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EQUITY FINANCE |
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> What is equity finance? |
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Seeking private equity will involve giving up ownership of part of your
business.
Investors generally show a preference towards businesses with high growth
potential. Some investors may also show a preference towards the type of
business, for example investing in technology companies.
Be prepared for the process of obtaining investment to take time. Investors
are unlikely to make quick decisions as they will need time to study your
business plans and objectives carefully.
What is equity finance?
There are two sources of equity finance: money introduced by the business
owner(s) and money introduced by investors (individuals or investment
companies).
Equity finance is capital invested into a business in return for a share of
the ownership of that business. Equity finance provides businesses with
capital to carry out their business plans, often when they are unable to
raise finance from other lenders.
Equity finance does not offer a guaranteed return to the investor, therefore
it is seen as inherently more risky than other forms of finance such as debt
or asset finance. To compensate for the risk, investors are looking for a
large future return on their investment. Investors are looking for
businesses to invest in which will allow them to achieve a typical average
return of 33 per cent per year. However, it is worth remembering that if the
investors’ share of the business has substantially increased in value, you
will also benefit from the increased value of your share of the business.
Equity finance is available at many different stages in a business’
development. For example, equity can be used at start up, during expansion,
acquisitions and for management buy-outs (MBOs).
Where can you get equity finance?
There are various sources of equity finance including private investors,
corporate investors, professional private equity firms and social
development funds. Private equity investors are often referred to as venture
capitalists and business angels.
Business angels
Business angels are private investors (acting individually or as part of a
group) who will invest in local businesses with high growth potential.
Business angels often invest smaller amounts of money than would be
available from venture capital funds (usually £10,000 to £100,000). This is
often more beneficial to new businesses or those in the early stages of
expansion. As well as providing the finance, a business angel can also bring
business expertise and may want to get involved in the business to help it
achieve its objectives.
Venture capital
Venture capital companies will usually make larger investments into
businesses. Typical investments are from £1,000,000 upwards. Due to the
larger investments made by venture capitalists, this is not always a
suitable option for a new business.
If you are just starting out in business, it may be possible to obtain
finance from a business angel in order to get your business started. The
business angel may support your business until it is at a level where a
venture capitalist may want to invest.
What do you need to secure finance?
A high growth potential business
A thoroughly researched business idea, with clear aims and objectives
A strong management team with the confidence, motivation and experience to
drive the business forward
A well-prepared business plan
How do you find a suitable investor?
Finding a suitable investor will depend on three factors:
• The value of investment you are seeking
• The stage of your business development, eg start-up, expansion, MBO
your industry sector
• The value of the investment you need will determine whether you should seek
business angel investment or venture capital.
The next factor to consider is the stage of your business development. Some
investment funds concentrate on helping start-ups, others concentrate on
established businesses seeking equity for expansion.
Finally, some equity investors may only be interested in specific industry
sectors. You may also feel that you need an investor who has a specific
interest in your business area. Alternatively, your business idea may be
attractive to a general investor.
It is therefore essential that you make sure that you are approaching the
right sources of finance. Research is vital and there are sources of advice
available to help you to build up a list of suitable investors. The British
Venture Capital Association can help you locate investors who may be
interested in investing in your business. The National Business Angels
Network can help you find the right business angel for your business and can
provide help and guidance in preparing and presenting your business
proposal.
When you have located a suitable investor, you will have to present your
business plan and convince the investor that your business idea is sound and
that you and your management team have the experience, confidence and
motivation to achieve your ambitions. You must be clear about why you need
their finance and what their investment will enable you to achieve. Many
businesses fail to secure finance, despite having potentially high growth
businesses, due to poorly presented plans. The SBS has launched six pilot
schemes to help businesses overcome this problem to enable them to become
‘investment ready’.
If the idea is of interest to the investor they will require more in-depth
information about your business. If your business is already trading, this
process will be similar to the due diligence process when selling a
business; your accounts will be scrutinised, contract and customer lists
checked and business practices investigated.
If the investor decides to go ahead, an investment agreement will be drawn
up. As you are selling part of your business, you will need to make sure
that you take professional advice on all parts of the contract. Negotiations
can take some time but it is essential that you fully understand what
changes will be required to your business and what your investors will
require from you.
How do the investors realise their investment?
The main aim of your investor is to make a profit from the money they have
invested in your business. The investor achieves a profit on the capital
when they sell their share in the company at a premium to the price they
paid for it, and may generally look to realise their investment within three
to six years.
For example, if £10,000 is invested for a ten per cent share of a business,
when the business is sold for £1 million, the investor’s share will be worth
£100,000.
It’s important that you are prepared for this and that when you approach
sources of equity finance you consider appropriate exit strategies for them.
Your investor will be able to discuss preferred exit strategies. The most
common exit strategies involve:
the sale of the business
the founders buying back the investor’s share of the business
company flotation on the stock market
Advantages of private equity
Private equity does not have to be repaid immediately. Many investors will
not be looking to withdraw their finance for several years.
Equity investors bring more than simply money to your business. They often
have many years of experience in business and have many contacts who they
will be able to use to further your business where appropriate.
It enables a business to undertake longer-term projects, which could not be
financed through traditional debt or asset finance, in order to meet
business objectives.
Disadvantages of private equity
You will need to be willing to share control of your business.
A large proportion of your profits will go to your investors who are looking
for high returns on their investments.
Legal fees and other costs can be very high.
Hints and tips
If you want total independence and control of your business, do not consider
private equity. Regardless of how much experience you have, your investors
will still want to monitor progress.
It is important to feel comfortable with your private equity company as you
will be working together for many years and it is essential you can build a
good relationship.
Before agreeing to any investment, make sure you fully understand what it
will mean for your business, especially in terms of management control and
exit strategies.
Taking professional advice from your bank or accountant can help you come up
with the best way to finance your business, making the most of the capital
you have to invest, the private equity that you have available and any loans
and grants you may have secured.
What to do next
Look realistically at your business idea and determine what type of equity
you are likely to attract.
Make sure you have researched your business idea thoroughly and have a
well-developed business plan.
Determine how much finance you require.
Make a shortlist of investors who are likely to be interested in your
business and approach them with your proposal. |
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