Fundamentals of Business

Long term finance

Types of capital
Share (equity) capital

Equity finance is a way of raising share capital from external investors in return for handing over a share of the business. This may take many forms including a share of future profits, but is most frequently associated with sharing the ownership of the business to some degree. When you own the whole of the company, your shares are 100%

Suppose

You issue x% of shares now, then your stake will be reduced to (100 - x)% of the company Say you issue further y% of shares, your stake will be reduced to [100 - (x + y)] of the company and so forth.
The two main providers of equity finance for private businesses are venture capitalists - also known as private equity firms - and business angels.

While shares are most obviously associated with the stock market, the majority of small enterprises won't go anywhere near a stock market in their lifetime. They are more likely to give out shares in their company in return for a lump sum investment. This may either be from friends and family or, for businesses that are looking for capital to fund high growth, through formal equity funding finance.

Formal equity finance is available through:
. business angel investors
. venture capital firms
. stock markets

These investors are willing to put up capital for a share in a growth business. The advantage of raising money in this way is that you don't have to pay the money back or pay interest to the investors. Instead, shareholders are entitled to a share of the distributed profits of the company, known as dividends.

Advantages and disadvantages of equity finance

Equity finance can sometimes be more appropriate than other sources of finance, e.g. bank loans, but it can place different demands on you and your business.

The main advantages of equity finance are: The funding is committed to your business and your intended projects. Investors only realise their investment if the business is doing well, e.g. through flotation or a sale to new investors. Resources for your business. The right business angels and venture capitalists can bring valuable skills, contacts and experience to your business and can assist with strategy and key decision making. In common with you, investors have a vested interest in the business' success, i.e. its growth, profitability and increase in value.

Investors are often prepared to provide follow up funding as the business grows.

The principal disadvantages of equity finance are:
. Raising equity finance is demanding, costly and time-consuming. Your business may suffer as you devote time to the deal. Potential investors will seek background information on you and your business - they will closely scrutinise past results and forecasts and will probe the management team. However, many businesses find this discipline useful regardless of any funding.
. Depending on the investor, you will be subject to varying degrees of influence over the management of your business and making of major decisions.
. You will have to invest management time to provide regular information for the investor to monitor. Your share in the business will be diluted. However, your share may be of a much larger business because of the funding.
. There can be legal and regulatory issues to comply with when raising finance, e.g. when promoting investments.

Is equity finance right for your enterprise?
Different forms of equity finance suit different business situations.

Venture capital is most often used for high growth businesses destined for flotation on the stock market - with shares available to the general public - or sale.

Business angels can offer investment, particularly in the early or growth stages of development, in return for equity. Because of the risk to their funds, investors expect a higher potential return than for safer, more secure investments. Equity finance is likely to be most suitable where: the nature of a project deters debt providers, e.g. banks the business will not have enough cash to pay loan interest because it is needed for core activities or funding growth