19/05/2011

By Guy Rigby, Head of Entrepreneurs of Smith & Williamson

It’s often assumed that raising external equity is a prerequisite to business success. In many cases, this couldn’t be further from the truth.

Most businesses start with very limited funding, typically provided by the founder, or by family and friends. ‘Keeping it in the family’ is generally the preferred choice – you get to keep your potentially valuable equity, along with the choices and freedom that brings. Many entrepreneurs fear any loss of control and strive to retain as much of their shareholding as possible.

However, cash constraints or growth opportunities may make it either necessary or desirable to raise additional funding. If this cannot be found through lending or other non-equity sources, then raising external equity may be your only option.

On top of this, many entrepreneurs realise that they can create far greater wealth by giving away equity in exchange for both money and expertise. As the saying goes, 50% of something is worth a lot more than 100% of nothing. Although it may feel expensive, there are many benefits to be achieved from equity funding. Investors are naturally less risk-averse than banks and the day to day financing costs can be low.

Ownership determines outcomes

Don’t underestimate the impact that external equity can have on your business. Your investors are there to make a profit and will generally have the right to a say in its management, including how much money you are allowed to earn and how you will spend their valuable resources. Equity investment will involve ceding elements of control to the investor.

So, as a general rule, if you want to run your business for life and make your own choices, try to avoid taking third party equity. This kind of investment typically means an exit at some point in the not too distant future, with varying levels of involvement along the way.

Timing is everything

Timing is vital when raising external equity. Where you are in your evolutionary process will be key to determining when you go looking for capital, as well as who you approach to raise it. Don’t leave it until the last minute – this won’t impress your potential investors, who will want to approach their investment in a measured and structured way. In the unlikely event that an investor is prepared to accelerate his investment process to meet your challenging timetable, you are likely to end up paying the price in terms of the level of equity you have to offer or the value at which you offer it.

So, you should think long and hard before taking the external equity route and, if you do, make sure you adopt a long-term, planned approach. The smartest way is to prepare and act well before the funding becomes a necessity.

If raising external equity finance is your chosen route, our other articles in this special report examine where to look and how to go about it.


A date for your diary

Later this year we will be hosting an event focusing on how to grow your business using external equity funding. “Inside Venture Capital” will be held in London in October.

If you are interested in attending please email your personal and business details to insideventurecapital@smith.williamson.co.uk.

If you would like to discuss the subject covered in this article or you want to sound out someone about raising finance for your business call Guy Rigby on 020 7131 8213 or email him at guy.rigby@smith.williamson.co.uk.