Raising Equity Capital
What is Equity Capital? - Private equity is a method of raising business finance in the form of share capital, to assist companies to the grow and succeed. The main purpose of raising equity capital is to start up a business, eliminated cash flow problems (caused by business debt), buyout a business or partner and expand and grow organically. Equity capital is usually underwritten by a shareholder agreement which outlines the financing arrangements between existing shareholders and a new shareholder. Equity capital can be obtained from established private equity capital firms, family and friends, private investors, financial institutions, insurance companies and pension funds. There are over 100 UK private equity firms, providing over £1 billion each year to companies. The vast majority of deals are for investments over £100,000. Equity investors will be looking for companies with a certain type profile, managed by certain type of team. In particular, they will be looking for industry sectors with high growth potential and companies and with a strong compelling sales message. They will also assess the people as much as the business idea, and therefore all shareholders need to be committed to offering an equity to a third party.
Private Equity Firms - private equity firms mainly raise their funds they require to make investments, from institutional investors such as pension funds or insurance companies. Some of these funds are organised as Venture and Development Capital Investment Trusts (VCIT's). The aim of the private equity firm is to invest in a broad range of high-growth companies, for between three and seven years. Many private equity capital firms specialise to investing in companies in specific industry sectors such as Banking & Finance, Construction & Property, Consumer Goods, Engineering, Health, Industrials, Leisure, Media, Natural Resources, Public Sector, Retailing, Support Services, Technology, Telecoms, Transport and Utilities. Other private equity capital firms specialise in investing in companies based on different situations and stages of development.
The main development stages are as follows; Firstly, business start-up's with little track record and small business revenues do not normally attract private equity firms. Their business plans may be unproven; the firm's market reputation may not be established. In short, an entrepreneur has a business idea and requires funding to get them off the ground. Secondly, businesses that are rapidly expanding and requires additional capital in areas such as product development, marketing resources, recruitment of staff and new premises. Thirdly, firms that need equity capital for debt re-financing purposes. This is a common problem for businesses where re-negotiation with existing banks or loan creditors has failed. Fourthly, management buy-outs in situations where the existing management team require finance to buy out their business division or the entire business. Lastly, corporate rescue packages where urgent new capital is required to save a failing business from imminent business insolvency and receivership.
Business Angels - business angels primarily focus on business start-ups will firms in early growth stages. In exchange for some equity in a business, a business angel may provide both the capital required, as well as possible skills, expertise and experience in a particular industry. These business angels are private individuals and investors who may provide the critical advice and capital required for struggling businesses to survive. Business angels are typically very wealthy, experienced, private individuals with a keen flair for business and an entrepreneurial outlook on business. A business angel might also be part of a larger syndicate seeking specialist investments in high growth industry sectors. Some syndicates or angels will require control of the company and others may take more laid-back and hands-off approach. It is important to challenge the skills and experience a business angel claims to bring to the table. If the Angel insists on day-to-day control and close working relationship, then any personality clashes could prove disastrous.
Venture Capital - venture capital providers also take an equity stake in the business in exchange for investment of capital. These businesses are largely targeting huge funds and invest millions of pounds at a time. Typically a venture capital organisation will raise money from other providers in order to provide a complete package for a business. Similar to all types of lenders, Venture capitalists will go through a due diligence process to establish the full facts provided by a start-up business or existing business, are accurate and correct. Venture capitalists are motivated purely by investment return and will exit the business usually within five years.
Differences Between Equity Capital and Loan Capital - providers of secured business loans have the right to charge interest as well as reclaim an asset secured against a loan, if the borrower defaults on the terms of the agreement. The loan capital provider does not share in the potential success or failure of the company borrowing the money. It is primarily concerned with the company's ability to repay a fixed sum of money over a given period. Banks usually place covenants within the terms of the business loan. If the business is struggling and cannot afford to repay its outstanding debts, owners of secured loans could force the company into receivership, to protect its loan. Conversely, private equity investors are primarily interested in the growth prospects of the company, its management team and unique selling points. If the business fails they risk losing their money. Some may take an active role in the business to assist it in achieving financial success. They work closely with the business owners to ensure their equity stake is protected, and they have the maximum chance of achieving a profitable return on their investment. Some will use shareholder agreements to guarantee their equity is restricted and protected. In addition, some spending decisions by the business owners may have to be approved by the private equity investor.
Creating a Compelling Business Plan - the business plan is a door opener into the office of the private equity capital firm. It must be concise, compelling and stand out from crowd of other competing entrepreneurs business plans. Investors will be expecting and scrutinising the Executive Summary to understand the business proposition, investment requirements, projected sales and profitability, unique selling points of the business and management experience. Please read out business plan guide to find out more. Under the Financial Services and Markets Act (FSMA), firms must be especially careful not to break rules regarding a 'communication or invitation or inducement to engage in investment activity'.
Sending a business plan out to potential investors may represent a financial promotion, and as such may only be handled by a qualified and approved person. In addition, the Act bans misleading statements within documents aimed at investors in companies or share opportunities. There are also specific rules surrounding the method of communications between the firm seeking equity capital and investors. Always seek legal advice on the latest rules surrounding investment and business transfer. Investors may take months to scrutinise the business plan, go through due diligence before making ay investment offers...
The Investment Offer - it is very important to ensure that any equity investment offer is carefully negotiated and considered by a qualified accountant or financial advisor. The accountant and financial advisor will:-
- Assist in preparing the business plan
- Valuing the company seeking capital
- Preparing accounts in the statutory format
- Organising meetings between the management and representatives of the equity firm
- Reviewing equity offers
- Negotiating and planning tax implications.
- Ordinary Shares - this is the most common form of shareholding for limited liability companies in the UK. Shareholders holding this class of shares will have no special rights or restrictions. They are entitled to income and capital, following the exercise of rights by other shareholder classes.
- Preference Shares - shareholders of this class are usually entitled to a fixed dividend payment. As the name suggests, they have the preferred rights over income and capital, before ordinary shareholders.