What is equity finance and can it benefit your business?
No matter how innovative your product or service is, every business can benefit from additional finance to help it thrive. From business loans to incubator and accelerator programs, there are a wide range of funding options available — but not all of these will be suited to an early-stage or start-up company.
A common choice for those who might not be able to afford the interest attached to traditional loans is to raise money through equity finance.
But what exactly is equity finance?
With our handy guide, we’ll help walk you through what equity finance is — plus how you can benefit from it and how you can get started — so you can work out if it’s the right type of funding to give your business the boost that it needs.
What is equity finance?
Equity finance is a process where you sell shares in your business in order to raise money. To do this, you can either sell your shares to new investors or existing shareholders.
You won’t need to repay the money that you receive for the shares, instead, your business’ investors will own a part of the company and they’ll receive a percentage of the company’s profits (also called dividends).. This means that they’ll then become shareholders in the business and you can decide with them how involved they want to be in the company.
Many businesses will try equity financing over other finance options as it offers a way to generate large lump sums of money that don’t need to be repaid. Investors will make a return on their investment when the company successfully starts turning over a profit.
What are the advantages of equity finance?
For some businesses, they’ll have enough money to set up, expand, and start generating profit once they set up shop. But others might need to take out a business loan — which some new or small businesses may struggle to get.
That’s why equity financing can be a convenient option. It can help you to develop and grow much faster as you’ll be able to use the money to improve your business.
Some of the main advantages of equity finance are:
Capital, essentially, is anything that can increase your ability to generate value. Generally, you can raise greater amounts of money through equity finance than you can by borrowing money. This is because with equity financing:
- There’s no expectation to repay the money you borrowed
- You won’t have to pay interest in any form
- You won’t have to pay any financing fees associated with many types of loans
- Loans will have a maximum amount that you can borrow
Freedom from debt
When you take out a loan, you’re borrowing money with the intention of eventually paying it back — plus interest and any finance fees. Regular loan repayments can hinder your growth plans, and the interest can put you in a worse position than you were initially.
It’s also worth noting that it might be tricky to get a business loan if you have a poor, little or no credit history. With equity finance, your credit score isn’t a factor, which makes it a better option if you’re struggling to receive a loan.
Investors bring experience, skills, and contacts
As well as supporting you by providing an upfront-cash payment, some investors can be much more valuable. When it comes to finding the right investor for your business, you’ll want to make sure that they have experience within your industry. They’ll then be able to provide you with expert advice, insider knowledge, and useful contacts within the industry. These can help to accelerate your business’ growth and you might not have been able to access these benefits without equity financing.
Your investor will want to help your business take off the ground as they’ll only see a profit if it’s successful. This means that it’s in their best interest to help accelerate your business’ growth, and they may even be prepared to supply additional funding if you really need it.
What are the disadvantages of equity finance?
As with any source of finance, there are always going to be drawbacks. Here are a few things to consider:
Possibly have to split any profits made
By purchasing a stake in your business, your investors will require a split of the profit. The amount that they receive should be mutually agreed on and be drawn up in writing, but you need to carefully consider how much you can viably payout.
Investors will own a portion of your business
In return for receiving a cash payment, you must also be willing to give up a share of your business. And it’s not just some of the profits that you’ll need to part with — your investors will also have a say in how your business is run. This can be advantageous if they have a wealth of knowledge that could benefit you from the industry, but it also means handing over some control when it comes to management decisions.
Raising the funds can be time-consuming
If you have existing stakeholders who are open to further business exchanges, equity finance can be a smooth and successful process. But if you don’t and you need to approach investors, it requires a lot of hard work and patience. Getting to the stage where a potential investor is ready to help support your business can be time-consuming and take away from other areas of business that need your attention. It might even cause your business progress to suffer.
Is equity finance right for my business?
Given the advantages and disadvantages of equity finance, it won’t always be suitable for every business. That’s why it’s strongly recommended that you do thorough research on not only equity financing, but other methods of finance funding.
Generally speaking, equity finance can be suitable for:
- Start-up or small companies that are struggling to obtain a business loan — As equity finance doesn't involve any money being repaid to shareholders, it can be the best funding option for anyone who doesn’t have the cash to pay repayment interest on a start-up loan.
It’s also useful for those who don’t have any tangible assets yet but need to cover expenses like research and development.
- An established company with plans for growth — If your company is doing well and the next step in your business plan is to expand, raising the capital to do this through equity finance can be the best choice. Taking out a loan demands repayments and interest further down the line, which might slow down your estimated rate of growth.
- A company that wants to acquire another business — Companies that are looking to procure another business, or buy out another business owner, often gather the funds by pooling together the capital from lots of different sources. Equity finance is often one of these methods.
- If you want to sell your business — To sell your business, you want it to be in as successful of a position as possible for it to be attractive to potential buyers. This will help you get the most out of the sale. In order to do that, you might want to consider equity finance so you can accelerate growth in time for when you’re ready to sell.
What are the main sources of equity finance?
The main concept of equity financing is relatively straightforward: you sell part of your business to an investor in exchange for a capital boost that helps you build and grow your company.
While this is the basic premise for equity finance, you can raise the money for it through a number of different sources.
Angel investors are often wealthy entrepreneurs or business people who use their money to invest in start-ups or small businesses to help them grow. Angel investors will tend to have a lot of experience in the industry that they’re investing in, which can be a big benefit to your company. Angel investors can invest individually, or as part of a group of other angel investors. This is known as a syndicate.
Since they often become involved at a company’s early stages, they are likely to have a close interest in the business’s future and will be keen to help it progress. Unlike other investors, angel investors know that companies have the potential to fail and that they’re putting their money on the line. Typically this means that they’re more determined to help and see the company succeed.
Venture capitalists (VC)
Similar to angel investors, venture capitalists fund during the early stages of a business to help them grow. There are two different types of venture capitalists; a venture capitalist who invests their own money or a venture capitalist firm that often obtains their investments from pension funds, wealthy investors or insurance companies.
VCs may also request a bigger share than angel investors, as they often want to ensure a significant return.
Equity crowdfunding involves pitching your business on a regulated crowdfunding platform. Investors and members of the public can consider your listing and decide to buy shares. The way that this works means you’re likely to raise small amounts of money from a large group of investors.
This source of equity financing is best for businesses that offer products or services, as the public often looks to invest in these types of companies.
Seed Enterprise Investment Scheme (SEIS)
The Seed Enterprise Investment Scheme is a government scheme that encourages investors to buy shares in early-stage companies. The scheme is incentivised as it allows people to invest up to £100,000 per tax year while receiving a maximum of 50% tax relief.
From a business’ perspective, they can raise up to £150,000 in total through SEIS funding. Visit the government website to find out more information about the SEIS scheme.
How to find investors
It goes without saying that obtaining more money to improve your business should be a goal for every business owner. Unfortunately, the chances of attracting potential investors without putting in the work is unlikely.
Thankfully, for anyone looking to secure a source for equity finance, there’s some easy ways to find potential investors to give your business a boost.
1. Crowdfunding platforms
There are a number of online fundraising platforms that you can visit to connect with potential investors like individual investors, angels, or possibly even banks and funds that are looking for new opportunities for their capital.
Some of the more popular equity crowdfunding platforms to try are:
It’s also important to note that even if you don’t manage to find funding through one of these platforms, it can be a way to help you and your business be noticed by the right people.
2. Friends and family
Tapping into your personal network may not sound like the most professional option, but believe it or not, family and friends are some of the most popular sources of early finance.
One of the benefits of seeking funding from people that you already know is that they may not request the criteria that traditional investors will most certainly demand. Your family and friends might not be concerned about interest rates, shares within your business, or a position as a board member.
However, this isn’t to say that investment from friends or family doesn’t come with its challenges. If your business fails and your investors’ money is lost, this could cause a permanent strain on your relationship.
3. Your professional network
If you’re already established within your industry or you have a wide net of contacts that you can reach out to, pitching to your professional network is an obvious way to find future investors.
Thanks to the internet, it’s never been easier to connect with your network. Social media sites like LinkedIn are made for networking with other business owners and businesses in your field. And if you have mutual contacts with a prospective investor, it might help to make you more legitimate and trustworthy.
Are equity and capital the same?
Equity and capital are both ways of describing an owner's or shareholder's monetary interest in a business. But they're not the same thing. Here's a quick definition of each, so you can easily tell the two apart:
- Equity is the value of a business once all its debts have been paid. As the business owner, the equity is the amount of money you'd have left if you sold off the business and all its assets and paid off its debts. Equity can be used to determine the financial health and value of a business.
- Capital is the total funds a business has to cover its day-to-day running and expenses, including payroll and the cost of producing products or services. Unlike equity, which relates to the overall value of a company, capital is the money available in a business bank account or a business loan.
How is equity calculated?
There is a simple formula you can use to work out equity:
- Equity = Assets - Liabilities
To do the maths, simply use your company's balance sheet to add up the value of all its assets, such as property and equipment. Then add up the total value of your business liabilities, which are any debts and other obligations your business owes.
Then subtract the figure you have for total liabilities from the figure you have for total assets, and the number you're left with is the equity in your business. If it's positive, the company has enough assets to cover its liabilities. If not, the business is in negative equity and its liabilities exceed its assets.
Giving your business the boost it needs with Bionic
If equity finance isn’t a viable funding method, Bionic can help you to find something that works for your business. Our business loans team can help you to explore the most suitable type of financing to meet your needs. They’ll also show you how you can access it and give you the best price on the market.
To give your business a financial boost, get in touch with us today.