Put simply, raising capital through equity is the process of drumming up funding via the sale of a stake in an enterprise. This will circumvent the need to borrow from traditional sources, and thereby avoid an interest bill required to service debt. However, unlike creditors, shareholders will expect a share in future profits, usually within three to five years.
There are many different categories of equity financing. Here we take a look at three aimed at the earliest stage businesses: personal capital, angel capital, and venture capital.
This is the most common kind of equity financing, particularly for small businesses and start-ups. Whether it’s savings, the proceeds from a property or funds from the sale of personal items, this method, sometimes known as ‘bootstrapping’, is when a business owner starts or expands a company with little or no assets.
Then there’s friends and family. This may offer a relatively quick way to access finance as those close to you may not ask for a business plan and will lend money on the understanding they will not receive a return until the business starts generating a profit.
Of course, there are potential pitfalls when it comes to accepting money from friends and relatives, not least the potential to affect relationships if things don’t go as planned, and some may want a say in the running of the business or demand a large stake. The friends and family financing path should not be trodden lightly.
Angel investors – also known as business angels and seed investors - provide funding in relatively modest amounts. So tens of thousands of pounds rather than six figure sums. It can be an individual or a syndicate who is looking for a return on their investment in approximately three to eight years.
Business angels have a degree of flexibility; it’s their money and they decide what to do with it. Be aware that while some may be passive investors, others will be more hands-on. On the plus side, angel investors tend to have a fairly long-term outlook. They are not generally seeking a quick return, which should take some of the pressure off the business.
The next step up from angel investors, venture capitalists anticipate a lot more than family and friends and individuals. Yes, they too want equity in the company, but they are professional investors and expect a significant say in how the business is run, usually taking a seat on the board. They tend to specialise in high growth industries where the risk is much higher and so anticipate a large return on their investment.
While angel investors may only invest tens of thousands in a firm, venture capitalists concentrate on multi-million pound outlays. They also invest the money on behalf of a fund targeting predetermined return requirements and hold periods. However, VCs also introduce significant experience and know-how and tend to open a lot of doors to develop the business – choose your VC wisely to access the best mix of skills, contacts and capital.
Venture capital is generally provided by ultra high net worth individuals, family offices and venture capital firms who will typically provide the funding in rounds – they want to know that you have achieved set milestones before handing over another tranche of money.
The downside is lack of control, both over business decisions and when the venture capitalist exits the company. But for many firms venture capitalism can be a vital source of money skills and contacts.