Equity finance of some kind is crucial for any business. Unlike business loans, equity investors do not receive interest payments but do get ownership of a share of the business. Getting investment from an external investor may also mean giving up a degree of control over the business, or accepting restrictions on what you can do.
Because equity financing provides a financial cushion to help the business cope with losses, a business that's high risk or not yet generating cash may need a relatively high level of equity financing. A good equity base also helps protect any lenders, making it more likely that they'll be willing to provide loans or other forms of financing.
Sources of equity finance
For many new businesses, the key source of funding is the owner or management team, perhaps backed up by additional financing from family and friends. As the business grows, retaining a share of profits helps fund further growth.
More ambitious businesses may also look to external investors. Individual business angels typically invest anywhere from around £25,000, while professional venture capital firms generally make investments of £250,000 upwards. As well as providing funding, investors like these may also be able to offer contacts and expertise.
A more recent innovation has been a growing trend towards crowdfunding websites, which attract investment from members of the public. For larger businesses, selling shares to outside investors as part of floating your company may also be an option.
Attracting equity finance
Attracting investment typically requires a credible business plan, showing that you know what you are doing and have a reasonable chance of making good profits. Investors typically look to invest in businesses that have the potential to provide a significant return, at an acceptable level of risk.
Different investors may focus on different elements of your business plan. They'll want to be convinced that there's a good market opportunity and that you can be competitive and profitable. Many investors look for evidence that the management team has the right expertise and is fully committed to the business.
Of course, the financial elements of the plan need to make sense, offering an attractive return and some idea of how and when investors will be able to realise any gains they make. Individual investors may be more interested if they can invest tax-efficiently under the Enterprise Investment Scheme.
You should be aware that making sure your business is 'investment ready' can require a lot of legal and financial advice. You may also find it difficult to bridge the gap between how highly you value the business and what an investor thinks it's worth. The whole process of negotiating a deal can be complex and costly, particularly for venture capital. It's not unusual for fundraising to take up to six months, and for costs to add up to around 10% of the amount raised.