Equity Funding: What you need to know
For some people, the words “equity funding” may conjure up images of lengthy pitch decks, boardrooms and Dragons’ Den. But don’t allow these cliches to intimidate or confuse you when considering equity funding for your eCommerce business. Instead, by stepping away from these stereotypes, we can actually get to the facts of equity funding - and there are a few things you need to bear in mind when seeking it.
So what exactly is equity funding?
To receive equity funding means that you would get cash from an external investor in return for a stake of your company. So, in order to receive the finance, you would need to give up some ownership and (usually, but not always) some control of your business. In the event of an insolvency, equity investors - or shareholders - are paid out last, after all the debts have been paid. Equity investors are much more a part of your business than debt investors, so are banking on your business doing well and sharing in future profits, alongside you.
Pros:
- Equity differs from debt because you don’t have to repay the cash - yay! Shareholders realise their investments via the success of the business, so they often add value to your company in other ways (besides the cash) - i.e. mentoring, introducing you to connections in their network, helping with business strategy planning etc.
Cons:
- Consequently, equity funding is a lot riskier for investors. What does this mean for you? Well, to address this risk, shareholders will need to do a lot of work to understand you and your company, so you’ll need to be prepared to open up your books, talk about your business and commit time, some money and resources to the process.
To keep things (relatively) simple, we’re going to focus on three categories of equity funding that are available for early-stage eCommerce businesses: equity crowdfunding, angel investment, and venture capital.
- Equity Crowdfunding
Equity Crowdfunding is offered through platforms like Seedrs and Crowdcube whereby multiple individuals group together to invest in your business. This model is based on the premise that - in theory - it’s easier to get lots of people to invest a smaller amount, rather than getting one person to invest a large amount.
So how does it work? As a company, you would launch a “campaign” on one of the platforms that allows individuals to participate in the funding raise. The minimum campaign size is usually around £10,000. Each individual will usually be investing a small amount, but added together it can add up to a sizeable injection for your business. Platforms like Kickstarter and Indiegogo offer a spin on the crowdfunding model, as individual investors receive products - not company shares - in return for their cash.
Pros:
- Crowdfunding is usually a lot quicker than attracting angel or VC investment. (That said, it can still be a lengthy process - it depends on the individual circumstances.)
- Crowdfunding can also be a lot cheaper than other fundraising options.
- Crowdfunding has the added bonus of enabling you to market your product and establish an early - and usually loyal - customer base who can support your business going forward.
Cons:
- You only receive the cash if the campaign is fully-funded, so like the other fundraising options, Crowdfunding isn’t necessarily a cure-all.
- Crowdfunding is only really good for smaller funding rounds.
Requirements for Crowdfunding
In order to qualify for Crowdfunding you will need:
- to pass the application to the platform. Each platform has a slightly different application - so make sure you set aside some time to look through each.
- a unique, engaging and effective pitch deck and video for the platform that explains what your company offers and why individuals should invest.
- to be SEIS/EIS eligible. Read more about what this means [here - LINK TO ANNIE’S SEIS/EIS article]. You need to be able to obtain Advance Assurance from HMRC.
- to show that your business has had some proven interest from investors before. Usually, this is by having some equity funding successfully under your belt already - often from angel investors or venture capitalists - but not always.
- Angel Investment
“Angels”, as they’re commonly referred to, are individuals who will invest cash in exchange for a slice of your business. They can range from friends and family, to high-net worth individuals to serial investors. Therefore, angel investment is usually the first source of equity funding for companies. For these purposes, we’ll assume you’ve already tapped your network of friends and family, so the “angels” you’re interested in are the serial, experienced type. These individuals will typically write cheques between £50,000 and £500,000.
Pros:
- Because angels can be anyone, if you’re raising a smaller amount of money or you have an obliging network around you, you can sometimes obtain money quickly.
- Larger amounts of money can also be raised...
Cons:
- …but typically these processes will take a lot longer.
- It’s highly likely that angels will want to be involved in the business - more so than with crowdfunding investors.
- They may also want a larger stake of your business.
Requirements for Angel Investment
In order to qualify for Angel Investment you will need:
- to have a minimum viable product. (A MVP is a version of the product with just enough features to satisfy early customers and provide feedback for future product development).
- to have properly established your company (i.e. the legal stuff is all in order)
- a pitch deck setting out how much money you want to raise and what for, your company’s pre-money valuation (its value before the investment is made) and how you are going to generate returns for the investors.
- to be SEIS/EIS eligible. Read more about what this means [here - LINK TO ANNIE’S SEIS/EIS article]. You need to be able to obtain Advance Assurance from HMRC, and you can find out more about this here.
- Venture Capital
Venture capital is a form of equity funding provided by sophisticated investors. Sophisticated funds aren’t funds that go around with a classy world-view, a fancy handbag and a certain je ne sais quoi. No, whilst they may have all of these things, a sophisticated investor is actually a funder who has enough experience, money, and net-worth to support larger and more advanced investments. These are your high-net worth serial investors - the people you want on your team to take your company to the next level. Venture capital investors are typically looking for promising companies - usually later-stage startups - to invest in that can generate returns for them and their investors. Investor-ception.
Pros:
- You can get access to significant capital - venture capitalists will typically provide funds between £250,000 and £50,000,000.
- Because they have tons of experience working with companies, venture capital funds can and will add significant value by providing support, advice, and introductions to useful connections.
- Investors at the venture capital level have been there, seen it, got the t-shirt, so they can give you a heads-up before you make a mistake - saving you valuable time and money.
Cons:
- Due to the additional value they bring, venture capitalists will look for a larger stake in your business – in the region of 15-30%.
- Usually you need to grant the venture capital fund a seat on your board, so that they can have a say in the running of your business.
- Venture capital application processes can take months. There are a lot of meetings required for venture funding, and all this time you spend away from your business can impact day-to-day operations, especially if you’re only a small team. Make sure you have support!
- Bear in mind the hidden costs that venture capital applications take - legal fees, company valuation costs such as getting the books up to date, costs relating to building your pitch deck, travelling to and from meetings, less time spent focusing on the business itself - it’s a big investment on your end too.
Requirements for Venture Capitalists
In order to qualify for venture capital investment, you will need:
- to demonstrate strong and rapid growth prospects with significant future returns for the venture capitalist.
- a strong, water-tight business plan including financials for the venture capitalist to study.
- an exit opportunity for the venture capitalist. In other words, the venture capitalist will want to see a clear path for them to be able to reclaim the value of their stake in your business within 5-7 years of investing. This will typically be via a sale or IPO (i.e. taking your company from a privately held enterprise to a public one).
Final Thoughts
So there we are - a trip into the wibbly-wobbly world of equity funding, completed.
Just one final thought: equity funding is extremely competitive. Ultimately, you need to be able to present a compelling story to equity investors covering why your product is valuable and how it is going to make you and your investors rich. Sorry to be so blunt, but it is money that makes the world spin.
When considering funding for your business, it’s important to weigh up the merits of equity vs. debt. Equity funding is great for raising (typically) larger amounts of money than debt, and for gaining the expertise of the venture capitalists onboard. However, equity funding also entails giving up control and answering to external shareholders – neither of which are attached to debt funding. It’s all about finding the right option for you and your business.
Want to talk through your options? We’re here to help.
