Whether you have just started or are planning to grow your business, bringing in outside money is something all founders consider at some stage. Raising funds can be a complex and tiring process, especially for those with no prior experience, or if you’re unfamiliar with the type of fundings available. So we’re here to hopefully help break down just one type of finance – equity funding.
Out of the types of funding businesses have access to, the most popular for startups and SMEs is equity funding. Simply put, equity financing is the process of raising capital through the sale of a portion of the company.
How can you access equity funding?
For public-listed companies, this means issuing shares of the company in the stock market for investors to buy. For private companies, the process is more complicated. Buying an equity stake of a private company is one of the most rewarding yet most risky investments an investor can make, due to the uncertainty of prosperity of the business and limited (or non-existent) exit opportunities.
It is, therefore, crucial for founders to have the capability of convincing potential investors of the potential of their business by displaying a good understanding of the market and the fit of the company as well as effectively communicating a realistic and well-thought business plan. This process can often become a full-time job, taking time and focus from the founder or CEO away from the business which could negatively impact performance and development.
Professionals at firms and Angel networks involved in Private Equity and Venture Capital tend to have great business sense, market awareness and have extensive experience having already been involved in similar ventures in the past. Founders, especially those with no previous experience in business, could benefit from having a PE firm or Angel network as a stakeholder since they can offer advice and provide access to a network within the sector that could be very beneficial for the future of the firm.
Most founders worry that by selling a share of their company they will lose control of the business and that equity investors will try to impose their wills over theirs, however, in practice most equity investors prefer to take minority positions where they play a supportive role rather than being involved in the decision making.
Founders should also consider Crowdfunding as a way of raising capital. In most cases, funding via crowdfunding takes place in a nominee deal structure where the shares will be held by the platform and investors will only gain the economic benefit of being shareholders of the company and will not have the right to vote or take part in decision-making.
What are the benefits?
The main ‘pro’ of equity funding in comparison to other options, is that by selling a portion of your company, you are also abolishing a portion of the risk that owning the company might incur. Similarly, any economic benefits the ownership of the company might generate in the future will proportionally be divided among all shareholders. Additionally, equity funding provides businesses with the opportunity of raising much larger sums than other alternatives. A great example of this is Graphcore, a business that raised over £265m via equity funding since the beginning of 2020.
The main alternative to equity funding is debt funding. Although by raising debt companies will still maintain whole ownership of the business, it comes with considerable risks. Firstly, as obvious as it might sound, debts have to be repaid.
For early-stage businesses, that could require the founder to take a considerable risk, since they would then be responsible for paying back the loan if the business fails. Furthermore, raising debt will create a constant cash outflow that will be reflected on financial statements and could act as a constraint on future business operations. Founders should also be aware that the debt-to-equity ratio of a business is considered by investors a very important measure for the risk of becoming a shareholder, therefore, raising debt could also lead to lower future valuations and prevent or diminish future equity terms in the future.
Weighing up the costs
There is a wide range of factors founders should consider when deciding whether to opt for raising equity or not. Firstly, it should be considered whether this is a good time to grow or not.
Raising capital can be a very exhausting and complicated process where success is not guaranteed, founders should consider whether it’s the right time for the business to grow and whether they will have the time to go through the process.
Secondly, the long-term impact of the raise should be considered, especially on how new shareholders could support the business and whether their goals align with the founders’. It is very common for equity investors to have an exit time (ie: 5 years) and that might not fit the plans of the founder. Additionally, the main reason why every founder should consider going through the process of raising equity is that equity investors, unlike banks and lenders, will make their decision of whether or not to invest in a business based solely on how successful their products and business model are expected to be. Attracting equity investors can also act as reassurance that the business is on the right track to success.
If this all sounds of interest to you, we highly recommend checking out TechSPARK’s and the Investment Activator Progamme’s events such as Silicon Gorge and PitchMe! since they offer a great opportunity to receive unbiased feedback from potential investors and business experts, helping founders identify the strengths and weaknesses of their business and leading to a more prosperous future.
Main image credit: Canva Studio