership. As long as you keep at least 51% of the shares, you remain in majority control of your business.

If you sell new shares equivalent to more than 50% of the business, it's a good idea to have more one investor. This prevents just one one investor owning a controlling stake.

As co-shareholders of the business, investors will always have input into how your company is run. That's why it's important to find investors that you feel you can work with. You should also consider whether they can add value to your business.

Who provides equity funding?

Equity investors can be anyone from the founder's friends and family to a large private equity house. The most common types of equity investors include:

• Friends and family
• Angel investors and angel networks
• The crowd (through crowdfunding platforms)
• Venture capitalists
• Government funds
• Private equity funds
• Corporates (directly or through venturing arms)

An early-stage company that only needs a small investment may be able to meet its needs from the friends and families of the founders and employees.

A larger, growth-stage business will need investors with more money — bigger venture capital funds could provide this funding.

Larger companies might turn to private equity firms or large corporations. This may happen before an acquisition or stock exchange listing.

Benefits of equity funding

Some businesses, particularly early-stage businesses, may not have the financial history required to borrow money from financial institutions.

Equity investors may provide investment with an understanding that the return on their investment will come later. In this situation, investors are accepting a level of uncertainty and risk attached to their investment.

Equity investment brings new people to the operation as shareholders, along with their skills and connections.

The right equity investor should bring benefits beyond just their money. Many will be well connected through their past investments or experience. This could help your business.

Your equity investor's interests and your business interests will also be aligned, because your growth and profitability will increase the value of your investor's shareholding.

Getting the right advice

Raising equity investment can be a daunting and time-consuming process. A number of sources can give you help and advice.

Corporate finance advisers can help you prepare to raise equity, broker the transaction and introduce you to potential investors interested in your sector. They often help with early-stage fundraising projects.

They'll still want to be involved in later-stage transactions such as acquisitions, mergers and sales. These advisers usually charge a percentage of the successful investment as a fee.

It's always advisable to have a lawyer when raising equity investment. This ensures that the terms of the investment are beneficial to both you and your investor.

Technical elements of equity finance

Raising equity investment can be complicated. Common technical elements that you should be aware of include dilution, share classes and valuation.

Dilution

As you successfully raise equity finance, you sell a stake of your business by issuing new shares. This reduces your own share in your business.

For example, let's say you own the one share that represents 100% of the share capital of your business. When you issue one new share to an investor, your own share will be diluted to 50%.

If you go on to receive more money from another investor and issue a third share in the business, both you and the original investor would be diluted. All three investors would now own 33.3% of the business. However, the value of the investments should increase the overall value of the business.

Even though you now own less of the business, the value of your holding should be higher than it was before.

Share classes

Standard shares in a company are often called 'ordinary shares' but they could be given any name.

A company can issue shares in as many classes as it likes, and these can have different rights attached to them.

The owners of ordinary shares usually have the option to vote at shareholder meetings. At these meetings, they might cast their vote on the number of dividends proposed, or the salary packages of board members.

Shareholders who hold 'preference shares' may be treated preferentially compared with holders of other share classes. This means that they will be paid specific dividends first if the company is dissolved, or in the event of a successful exit.

Investors will insist on certain share rights before agreeing to invest in your company.

Valuation

The value of your company will determine how much you are diluted and how much of your business your investors end up owning.