Equity Finance – What Are Your Options?
In 2018 we published an article on equity finance and explored what options were available. Given the current situation we want to revisit that topic.
During the pandemic, and specifically the lockdown, businesses face unprecedented financial pressure. As such obtaining funding may be the only option to ensure survival. There are many ways that a business can be funded, but essentially it falls into two main categories:
Equity and Debt
As a finance brokerage, we specialise in arranging debt finance for business owners. This is a topic we will be looking at in the coming weeks. However, we also get asked for guidance on equity finance. As such, in this article, we have outlined the main options for raising equity funding.
Equity Funding Options
Bootstrapping – The Business Funds Itself
As your business develops, it should generate enough cash to enable further growth and expansion. In other words, you are using the capital you have generated to invest back into the business.
The benefit of bootstrapping is that you don’t give away any equity in your business to a third party to generate additional capital. As such the business remains in your sole ownership. You also have the benefit of not taking on any debt funding with the obligation to repay it.
The downside of bootstrapping is that it may slow and potentially hold back future growth. This is because you can only invest in the business when you have generated enough cash from sales. In addition to funding your capital expenditure you have to continue paying your day-to-day operational expenses.
Clearly there is increased risk and little room for error in calculations with this option. It also does not allow for crisis and emergency planning. Businesses funded in this way will likely be struggling in the current climate.
This is probably the most common way of funding a small business or start-up. The business owner will self-fund the business from savings or personal debt, such as a re-mortgage or second mortgage on a private residence. Alternative forms of personal debt also include unsecured loans or credit cards.
As with Bootstrapping, self-funding has the advantage of enabling the business owner to retain full control of the business.
There are potential consequences. If the business owner uses their savings for self-funding, they need to be aware of the future impact for example when considering retirement. Additionally, personal debt secured on the business owners’ main residence poses a risk to their home if the venture is unsuccessful.
Lastly unsecured lending such as loans or credit cards usually carry a high rate of interest. As such they should only be considered for a short term investment where the debt can be paid off quickly. This will help to avoid the high and rapidly escalating interest charges.
Friends and Family
As a finance broker we generally advise against this option for funding your business. However, it is a consideration for many business owners.
Funding in this way will likely be achieved through debt or equity funding. In other words, you borrow capital from family or friends, or they invest in your business and as such retain a stake.
As the friend or family member now has a vested interest in your business you have lost full control. Not only that, but businesses do fail, and that’s when the problems can really start.
The result can be ruined friendships, unpleasant family gatherings, and difficult conversations. A colleague once commented: “Everyone will be your friend until you owe them money”.
Whilst it may be tempting to accept help from family or friends very often they don’t fully understand the risks involved until it’s too late. Our advice on this as a funding option is – proceed with caution.
Taking on a partner can be a very good method for sourcing funding. Generally, a suitable partner is or has been in business themselves and as such understands the risks as well as the journey.
An interested partner may wish to have some involvement in the business, either in the day-to-day operations or in a more advisory, non-executive role. This can be beneficial however remember, you are no longer in full control. You now have a partner and have given away some equity in your business.
Additionally, it is vital that you choose your partners with care. Do you know them? Can you trust them? Over the years, we have had clients who’ve learnt from bitter experience that the partner wasn’t as trustworthy as they had originally thought.
This is another option that requires careful consideration. It can be a great source of equity funding, but tread with care when choosing your partner. The wrong partner could place your entire business in jeopardy.
Angel investors are typically high net worth individuals who are both able and willing to invest in a business. In return they usually receive convertible debt or ownership equity. There are many benefits of choosing an angel investor, not least of all that you profit from their experience.
When it comes to approaching an angel investor for an equity investment, they will want to know all about your business. As such, you must be well prepared. They are a tough crowd, so you must take all aspects of your pitch seriously. Similarly, you need to ensure you are pitching to the right investor. Ask yourself is this someone you really want to work with?
Think carefully about whether this is a process you want to initiate. Many business owners like the idea of an investment partnership such as this, but are less keen on the accompanying accountability.
Crowd funding is a form of angel investing, except instead of just one investor you have numerous investors. This method for raising finance is web-based and can work for either an established or start-up business.
This could be a good option particularly if you have a well-established business audience, or a popular brand. Crowd funding can be effective when utilised to promote individual aspects of business development, or to support the growth of the business as a whole.
As an example the organic food vendor Neigh, who sell their produce from converted horse-boxes at boutique festivals around the UK, utilised crowd funding solely to replace a stolen, converted vending facility. The funding event was relatively small however, enabled them to maintain trading at a crucial time in their business journey.
The Final Word
There are multiple options to consider when it comes to equity finance however, we do advocate seeking professional advice before deciding on a particular option.
While equity finance is not something we arrange, we are always happy to chat through the options with you in more detail if that would help. In the meantime, if you think your business could benefit from some correctly structured debt finance in the form of a business loan, mortgage, invoice finance or asset finance, why not get in touch.