Equity Financing refers to raising money through the sale of ownership shares in a company. This can be used by companies for multiple reasons, out of which raising funds for large investments or asset purchases is common. The term “Equity Financing” is generally used for public companies listed on an exchange but it may also apply to private company financing. Equity financing can come from various sources which are often contacts of the entrepreneur. Getting proper professional advice before equity financing is very important.
Valuing your business properly is arguably the most important part to focus on before you go for equity financing. The issue here is that there are many methods used to value a business, and you may feel that none of them value it accurately. It is advised to use a combination of methods for this purpose while keeping in mind that at the end of the day, it is really about how much the investor is willing to pay for a part of your business. Therefore, it is important that you know how an outsider will do their own valuation. Generally, this is done in two ways. The first way is to add up the market value of all the assets – this might be appropriate for a very asset-heavy organization, though it may miss some of its value.
The second way is to try to estimate the potential future profits. If you’re looking forward to a considerable investment, it is advisable to seek help of a professional advisor. Banks as well as financial advisory firms provide these services. Your potential investors, especially if they’re institutional investors, will do their own analysis as well. However, it is in your best interest to have a sound understanding on your strengths and weaknesses by conducting a SWOT analysis, which would ultimately become negotiation points.
While all this looks rational and good on paper, it is likely that everything will simply depend on how good a negotiator you are. Make sure that you are persuasive, that you sound confident and that you are well prepared when you go to meet your potential investors. You may forget that equity financing is not simply a game where two parties trade shares in return for funds. There are other factors that also play in the arena. For instance, once a share is bought, the investor gains voting rights, rights to dividends and perhaps even the right to change the rights of future shareholders. In other words, this means that the investor will have the ability to have a say in how the business is run. There might be instances where you have to decide whether to own a non-controlling stake in a high value business or to own a controlling stake in a relatively smaller business.
Coming up with the perfect agreement is a tricky business. The key is to get everything double-checked, maybe even triple-checked by your legal team and even external advisors, and make sure that you have included the most important clauses. The agreement should be made to match the level of funding with a fair proportion of the ownership of the business. This will result in the cash being handed over. The agreement may include business advice from, or even access to other business support functions provided by the investor, that may easily be just as valuable as, or more than, cash. These agreements should also comply with the regulatory requirements that may change from sector to sector.
