In part three of our funding series, we take a look at more traditional equity funding and how it might be used to benefit impact ventures.
What is Equity Funding?
In order to gain extra capital at the various stages of company growth, an entrepreneur can sell a percentage of shares in their business in exchange for money.
For example: “A company has an initial valuation of €1.5m and external investors wish to pay €150,000 in exchange for shares. The investors now own 10% of the company and the start-up has gained €150,000 to invest in company growth. The investors might expect a financial return of approximately 1,000% in three to seven years – most likely through selling shares to a later-stage investor.”
Pros of Equity Funding
- No repayment necessary
- Cash injection to the business
- Negotiable valuation
- Freedom to spend investment
- Mentoring from investor(s)
- Access to investor(s) business network
Cons of Equity Funding
- Dilution of company shares
- Loss of control
- Pressure to hit financial targets
This method of investment is an exchange of money for company ownership. Therefore, there is no repayment or interest to worry about as in the case of debt finance. The deal can take 3 to 24 months to finalise depending on the investors, the amount of money being sought, the stage of the company and the nature of the negotiations.
In the early stages of a company’s growth, ‘seed’ investment of up to €150k allows time for a young company to grow without the pressure of debt. Investors will recoup their investment through dividend pay-outs or, more likely, selling their shares at a later stage to new investors. In many countries investors also enjoy tax benefits for their investment.
At a later stage (further funding rounds, series A and beyond) where the entrepreneur is looking to raise in excess of €500k, venture capital investors become an option. Factors such as company assets, profitability, traction in the market, intellectual property and the quality of the leadership team will affect investor interest.
Shareholders of the company will own shares until they are sold on or the original entrepreneur makes enough profit to buy them out.
When negotiating the exchange, it is important to consider the shareholder agreement as this will determine how shareholders are able to value and sell their shares as well as setting the terms and conditions of the contract.
Also known as business angels, private investors or seed investors, these are affluent individuals (high net worth) who seek promising early-stage companies to invest personal funds into with an eye to making medium-term returns. These stakeholders will invest early on when the project is still fairly high risk because shares are cheaper than they may be in the future.
Venture Capital (VC) Funds
VCs provide funding to companies with more traction and that have likely already secured funding from seed rounds. These investments come with an expectation of high growth and returns. Expect the VC to request board-level representation, a significant chunk of company shares and an agreement that the company must hit financial targets.
A primary difference between VCs and angel investors is that while angel investors use personal funds to invest, venture capitals act on behalf of an organisation or company, using institutional money.
- Develop business plan, pitch deck, pitch video, financials etc
- Present business to potential investors
- Negotiate company value, investment amount, criteria and KPIs
- Due diligence process and negotiation of shareholder agreement
- Agreement signed, receive funding
|A good article and video with all the basics of equity funding
|An American-focused article on the pros and cons of equity (and other) funding
|British Business Bank
|Some excellent content about raising funding
ABOUT THE AUTHOR
Alex has over 15 years experience in founding and running businesses, the most recent company having raised over £50m in funding for businesses based across the globe. He has a thorough knowledge of business funding options and can draw on many successful consultancy engagements to bring impetus to venturing. Alex has now set his focus to working with entrepreneurial teams looking to make a positive impact on the climate crisis and the broader UN Sustainable Development Goals.