Equity
In simple terms, equity is the net value of a company after deducting its liabilities from its assets. However in financing language equity is usually taken to be the share capital in the business, and a slice of equity can be sold to raise money either to invest in the business or for shareholders to realise some cash for themselves, or a mix of these.
The growing SME will typically need to raise money for investment. The percentage of equity, or ownership, released will depend on the amount of cash required and on the value of the company. The valuation of a private enterprise (as opposed to a listed company which will have a published share price) is largely down to subjective judgment and horse trading! There will be many factors involved in valuation, including growth potential, size and appeal of the market sector, quality of management, any previous share sales, level of overall risk, amount of money required and - very often - personal chemistry. An investor will want to be able to realise his investment at the right time - this is known as the 'exit', and could be through flotation, trade sale or simply a buyout of their shares by another investor.
Although you lose some percentage of ownership, there are several advantages in releasing some equity and it's good to have an open mind on potential benefits -
• raise money without the burden of interest payment or compulsory capital repayment (although dividend payments may be required at some stage)
• you can bring strategic partners into the company, which can help with credibility
• the new shareholders may well participate in further rounds of financing
• they can provide expertise e.g. as non-executive directors
How will you obtain the best valuation for your business, so you don't give too much equity away? A large part of the battle is to be well prepared, so you look credible, organised and well on top of the issues. You also know what to expect and how to negotiate. This is Investment Readiness.
Sources of Equity
Personal resources, friends and family - but beware the pitfalls!
Business Angels - private, high net worth individuals who wish to invest their own money in growth companies. BA's will invest from a few £000 up to several hundred £000, occasionally over £1 million. Higher amounts may well be syndicated by a number of BA's with one of them acting as the lead investor, who does the deal work. Access to BA's is through individual contact or through a BA network such as NBAN and Beer & Partners. They will look at start up/early stage proposals. Quite often, a BA will get involved in the business and many will bring useful experience. They will want to see a robust business plan which demonstrates the ability for them to exit the company at a healthy profit, usually within five years but often longer. BA's can benefit from tax allowances on investments, such as EIS (Enterprise Initiative Scheme). See for example www.swain.org.uk and www.xenos.co.uk
Venture Capital - firms who will invest money they have raised from private and institutional investors. Deal size can range from around £2 million to several hundred £ million (the larger deals being more in the 'Private Equity' arena). There are a few funds that will look at smaller amounts; typically they are venture arms of the big banks, e.g. HSBC Ventures UK. VC's will typically look at only later stage companies with a more proven business model, and will want to exit in 3+ years. They will look for significant growth potential, and would normally want to see forecast revenues exceeding £30 million p.a. in five years. There are over 200 VC firms in the UK, the largest being 3i plc. Firms based in the US and Europe will look at UK proposals, particularly if there is international sales promise. VC's will often fund management buy-outs or buy-ins (MBO and MBI).
Corporate Venturing - where a major company invests in a smaller one, to gain access to innovation and ideas.
Government/European sponsored funds - a number of equity funds have been established, financed by a mix of public and private money, to help certain defined industry sectors or UK regions. These include-
• Regional Venture Capital Funds - matched investment up to £500,000 - see www.southwestventures.co.uk
• Finance Cornwall - matched investment up to £1 million - see Finance Cornwall summary
• Finance South West - see Finance South West
• Finance Wales - see www.financewales.co.uk
• Bridges Fund - disadvantaged areas throughout UK - see www.bridgesventures.com
Private Placing - a company's shares are sold to a number of individuals and/or institutions. It could be a mix of business angels and your contacts, with perhaps a small VC as lead investor. Typically offered to more than fifty participants, a private placing is likely to be managed by an investment bank or corporate finance boutique and will need a full prospectus rather than just a business plan.
Flotation - the listing and sale of your shares on a public market. Used to raise finance and provide a wider market ('liquidity') for a company's shares. The reality is that very few companies achieve or even desire a public listing. Professional fees for a flotation can be high, so it is an uneconomic option for smaller fundings. There are now dozens of exchanges in the UK and Europe for share listing and each have different criteria. In the UK, the main exchanges for smaller companies are Ofex and AIM. Typically, one would raise £0.5m-£3m on Ofex, and £3m-£25m on AIM. Flotation is also known as an IPO (Initial Public Offering).