With a wide range of finance options available to a business seeking growth funding, James Darlington, Senior Investment Manager at Maven, provides his thoughts on why equity finance may be the most appropriate funding option for businesses with growth aspirations.
There are a number of viable strategies that can fuel business growth, such as reinvestment of profits, acquisitions, taking on company debt and raising equity. Without debt or equity financing, business growth is predominantly influenced by management drive and profit reinvestment. Although some might view this to be preferable, it may not be the right growth strategy for all businesses, especially those wanting to scale rapidly.
When facing uncertainty, such as the current economic environment, businesses will often be reluctant to take on external funding. However, companies that are under pressure, due to a market downturn or from competition, may see benefits of taking on outside investment to ensure they maintain their market position and ultimately become stronger.
Debt financing, commonly in the form of a loan, involves borrowing money and paying it back with interest, so may be attractive to business owners as no equity and control rights are conceded. However raising debt also carries several notable drawbacks:
- The capital must be repaid in full and with interest within a fixed amount of time. This places additional financial burden on the company as it has less available to invest in growing the business.
- The company needs to evidence stable revenues with positive cash flows in order to service the debt. This is often not the case with small early-stage businesses or high-growth strategies.
- The company may often have to provide security on some or all of its assets.
- A personal guarantee on the director(s) may be required by the company.
- There are various financial restrictions, in the form of covenants, that can hamper the growth strategy.
- Taking on large amounts of secured debt, whilst strengthening the balance sheet, can adversely impact profitability and valuation, which may limit the ability of the company to raise capital by equity financing in the future.
This leads to the option of raising funds via equity i.e. selling a portion of the company’s ownership in return for an injection of capital to accelerate growth. Businesses may seek equity funding for a variety of reasons, such as to invest further in R&D, enter new markets or hire additional staff. Regardless of the specific requirement, or indeed the point in a company’s life cycle, if the business model is backable there is likely to be a suitable equity match, whether that be angel/seed investment to support early-stage funding, or undertaking an Initial Public Offering (IPO) to generate large sums of liquidity for more established entities.
Equity financing places no additional financial burden on the company, since there are no monthly payment obligations, meaning that the company has more free cash available to invest in growing revenues. Raising capital this way facilitates a longer-term growth strategy, allowing business owners to focus mainly on value creation without being overly constrained by the need for cash management and adhering to covenants. The equity funding can be provided on the basis that it will helps the business through a period of short-term losses and deliver a growth strategy that will see revenues grow substantially and generate added value for all stakeholders.
The flexibility of equity finance makes it a good fit for high-growth businesses that needs to rapidly grow market share. In addition to the financial support, the equity investors will typically provide invaluable expertise to support the company’s strategy, including: introductions to sector experts; advising on the recruitment strategy; aiding best practice corporate governance; financial management and providing sector insights. Equity investment is a shared journey where an investor should work collaboratively with management teams to achieve their business plan, as results are optimised when there is alignment in interests and all parties have a common vision for driving the business forward and maximising value.
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