Secure equity investment

Equity finance is a way of raising capital from external investors in return for a share of the business. If you have a viable business with high-growth potential, but you are finding it difficult to obtain bank finance – or are unable to or do not want to pay loan interest – then equity finance may be useful.

There are two main providers of equity finance for private businesses – venture capitalists and business angels. The equity finance provider that is best for your business will depend on a number of different factors including the amount of investment you need, your return potential and development opportunities.

If you are thinking of securing private equity finance, this guide will help you to understand investors’ points of view more clearly. It identifies what you can do to make your business more attractive to potential investors and provides information about how to identify the right investors for your business.

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Is private equity investment what your business needs?

If you want to attract sound capital investment you need to make sure your business is investment-ready. You also need to understand how investors operate, because this will help you to find financial backers that are right for your business. There are two main types of capital investment:

• private equity finance – where investors provide funding in return for shares in your business that are not listed on the stock exchange
• debt finance from financers who provide capital in return for repayment with interest at a later date – eg banks

Small and medium enterprises and growing businesses in the UK can also access various government sources of finance, such as the Enterprise Finance Guarantee and Enterprise Capital Funds. Selling shares in your company on one of the UK stock markets is another way of raising business capital – for more information, see our guide on floating on the stock market.

It is important to decide which type of investment is right for your business before rushing into a decision. Usually, businesses will look for private equity investment only when they find it hard to obtain debt financing, but where they have the potential for high growth. This potential is what private equity investors are looking for, as it allows them to make profits on their investment in the long term, in return for the risks they take.

Differences between private equity finance and bank loans

Banks have a legal right to charge interest on a loan, and to demand repayment of the loan by a specific date. This is the case whether or not your business succeeds once you have taken out a loan. In order to make sure that they get their money back, banks usually require you to secure your loan against business or personal assets – such as your home – which could be extremely risky if your business does not succeed. See our guide on bank finance.

However, private equity investors do not have these legal rights to interest and capital repayment, so the only way they can get their money back is through a capital gain if your business succeeds. They will want to take out more than they invested when they exit from your business. Therefore, they look for high-growth potential businesses to invest in, and are likely to be more hands-on than banks. They can also often bring useful expertise into your business. See the page what is equity finance and is it right for your business? in our guide on equity finance.

For more information on private equity investment and government sources of finance, you can download a private equity guide for new businesses seeking private equity finance from the British Venture Capital Association (BVCA) website (PDF, 746K) – Opens in a new window.

Is your business ‘investment-ready’?

If your business has been operating for some time, potential investors will be interested in your past activities so that they know exactly what sort of business they will be investing in. It’s a good idea to clear old debts or liabilities before you seek investment.

Investors will also want to know about your business’ intellectual property, especially if anyone outside the business has a potential claim to it. This may be the case if you’ve developed new products or services in collaboration with anyone outside the business.

Raising capital can be time-consuming and you should plan to only do this a few times during your business’ development. You should also make sure that you are ready for investment, by considering:

• why you need funding – ideally for a specific reason such as expansion, or to develop a new product or market
• how much funding you will need – always be careful not to underestimate how much you will need
• when you need the funding by – eg it might work best for you if you receive the amount in instalments instead of all at once
• how you are going to pay any money back – it is very important that your business is able to meet any repayments on time, including any interest charged
• what the right source of finance is for you – see our guides on bank finance and non-bank finance

For more information, see the page on deciding whether you’re ready for financing in our guide on obtaining bank financing.

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Finding the right private equity investor

The main sources of private equity are:

• venture capitalists (also known as private equity firms) – who are likely to provide finance of between £250,000 and £2 million at all investment stages – see our guide on venture capital
• business angels, who tend to fund start-ups and early-stage businesses with smaller investments of between £10,000-£750,000 – see our guide on business angels

What private equity investors are looking for and what’s in it for them

You will need to find out what potential investors are looking for, so that you only approach people who are looking for businesses like yours. For example, you should make sure that you approach investors who would be interested in investing:

• at the stage your business’ development is at
• in your sector
• the amount of finance you are looking for
• in your region

The British Venture Capital Association (BVCA) Directory of Members provides information about private equity firms’ investment preferences. The BVCA Directory of Members is free to members and available for purchase by non-members. Find the BVCA Directory of Members on the BVCA website – Opens in a new window.

For information about how to find business angels who are interested in your kind of business, see the page on business angel networks in our guide on business angels.

If you are looking for private equity investment, you should also find out about the investor’s own funding cycle. Private equity firms raise their own funds, invest them, and reap the profits over a period of between five to eight years. They profit from their investment by selling their equity stake in your business and then repay the cash to their own investors. Their funding cycle determines the length of time they will invest in your business, and how they will want to get their money back (with profit) when they are due to exit from your business.

It’s useful to find out when your potential investor raised their last fund, how big it was and how many investments they have made. Have they already invested in businesses that you could usefully collaborate with? Or have they invested in your competitors?

Also, private equity firms usually finance new businesses early in their funding cycle, allowing time for the businesses to grow and return a profit on the investment. Towards the end of their funding cycle, private equity investors are more likely to invest in mature companies that are likely to offer quick financial returns.

Your business should look for investors that can offer useful knowledge, experience and relationships, as well as capital funding. You can judge whether this is the case by talking with the investors as well as asking for references from the other businesses they have invested in. You may find it helpful to work with an adviser who can explain the different investment preferences of various private equity firms.

If you gain investment in exchange for investor equity in your business, you will inevitably dilute the profit share for founders of the business, existing investors and any shareholders. You can keep more equity in your business if you ask for smaller amounts of funding later in your business’ development.

See the page in this guide on securing equity finance – preparation.

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Value your business accurately

When potential investors are considering whether to invest in your business they will need to know what it’s worth. They will also be more interested in the value of your business once they have made the investment (post-money valuation) than before (pre-money valuation). This is because they will use the post-money valuation as the basis for assessing how they can achieve their required rate of return when they exit from your business at the end of the investment period.

However, you may be more interested in the pre-money valuation.

How a business can be valued

There are various ways for private equity firms to establish the value of your business to them. They may calculate the value of the company in comparison with the values of similar companies quoted on the stock market. This involves establishing the price/earnings ratio for your business.

Alternatively, they may calculate a value for your company that will give them their required rate of return over the period they anticipate being shareholders. For more information, download a private equity guide for new businesses seeking private equity finance from the British Venture Capital Association (BVCA) website (PDF, 746K) – Opens in a new window.

Another method of valuing your business is based on calculating the value of your assets. There are two types of business assets – tangible and intangible, and you need to include both in your valuation. Tangible assets are physical, material and financial resources, such as plant, machinery and office equipment. Intangible assets are valuable resources that may not have a physical presence, such as brand value, skills and know-how and trade secrets. It could also include employee, customer and supplier relationships and goodwill.

For more information, see the page on identifying and valuing assets in our guide on identifying, protecting and transferring your assets.

You can also value your business by using discounted cashflow (DCF) analysis. DCF valuation is based on using projected future cashflows to calculate how much your business is worth. You can find a free DCF valuation spreadsheet on the Business Valuation website – Opens in a new window. For more information, see the page on common methods of valuing a business in our guide on how to value and market your business.

Potential investors will also want to see how the value of your business is likely to change over time. Milestones, which are markers of how your business is developing, provide one measure of this. Investors will be interested in the milestones that you have already achieved and the future milestones that your business must reach to be successful. A milestone could be the number of customers who’ve signed contracts for your new product or service and if you can show that you have reached it, the value of your business will increase in the opinion of the investor.

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Securing equity finance – preparation

Once you have decided to seek equity finance, you will need a comprehensive business plan incorporating a detailed marketing plan and realistic financial projections.

You may find it helpful initially to hold discussions with your business adviser and to research potential investors.

Consider the following issues:

• how much funding you need and what the funding is for
• how much control you’re hoping to retain and the skills the business needs
• how long you need the funds for

Any potential investor will be looking for a number of core issues in your business plan:

• what your funding needs are
• whether your plans for the business are realistic
• whether your venture is appropriate for external investment

Your business plan should seek to address these issues and you should tailor the information you provide to each investor you’re approaching. The plan should include a series of detailed financial forecasts, what you intend to do with the funding, how you’ll repay the investor, your management’s level of expertise and what the investor can expect in return.

See our guides on how to use your business plan to get funding and how to prepare a business plan.

Approach shortlisted investors directly through an introduction or contact, or through their association or network. Remember that many private investors are interested in specific industry sectors or geographical regions, so ensure your shortlist only includes suitable candidates.

Networking is an important way of finding investors, so go to events organised by your chamber of commerce in order to introduce yourself to people and get your business known to potential investors. It is also possible suitable candidates can be found through recommendations from the industry you operate in or its associated network.

Read about finding business angels on the British Business Angels Association (BBAA) website – Opens in a new window.

Download a private equity guide for new businesses seeking private equity finance from the British Private Equity and Venture Capital Association (BVCA) website (PDF, 746K) – Opens in a new window.

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Securing equity finance – the pitch

Pitching your plan or proposal effectively to potential investors is important. Try to anticipate the questions and concerns that investors may have and show the benefits of their involvement. For example, you could emphasise the:

• amount of investment required
• terms you’re proposing – eg share of control, skills, timescale of investment
• ability of the management team to proceed with the plan
• likely return on any investment

Make sure your presentation is informative, relevant and engaging. You could include other members of your team in the presentation if you think this will better demonstrate your business’ strength. Many investors will also be interested in your personality, so be enthusiastic and passionate about your business and its potential, without being unrealistic about its prospects.

Potential investors are more likely to invest in someone they feel they can trust and who has a clear business strategy. So ensure that you prepare for all their possible questions beforehand.

You will also need to provide detailed, credible and professionally presented information for the investor. This should include:

• historical and forecast financial information
• business policies and procedures
• customer and supplier details

If the potential investor is interested in collaborating with you, you can start negotiating key issues in detail – eg respective responsibilities, growth targets, the investor’s exit strategy, service contracts, warranties and indemnities. You should also specify how the investment relationship will be managed and what involvement they’ll have in the company.

Enlist the help of a specialist accountant and legal adviser to negotiate investment terms. See our guide on how to choose and work with an accountant.

If your pitch is successful, you’ll need to draw up a plan of how the investor will fit into the way you manage your business.

Some investors may be more of a ‘sleeping partner’. They will invest money in the business and share in its profits, but will not take part in running it. Others may want to be actively involved in the management of your business. You won’t have to give up day-to-day control but you will need to negotiate with your investors about the level in which they become involved. Remember that most investors may not only be offering cash to your business but also their expertise.

You can read information about business angels on the British Business Angels Association (BBAA) website – Opens in a new window.

Download a private equity guide for new businesses seeking private equity finance from the British Private Equity and Venture Capital Association (BVCA) website (PDF, 746K) – Opens in a new window.

In Scotland, LINC Scotland will direct you to local and appropriate business angel networks and provide guidance with preparing and presenting your business proposal. You can find out about business angels on the LINC Scotland website – Opens in a new window.