Equity financing refers to the percentage sale of ownership in your company in order to raise funds for business purposes. Raising capital, to buy office premises, by selling shares in your company needs careful consideration. The potential cost saving of owning your own premises must be weighed up against the cost of selling the shares. It also raises the question of the type of equity partner you need in your business. Are you simply looking for capital or are you looking for a more active partner?
Equity financing can differ tremendously in scale and scope: For example, a small business owner may sell shares in his/her company to raise anything from a few thousand Rands to a couple of million Rands, whereas a listed corporation will sell shares to investors (companies and individuals) to raise billions of Rands (for example, Google and Facebook).
The most important point to bear in mind is that if you intend using equity capital to purchase your own premises, your business plan needs to show how this purchase forms part of a bigger plan that will grow the business and improve revenue and profits. If this cannot be done, the chances of obtaining equity capital are small.
Ambitious small companies that grow into successful businesses will often have several rounds of equity finance investments during their growth. There are many different types of equity financiers: Most have a distinct preference for the type, size and sector focus of the companies they invest in.
In general, businesses start by using the business owner’s savings, often with help from friends and family. Then the business reaches a stage where they need finance in order to grow; and it is at this point the business owner looks for early stage equity finance partners.
Equity financiers who invest in early stage businesses, often called Angel Investors, are really picky about who they’ll invest in. They have a lot to lose since such a high percentage of small businesses fail in the first 5 years. Equity financiers also expect to exit from the deal at some point. This is called an exit strategy.
Very few equity finance companies are willing to invest permanently in your company. Invariably the deal is structured to include an exit clause that dictates the terms of how they will exit from the ownership of your company, how they will be paid as well as the length of time they want to invest. Payment options can include the owner buying back the shares that had been sold to the equity partners - at the price specified in the agreement. Sometimes payment for the exit of the first round of equity partners can be made when a second round of investment happens. Either way, the terms and price guidelines for exit will be clearly set out in the shareholding agreement.
Equity financiers will want to keep a close eye on the progress of the business. Expect them to at least sit on your Board and at most to be quite active in the management of the company. Again, the level and type of involvement you are willing to work with should dictate the type of equity funder you select initially.
Some of the government agency equity financiers automatically assign mentors to smaller businesses that they have invested in. Business owners have to cooperate with the mentorship program as part of the equity deal.
This type of investment comes from private individuals, private companies or family and friends who are prepared to risk their money on start-ups and/or early stage businesses.
Your investor might be willing to invest in you because you already have a relationship that involves trust. However, in the case of private individuals and companies that provide seed funding for start-ups they will want to examine your business more thoroughly and insist on a due diligence before formalising the investment offer. Some investors like to be actively involved in what happens in the business, in which case your company will benefit from their expertise. Others prefer to take a back seat and let you run with it provided they receive regular feedback on financial progress. How much they invest in your business, and the shareholding structure, depends on available funds, their perception of your business and its growth opportunities and how you negotiate the deal.
Deciding to sell shares in your business is a big deal. Like all major decisions, you need to weigh up the positives and the negatives before making the final decision. It is also critical that you carefully select your equity finance partner to make sure that whoever will co-own your business brings additional value and business acumen that can help grow your business.
Some equity funders only invest in high growth companies. They are looking for a 20% to 25% upwards return on their investment.
Many of these investors have minimum amounts that they will invest, this is usually in the region of R10 million to R20 million but varies from fund to fund. The assumption is that you need money for gearing and that you are on the brink of a big breakthrough. In South Africa, there are few funds that would invest this type of equity in start-up businesses, unless they believe you have a groundbreaking business concept and a strong management team. It’s just too risky.
There are equity finance companies that balance their portfolio of investments to include investments in the following types of businesses:
Generally, equity finance for ordinary businesses is more available. These investors are looking for regular, steady returns on their investment and some specialise in specific sectors as well.
Whichever investment option suits you best, it is useful to take expert advice to make sure you understand the terms and conditions of the investment and that it is fair and does not unduly prejudice you.
Whilst equity finance may not cost you that much in the beginning it could be costly if your business does really well. That is, costly in the sense that you would be sharing your profits with the investors. However, you would also need to acknowledge that the growth probably wouldn't have happened if they hadn't taken the risk of investing in your company!
Costs you should be prepared to finance in order to conclude an equity finance deal include:
If you are interested in exploring equity finance as an option, then read What Angel Investors and Venture Capitalists look for. After that, take the finance readiness quiz and if you successfully answer the questions, you'll be linked to a list of equity lenders.
Finfind provides its services free of charge to businesses seeking finance. Our primary purpose is to link SMEs with all the relevant finance providers and finance products that match their funding needs. As a matching service we are not required to be a registered finance provider as we do not loan money directly.