Strategic equity

Business owners are often extremely reluctant to part with equity as a fundraising strategy, preferring to own 100% of something small rather than a lesser portion of something larger and expanding. But in the right circumstances and with careful consideration, selling equity can leave you in a much stronger position overall.

Before making any decisions, it’s important to weigh up the pros and cons.

Pros

• Provides liquidity to support growth of the business
• The equity provider can be a sound source of advice for the business
• Equity finance (compared to debt finance) will protect the short-term liquidity of the business as there is unlikely to be an amortisation repayment profile – this will in effect support the business in pursuing growth opportunities

Cons

• You are selling a portion of the future profits of the business, and you will need to be mindful that the investor may be under no obligation to dispose of their shareholding back to you
• You are ceding the autonomy of being a single shareholder – there can be operational implications of this, especially when it comes to critical decision-making

Choosing the correct time to divest some equity in your business is not an exact science. If you raise equity too early in your life cycle, you are likely to give away too much of your business. If you wait too long, there may be cheaper sources of finance available to you (i.e., debt).

Increasingly we are seeing business owners looking to bring in private equity to protect their financial future by taking some money off the table while continuing to grow the business. For many owners, their entire wealth may be tied up in the business. Realising some value along the way can be very motivating.

When determining the optimal time to sell equity, consider:

• How do you intend to deploy the funds you raise? If there are opportunities to invest this capital to accelerate the growth in your business, the benefits may far outweigh the dilution of your shareholding
• Who are the equity investors and what can they add to your business? Private equity investors can typically provide excellent strategic support as you seek to grow your business. Understanding the skill set of these investors and how you might be able to leverage their expertise can be an intangible gain from the private equity process.

Once the process starts, any potential private equity investors will be looking in detail at your company to determine its value. They will be planning an exit strategy in advance of committing capital, and they will have predetermined hurdle rates that they wish to achieve in terms of return on capital employed. Their approach to valuing a company therefore tends to be systematic in nature and the emotion of owning (or part-owning) a business does not tend to be a factor in their decision-making process.

Preparation and planning are key in order to make the process run smoothly and achieve the best results for you and your business. Having a robust business plan that clearly outlines the anticipated future trajectory of your business is critical. Ensuring that you have an excellent management team in place to drive the business forward will provide comfort to a private equity investor, who will materially be a passive shareholder in the business.

Fundamentally, for the proposal to be attractive for private equity, there needs to be a clear plan in terms of how the business is going to increase in value across an appropriate timeframe. Illustrating market opportunity and management capabilities is paramount to a successful outcome.

This article has also been adapted as part of the recent Irish Times Corporate Finance Special Report.

Crowe's corporate finance team has a wealth of experience in helping businesses to make the right decisions to maximise value. For independent advice from experts who understand your business, contact us today.