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The Cost of Money: Equity Investment – What’s That All About? Part 1

Wyn Jones, Regional Cluster Manager


A very popular feature which raised a lot of interest on our Investor Zone stand at the recent Taste Wales event, was our Equity Venn Diagram (see below). It maps out, in general terms, where different types of equity investment might be appropriate in a business life cycle.


To be clear, when a business receives equity investment, the following transactions take place:

  1. The business owners sell a portion of shares in the business to a third party (the investor)

  2. In return for the shares, the business receives a sum of cash

  3. The cash investment is not repayable, and interest is generally noy charged on it, which is the major advantage ‘investment’ has vis a vis debt.

  4. The investor retains the shares with the plan of selling them in the future when they hope they will have increased in value, and could possibly receive dividends on their shareholding, if available through profits.




Types of Investors:


In this edition I’ll be looking at the three Fs, crowdfunding and business angels. These are typically at the start and early years of a business’s life cycle.


3 ‘F’s Friends, Family and Founder


This type of investment is normally first into a business at concept or start-up stage. It’s usually just sufficient to get set up, at an average value of £1 - £10k, for a minority share in the business. Often very informal, unregulated, and high risk to the investor, but a quick resource of cash for the business owner.


Equity Crowdfunding


This is the practice of funding a business, by raising small amounts of money from a large number of people, typically online through a crowdfunding platform e.g. Crowdcube or Seedrs.


Crowdfunding is still a relatively new form of equity investment source in the UK and continues to evolve. Normally used at start-up, often before any sales have been generated, but is increasingly popular for scale up businesses with an element of trading track record. Historically, the average fund raised is £50k to £100k but there have been much higher raises in recent times, with £2m not being uncommon. This method is not suitable for all businesses though, the key is having enough of a ‘crowd’ of people interested in what your business is about.


Crowdfunding is very high risk to investors, but for low value.


A lot of preparation work is required by crowdfunding companies e.g., preparing robust plans, pitches and marketing materials. Fees are payable to the platform, and thorough due diligence is undertaken, which can be off putting, especially as there are no guarantees that the offer will be taken up.


Business Angels


An angel investor is an individual who provides capital for a business, in exchange for a minority ownership or equity (shares). These are high net worth individuals looking for a return on their capital. Business angels often invest in businesses operating in the sector or stage where they have already successfully run businesses, so that they bring money and experience. They sometimes invest as a syndicate, a group of individual investors with similar attitudes to risk and sector preferences. These individuals are often looking for close involvement in the business, commonly in the role of a mentor to the senior leadership team.


Preparation, pitching and due diligence can be exhaustive and time consuming, but very worthwhile if the right angel can be found. Finding the right ‘chemistry’ between business owner and angel is also critical. The average investments are for periods of 5 to 10 years.


Summary


This article is a high-level overview of the types of investment potentially available to SMEs looking for finance at the start or in the early years of their business’s life cycle. One of the most under-estimated challenges of equity investment in your business can be the demands on management time. Maintaining ‘investor relations’ tends to be more time consuming and complex the further down the list of investment types. More sophisticated investors will demand a continuous flow of business performance data, up-dates on progress with projects, market information etc.


It cannot be stressed enough that whatever level of investment a business is considering, a critical factor is the chemistry or relationship between business leadership and investors. If this is not right, the investment is unlikely to be successful for either the business of the investor.


Each of the types of investment listed above has its place and is appropriate and beneficial for a specific set of circumstances in a business’ life cycle, but they all have challenges and disadvantages. Use the links in our Equity Venn Diagram to understand the pros and cons of each type, or contact one of our Regional Cluster Managers if you would like to discuss further, contact details can be found HERE.


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