Equity funding: Investment v control - where do you draw the line?
What to look out for
- Red Equity Funding involves giving up a share of your business - and some future profit with it
- Amber Cash introduced into the business means you no longer get all of the profit but your income may still grow
- Green Equity funders can often bring specialist skills and business experience to the party
Using equity funding to invest in your business also means potentially giving up some control. Where do you draw the line?
What is equity funding?
Firstly, we need to understand what “equity” is, and in this context we are really talking about the proportion of the business that you own and control. If all of the shares in the company are in your name, then you own 100% of the equity. If you “give up some equity”, then you sell some of the shares in return for an amount of cash, this cash often being used to invest in to the business.
How does this loss of equity impact?
It means that you have to pay dividends to the new shareholder in relation to the percentage of shares that they own. If you have sold 30% of the shares and are paying dividends of £100k, then £30k will have to go to the new shareholder.
If you still own 51% or more of the shares, then you should still have a controlling interest, but you are now no longer the only interested party in the business and it is likely that you will have to pay more attention to your “Corporate Governance”, so regular shareholder meetings, reports and generally being held more accountable.
Does equity equal accountability?
Accountability is not always a bad thing: you should be accountable to yourself and your company anyway, so having to do this for another party often just focuses the mind and makes things a little more formal. For example, preparing regular financial information is a good discipline, helping you to remain fully informed and thus making it quicker and easier to spot – and correct – any anomalies.
Are there any other aspects of equity that I should be aware of?
You probably want to ensure that you remain in overall control of the company, so don’t give up too much equity, and pay attention to the full wording of the sale agreement and its implications.
What are the other advantages of equity?
Apart from the cash that this can bring in, another potential upside is that the person buying the shares may have other things to bring to the party too. They may have existing specialist knowledge, previous business experience or perhaps some important connections within the industry, any of which might be on offer to help you and your business move forward.
Bear in mind that the new shareholder now has a stake in the business, so is certainly going to want to see it succeed as they want bigger long-term profits to share in.
Is equity funding available for any business?
In theory yes, although businesses with the potential for high growth are always likely to be more attractive to investors. They would normally see such equity purchase as fairly high risk, for which they would expect the potential for high rewards to balance this.
How much equity would I need to give up and what would I expect to get for my shares?
Yes, an expected question and, unsurprisingly, no easy answer. For one it will depend on the percentage of the shares that you are selling, the existing trading performance of the business, the potential for growth and what the third party is bringing to the business. As with all transactions, you can only get what someone else is prepared to pay and - almost inevitably - your own valuation will be higher than that of any potential investor: think Dragons’ Den.
Where might I look for equity funding?
Different approaches are necessary for different circumstances and requirements, but potential providers include venture capitalists, business angels and crowd funding-type operations. You might even wish to consider approaching existing business connections, friends or family, but do consider the potential long-term impact of such approaches. As I said earlier, you need to bear in mind that any potential investor will need to be convinced of, and satisfied with, the potential levels of return, so make sure that you are well placed to do this and have an appropriate Business Plan prepared.