Raising equity finance

If your business needs money to grow, one of the options open to you is issuing new shares in exchange for investment.

Is equity finance right for your business?

Interested in equity funding but don't know where to start? Watch our video with finance expert, Gary Torbett, as he talks you through risk, business plans, exit strategies and how to handle investors.

By owning shares in a company, investors hope to gain from your company's profits through the payment of dividends. Investors also hope their shareholding will increase in value. It means they would benefit financially through the sale of the business or through a listing on the stock exchange in the future.

By issuing shares in return for investment, you need to relinquish some ownership. So long as you retain 51 percent of the shares, you remain in majority control of your business. If you sell new shares equivalent to more than 50 percent of the business, it would be a good idea to avoid having only one investor. This would avoid having one investor owning a controlling stake.

As co-shareholders of the business, investors will always have input into how your company is run. It is therefore important to find investors that you feel you can work with and could add value to your business.

Who provides equity finance?

Equity investors can be anyone from the founder's friends and family to a large private equity house. The most common types of equity investors include:

  • Friends and family
  • Angel investors and angel networks
  • The crowd (through crowdfunding platforms)
  • Venture capitalists
  • Government funds
  • Private equity funds
  • Corporates (directly or through venturing arms)

An early-stage company that only needs a small investment may be able to meet its needs from the friends and families of the founders and employees. A larger, growth-stage business will need investors with more money - the bigger venture capital funds could provide this funding.

Larger companies might turn to private equity or large corporations. This may happen before acquisition or a stock exchange listing.

Advantages of equity finance

Some businesses, particularly early-stage ones, may not have the financial history required to borrow money from financial institutions.

Equity investors may provide investment, understanding that the return on their investment will come later on.

Investors would be accepting a level of uncertainty and risk attached to their investment.

Equity investment brings new people on board as shareholders, along with their skills and connections.

The right equity investor should bring the benefit of more than just their money. Many will be well-connected through their past investments or experience and this could help your business.

Your equity investor's interests and your business interests will also be aligned because your growth and profitability will increase the value of your investor's shareholding.

Getting the right advice

Raising equity investment can be a daunting and time-consuming process. A number of sources can give you help and advice.

Corporate finance advisers can help you prepare to raise equity, broker the transaction and introduce you to potential investors interested in your business sector. They'll often help in early-stage fundraising projects.

They'll still want to be involved in later-stage transactions such as acquisitions, mergers and sales. These advisers usually charge a percentage of the successful investment as a fee.

It's always advisable to have a lawyer when raising equity investment. This ensures that the terms of the investment are beneficial to you and your investor.

Technicalities of equity finance

Raising equity investment can be complicated. Common technical elements that you should be aware of include dilution, share classes and valuation.

Dilution

As you successfully raise equity finance, you sell a stake of your business by issuing new shares, which reduces your own share in your business.

For example, you own the one share that represents 100% of the share capital of your business. But when you issue one new share to an investor, your share would be diluted to 50 percent.

If you go on to receive more money from another investor and issue a third share in the business, both you and the original investor would be diluted.

All three investors would now own 33.3% of the business. However, the value of the investments should increase the overall value of the business.

Even though you would own less of the business than before, the value of your holding should be higher than it was before.

Share classes

Standard shares in a company are often called 'ordinary shares' but they could be called anything.

A company can issue shares in as many classes as it likes, and these can have different rights attached to them. The owners of ordinary shares usually have the option to vote at shareholder meetings.

At these meetings they might cast their vote on the number of dividends proposed, or the salary packages of board members.

Shareholders who hold 'preference shares' may be treated preferentially compared with other classes of shares. This means that they would be paid specific dividends first if the company was to be dissolved, or in the event of a successful exit.

Investors will insist on certain share rights before agreeing to invest in your company.

Valuation

The value of your company will determine how much you are diluted, and how much of your business your investors end up owning.

Got a question about accessing finance?

Get in touch with our team of experienced financial readiness experts who can help you secure funding from a range of sources including bank funding, equity funding, and grants.

Disclaimer

This guide was written by our investment team at the Scottish Investment Bank who work with Scottish businesses and UK and international investors.