Equity finance is a term used to describe capital that is invested into a business by an external contributor and in return for the investment, the investor will receive shares in the business. Equity finance is an alternative finance option to business loans which doesn’t require you to repay the loan, however, you will be giving away part of the business instead and possibly some of your control over the business.
Equity finance is often chosen by businesses that are looking to expand or to finance projects which traditional lenders may not lend to. Others may choose equity finance so that they don’t need to factor in loan payments or provide collateral to support the loan.
There are six different types of equity finance available to businesses which can offer different finance mechanisms and levels of finance. We have outlined below all six of the different types of equity finance which provide a range of options suited to different businesses and opportunities.
Business angel is the term used for private individuals who invest in start-up and early-stage businesses which can be done as individuals or as part of a group. This equity finance operates by the business angel receiving shares in the business in return for their investment which is typically for values up to around £150,000.
These individuals often also offer their business skills, experience and contacts to the business to help it succeed for all concerns. This is very much like the TV show Dragon’s Den model where the Dragons offer a combination of finance and their time and expertise.
Like with the Dragon’s Den, the investors make their own decisions and will invest in the business based on its viability and how much they think they can gain from the investment in the future. They will be looking to get a good return on their investment and time in assisting the business to grow.
Business angels can be from businesses that you are already affiliated with such as suppliers, customers, businesses that you partner with on delivery and even competitors. They could also be from an unaffiliated individual that has no connections with your business which may be harder to find.
Business angels through the nature of providing both financial and practical business support can really help businesses to grow and develop their expertise in areas that they previously haven’t been in or have been weak in. The business angel can help develop fledgeling ideas and products and assist you in getting them to market in a more cost-effective and efficient manner.
Venture capital is another form of equity finance that tends to be for larger sums of money that what you would get from business angels. Venture capital is more suited to businesses that are start-ups or small businesses that are seen to have long-term growth potential or those that have the ability to expand beyond their existing capabilities. Venture capital is typically for a larger amount of over £250,000 and in return, they will take a share of the business.
The finance behind venture capital tends to come from investors, investment banks and other financial organisations. But like with the business angels, venture capital can offer more than just finance, as it can also offer managerial expertise to help plug a gap in the business, or technical expertise to help guide the business through expansion or growth into a new area.
Venture capital is an attractive option to new and fledgeling businesses as it provides them with the finance they need to get started or grow quickly when other finance options are often not available to them. It allows an injection of cash without the burden of having to factor in loan payments into their operating costs.
For those investing in the business, it is also an attractive opportunity as they are able to invest in a business that should reap them above-average returns. They will get a share and a say in the business in return for their investment which can help them to influence the direction and growth of it.
Private equity is designed for businesses that are generally established and that require investment to assist them in their growth or expansion, however, it can be used in some cases to assist business start-ups. This investment is classed as private as the capital is not listed on the public exchange. The funds tend to come from private equity firms that are institutional investors or accredited investors.
Private equity finance can also include venture capital as one of the types of finance that are available. The private equity firms generate their revenue from management fees and performances fees.
Private equity finance can be used for a variety of purposes including financing company buyouts, making acquisitions, making purchases of equipment, purchasing real estate, expanding working capital and improving the company’s balance sheet.
To take private equity finance you need to be a private business and not be publicly listed. It can be used for businesses that have been de-listed as they are no longer a public business. The advantage of private equity finance is that it enables businesses to take investment without the pressure of quarterly earnings and repayments on loans.
One drawback of private equity is that the share value of the company is not determined independently but is a negotiation between the investor and the business, as well as what the rights of the shareholders are. The private equity firm can also take a large or controlling share of the business which can result in a loss of control of the business.
Equity crowdfunding is like it suggests a mechanism for a group of individual investors to crowdfund the investment collectively. It is typically used for early-stage or business start-ups that require capital to get started.
Equity crowd funders will become individual shareholders in the business and will receive dividends and be exposed to the same risks as any other investor would be. They will tend to hold a low number of shares in the business each and therefore not have a controlling share individually, although collectively this could be different.
Most equity crowdfunding opportunities take place on online platforms that are open to a variety of individual investors who can assess the opportunities available and choose which investments they want to contribute to. These online platforms will assist both the investors and the business seeking funding to find investment. The platforms can offer a range of support including managing financial transactions and communications such as messaging and video conferencing.
Equity crowdfunding works best for businesses that are looking for funding that will assist in the growth and development of the business as this will attract more investment at a desirable level. It allows you to reach a different audience of investors with potentially millions of people through some of the crowdfunding platforms. It also allows for people who want to make low-level investments to access investment opportunities in businesses through the collective funding model. And unlike other investment opportunities, investors can offset some of their risks through the government’s tax relief schemes.
Enterprise Investment Scheme
The Enterprise Investment Scheme is also known as EIS or SEIS (Seed Enterprise Investment Scheme) and also Venture Capital Trusts (VCTs) and Social Investment Tax Relief (SITR) are all government schemes that have been designed to assist qualifying businesses to access equity funding from investors. The focus is primarily on investment into business start-ups and early-stage businesses and each scheme has slightly different qualifying criteria based on the level of investment and the targeted businesses.
These schemes offer advantages to individual investors in the form of tax benefits which includes the investor being able to access income tax relief at 30% on the share cost, and being able to access deferral of Capital Gains Tax on the sale of assets by reinvesting in shares. Individual investors will be required to complete self-assessment income tax return for their Enterprise Investment Scheme investments.
The Enterprise Investment Scheme allows businesses to raise up to £12 million of investment through the scheme throughout the business’ lifetime, and it incentivises private investment into these companies from individuals. This helps businesses to make their investment opportunity more attractive.
Venture Capital Trusts are listed companies that have been approved by HMRC to offer investment or loans to private companies. It is again used as an incentive to support the investment into small and fledgeling companies.
Social Investment Tax Relief is similar to Enterprise Investment Schemes, but it is targeted towards social enterprises rather than private businesses. It offers incentivisation to private investors who make investments in social enterprises.
Initial Public Offering (IPO)
Initial Public Offering is where a company is first listed publicly on the markets for shareholders such as on the London Stock Exchange. It is termed as initial as it only applies when the company is listed for the first time and not whilst it continues to be listed.
Equity finance is raised through selling shares for the company on the open market through either the public market or a stock market. The finance gained through Initial Public Offering can help assist businesses to grow and raise finance to develop the business.
Businesses are required to meet certain eligibility criteria before they are allowed to be listed for the first time and to seek Initial Public Offering. This includes needing to appoint specialist advisers such as corporate adviser, a broker, an accountant and a lawyer. You will also need to prepare a range of documents and ensure you have control of your assets, amend any contracts impacted by the IPO, protect any intellectual property and have adequate insurance cover.
Through the IPO, businesses can raise substantial funds for their business in return for shares in it. The advantage of doing an IPO over other forms of equity finance is that it can help you to retain control over your business. It also allows you to have a mechanism in place to raise finance again in the future. However, listed companies have to disclose more financial information more regularly including publishing half-yearly and annual financial results.