Equity funding is a route SMEs can take where an investor provides funding in exchange for shares in a company. With equity funding, the amount an investor can offer will depend on what the SME can provide in terms of stock and ownership in the company. Equity investors can come from all manner of backgrounds, including friends and family as well as venture capitalists, with 61% of UK SMEs launching with either personal capital or that of friends and relatives, according to the Bank of England (BoE).
Below you’ll find a breakdown of the most common forms of equity funding, exploring the relative appropriateness to different businesses and the pros/cons of each.
1. Angel Investing
An angel investor is a wealthy individual who provides a capital loan for new businesses. Typically this is in exchange for some sort of convertible debt or ownership equity, depending on the deal’s terms. Angel investors usually swoop in when few others are willing to put money on the line for an idea, so historically these individuals are typically less risk-averse than other investors.
Before searching for a broader network of angel investors, ask family and friends if they know of anyone within your circle who might have the means and be willing to take a look at your proposal. You may end up with a better deal that way.
If you’re looking to raise a small amount of finance to start out, then raising investment from angels is probably the best way to get it. Investments typically range from £10K to £500K (under SEIS or EIS). Raising from an angel is often much more straightforward than raising from VC or institutional funds.
With an angel investor, you’ll also likely get a mentor and an experienced partner as an investor to support you in starting your business. Try to make sure your partner understands your area as well; experience can be more valuable than money. A media company, for example, should get an investor who has significant experience in media.
Although the due diligence is much less than with VC investment, you’ll need to make sure your paperwork and finances are up to date and ready for inspection. Often the only way to find an angel investor is through your network, so go out to events and start mixing.
2. Venture Capital
Venture capitalists invest huge sums into startups or expanding businesses with tremendous growth potential and traction, typically investing considerably more capital than angel investors. VCs are professional investors, responsible for investing and growing some of the world’s most innovative companies, including Facebook, Spotify and Airbnb.
As with angel investors, there’s no obligation to pay back the investment if your startup fails. Venture capitalists are attractive as they can offer considerable business knowledge, vast sums of capital and often take much higher risks.
With higher risk comes the expectation of a higher reward. VCs will expect considerable returns and will want a clear exit plan, in the form of acquisition or selling shares. These are professional investors, so they’ll want to see a solid business plan and sound accounts.
The type of funding is typically reserved for more developed technology businesses. It’s often more complicated, as such significant sums of money come with more hands-on investors who will want more control over their investment, and therefore within your business. Venture capital is a good option for high growth companies looking for serious finance in exchange for equity. Typically, VC money in the UK starts from £500K and goes up to £50 million for a single investment.
Finally, bear in mind that you’re taking on a serious equity partner who has experience investing professionally. VCs bring lots of money but also pressure and structure beyond what you have currently, so make sure you’re ready for that.
3. Crowdfunding
Crowdfunding has really grown as a source of investment for businesses overall and for specific products. It involves taking a small amount of investment from a lot of people to equal a much larger sum. Crowdfunding can be divided into two types:
- Equity based: You give away equity in return for investment funds.
- Rewards based: You give away perks, rewards or thanks for people supporting a specific product or business.
- Loan based: You can crowdfund loan, hence source of finance.
High tech and product based businesses generally use crowdfunding. It’s important to consider that the success of a crowdfunding campaign is typically reliant on your ability to market your proposition. It can be a great source of finance, especially if you’re launching a product, as you’re effectively doing pre-sales to fund development and launch. There is also a good range of crowdfunding platforms to choose from, including kickstarter, Seedrs, Crowdcube and IndieGoGo.
If you’re looking to raise money to start or grow your business, equity-based crowdfunding has become a popular way to do it. Be careful though; unless there’s a nominee structure, you may have to report to thousands of small shareholders if you raise funds this way.
Summary
Equity funding can be a great way to support your business to launch or grow, however it’s worth exploring other funding alternatives to see what fits for your business.
