Equity Financing

Often, entrepreneurs prefer not to involve other people in their business so that they do not dilute their shareholding in the business and secondly, so that they have full control over decisions relating to their business. However, in order to start a business or to grow a business to certain level, it may be necessary to sacrifice full ownership of the business in exchange for capital from other partners in order to achieve these business goals. It is better to own 1% of a ten million-dollar business that was founded on your idea, than it is to own 100% of nothing but the idea itself. On the other hand, some entrepreneurs recognise the value of bringing partners into the business at the outset, not only in terms of the capital that other partners can contribute but also in terms of the unique skills and the networks that they bring to the business. In that case, the entrepreneurs envisage a business with equity partners from the outset and more so, if they have high growth ambitions for the business. There are several equity-based financing methods from third party sources and these include:

Often friends and family can make a contribution to start-up capital for a business but more commonly they are a source of additional capital to finance growth of a business to the next level. However, with capital raised from friends and family, it is important to have an agreement that clearly spells out if the money supplied is a grant, a loan or an investment in return for shareholding, so as to avoid confusion and legal disputes in future. If it is an equity investment, then, the agreement should indicate the agreed levels of shareholding and how the shareholding can be disposed of in future and when that can take place.

Angel investors are independent high net worth individuals available locally or elsewhere such as other business people, corporate executives, lawyers, doctors and so on, who may have significant funds that they are prepared to invest in business ventures that promise a high return for their investments. Angel investor networks are growing worldwide as high net worth individuals look for promising business ventures to fund for higher returns than those available on traditional financial markets. Examples include: AngelList, Funded.com, iAngels, Tech Coast Angels, Investment network, Angel Investment network and many others.

crowd funding is a relatively new online form of financing in which online communities of small investors evaluate business ideas presented and fund those that are of interest to them. Crowd funding pools together funds from many small investors that each face lower levels of risk than a single large investor might. As a result, it is easier to access through crowd funding than it is perhaps a commercial loan from a single financial institution. Examples of crowd funding websites include: Kickstarter, Indiegogo, crowdrise, Gofundme, Razoo, Rockethub, etc. Crowd funding platforms come in two forms which are:

  1. Rewards-based crowd funding platforms in which “investors” fund certain ideas in return for some rewards or a free product from the entrepreneurs.
  2. Equity-based crowd funding platforms in which investors take equity in the business. Investors do not receive any repayments whether the business succeeds or fails. If the business fails, then the investors have lost their entire investment and if it succeeds then investors can score big wins when they sell their equity in the business.

Accelerators are special programs by the government and other organizations that are designed to promote entrepreneurship by providing start-up capital or financing for business expansion. The emphasis is on speeding up the growth of existing start-ups, hence their name; accelerators. These are important sources of soft financing for small businesses and usually have a structured program through which beneficiaries progress that includes: training, incubation, mentorship coaching and other service packages that are all designed to increase the chance of the start-up becoming successful. Examples include: Google Accelerator Program, YCombinator, UAE Government Accelerator, Toyko metropolitan Government Accelerator Program, Founders Space, AngelPad, LaunchPad, AlphaLab and many others.

Venture capital companies [VCs], like the business angels, also finance start-ups and take a shareholding in them. The difference with Angels is that VCs are organised businesses that have large investment funds and typically make large investments in start-ups. Thus, the main difference between the two is in terms of scale and organization. The primary objective of the venture capital firm is to cash-out as soon as they can and therefore, tend to push start-ups towards an Initial Public Listing [IPO] as soon as possible. For that reason, they tend to focus on ground-breaking, high-growth potential start-ups. Some venture capital companies are global in terms of their focus and therefore, will finance ideal start-up businesses regardless of which country these start-ups may originate.

Bonds are debt instruments traditionally issued by governments, municipalities and large corporate through which they borrow money at a given interest rate. Start-up bonds have come on the scene and operate on the same principle, except that interest due to investors can accumulate over a period of time and it is convertible into equity in the business in the event that the entrepreneurs cannot meet the debt repayments. Start-up bonds work through direct issuance of “junk bonds” [high-yielding, high-risk bonds] by start-ups that are already in the early stages of their existence and have demonstrated strong cash flows and high growth potential.  Alternatively, start-up bonds can be issued through crowd funding for start-up bonds. Private placements are the primary means of issuing fixed rate start-up bonds.

Initial Currency Offerings [ICO] also known as Initial Coin Offerings [ICO] represent an emerging financing option that shares some characteristics with start-up bond issuance, peer-to-peer lending, crowd funding and initial public offerings. Initial currency offerings [ICOs] are a crypto-currency initial offering. As such, ICOs are highly risky and lend themselves to scams quite easily. However, they can be a legitimate source of finance for trustworthy entrepreneurs. The way they work is that start-up entrepreneurs that have great ideas that promise exceptionally bright prospects write a white paper [a proposal outlining the idea, how it will work, the market for the idea, and so on], essentially a prospectus. Early backers of the idea invest money in the start-up in exchange for a crypto-currency that has been initiated by the entrepreneurs. In this case, the crypto-currency operates much like a share certificate which is the investor’s proof ownership and that can be traded. An investor can sell their crypto-currency in exchange for cash or other crypto-currencies such as, Bitcoin or Ethereum, for example. An ICO amounts to informal trading in ‘unlisted shares’. If the target amount has been raised from different investors, then, the ICO will have been successful and the entrepreneurs can use the money for what they intended. However, if the target amount is not raised, then the ICO will not have been successful and the money raised so far will be returned to investors. ICO investment activities are generally not well-regulated meaning that the potential for fraud is high. Therefore, trust in the entrepreneur’s reputation or their experience with crypto-currencies or trust in the reputation and crypto-currency trading experience of those that are involved in the business with the entrepreneur is very important.

After a business has been in operation for a period of time and has demonstrated exceptionally high returns and exceptionally bright prospects, it may attract a great deal of interest from potential investors. If the entrepreneurs believe that investor interest in the business is not only strong but widespread, they may seek funds to grow the business to the next level by listing on the stock market through an initial public offering [IPO]. For example, numerous internet start-ups, high technology firms and biotechnology firms, such as Facebook, Google, Twitter, Foundation Medicine, Samsung Biologics and many others have taken this route. However, this avenue is open to a select few companies that have a really exceptional underlying product that is highly attractive to national or global market.