What is Equity Finance?
Equity Finance is share capital invested in a business for the medium to long term in return for a share of the ownership in, and in some cases an element of control or influence over the business.
The main advantage of Equity Finance (over asset or debt finance) is that it is not usually repayable at least in the short/medium term. Equity investors will expect a return typically over a 3 - 8 year period in the form of dividends (where appropriate) and from the sale of their share of the business when the business ‘exits’ via trade sale or flotation.
To prospective investors an Equity investment is the highest risk form of capital and as such they will expect the highest form of return in the medium to long term.
Is Equity Finance right for my Business?
The providers of Equity Finance will most often make the majority of their return when the business is sold or floated. If you are not contemplating the eventual sale or float of your business then Equity Finance will not be appropriate for you.
The providers of Equity Finance take the greatest risk of all prospective investors. As the providers of capital that is at the greatest risk they will expect the greatest return on their investment and to be capable of making returns of the magnitude required such investors are typically looking to invest in businesses with high and fast growth opportunities. If your business does not have the potential to grow and to grow quickly then Equity Finance is most probably not for you.
The nature and risk profile of Equity Finance means that the providers of this type of capital will often take an active interest and involvement (often non-executive) in your business. They will also place certain restrictions on the things that you will be allowed to do without their specific consent.
Most Equity Investors prefer to take a minority stake. They don’t want to own your business. Equally they don’t want to take sides in a family fall out, so if your business is family owned then Equity Capital may not be the ideal solution.
For businesses and managers that are focussed upon a strategy of fast growth for exit then the involvement/support of the Equity Investor and the limited restrictions that they will impose do not represent a material challenge but if you are the sort of business owner that would find this type of regime a challenge then maybe Equity Finance is not for you.
What are the Sources of Equity Finance?
Equity Finance can be procured from a variety of sources but the most common of these for SMEs will be Development Capital Funds, Venture Capital Funds, Business Angels, Equity Crowd Funding platforms and possibly Mezzanine Finance.
Development Capital Funds
Development Capital (also called expansion Capital and Growth Capital) can take the form of Mezzanine Finance or Equity Finance (and not uncommonly a hybrid of both).
This type of finance is often used to support slightly more mature businesses than its Venture Capital counterpart where the business needs finance to support its growth ambitions but the finance sought is not available in the debt market (this may be because the balance sheet is already heavily geared or simply because the finance ‘ask’ is just too rich for the debt market).
Development Capital is often structured as preferred equity, although investors may well seek to structure the investment to include some element of debt-like repayment.
In reality the distinction between Development Capital and Venture Capital is blurred and many of the investors that operate in this market will consider either type of investment opportunity.
The types of investors that provide Development Capital to companies span a variety of both Equity and Debt sources, including Private Equity and late-stage Venture Capital Funds, Family Offices, Sovereign Wealth Funds, Hedge Funds, Business Development Companies (BDC) and Mezzanine Funds. Jerroms Corporate Finance can help find the right investor(s) for your business. We manage the whole process from helping you to prepare to approach the prospective equity investor, to finding the investor, to negotiating the deal terms enabling you to do what you do best – running your company.
Venture Capital Funds
Venture Capital Funds are investment funds that manage the money of investors who seek private equity stakes in start-up and small to medium sized enterprises with strong growth potential. These investments are generally characterised as high-risk/high-return opportunities.
Venture Capital is a type of equity financing that gives entrepreneurial or other small companies the ability to raise funding. Venture Capital Funds are Private Equity Investment vehicles that seek to invest in firms that have high-risk/high-return profiles, based on a company's size, assets, and stage of product development.
Although the distinction between Development Capital and Venture Capital is blurred (with many of the fund managers in this market open to the consideration of either type of investment opportunity) Venture Capital will usually consider an investment in earlier and slightly more risky business propositions and it is less likely (although not entirely uncommon) that they will structure their investment terms to draw surplus cash out of the business in the form of debt-like repayments.
There is also a sub-set of Venture Capital Funds that are specifically focussed upon earlier stage and higher risk of investments. These are known as Venture Capital Trusts (VCT’s).
Venture Capital Trust (VCT)
A Venture Capital Trust or VCT is a tax efficient UK investment scheme designed to provide venture capital for small expanding companies, and income (in the form of dividend distributions) and/or capital gains for investors. Investors enjoy up to 30% income tax relief on investment that they make into the trust (total investment is presently capped at £200k for each tax year), exemption from income tax on dividends received and an exemption from tax on capital gains (providing the shares are held for at least 5 years).
VCT is one of a number of UK tax schemes that are intended to encourage investment into the equity capital of risky, early stage, UK SME’s. Two of the other better known schemes are the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS).
Enterprise Investment Scheme (EIS)
What is EIS Tax Relief?
EIS is a government scheme designed to help smaller higher-risk trading companies to raise equity finance by offering a range of tax reliefs to investors who purchase shares in those companies.
What are the investment amounts?
Individuals may invest any amount in EIS shares. However, only the first £1,000,000 invested in any one tax year will qualify for relief, although a carry-back facility to the prior tax year is available.
What can the investor expect?
The investor can expect income tax relief at the rate of 30% on the amount invested in qualifying investments. EIS relief can be withdrawn if certain events occur within three years (e.g. the shares are sold).
- Provided that income tax relief has been claimed, any gain arising on disposal of the shares after three years will be exempt from capital gains tax.
- Deferral of capital gains (no limit) on any other assets, by reinvesting all or part of the gain into an EIS company within one year before, or three years after the gain occurred.
- Relief for any losses made on the disposal of EIS shares against Capital Gains Tax or, in some circumstances, income tax in the year of disposal or previous year.
- An investor can, subsequent to the investment, have the opportunity to participate in the running of the business and to receive reasonable remuneration for doing so.
What can the qualifying company expect?
- Certain company activity restrictions.
- The company can enjoy the opportunity to raise finance either for initial start-up or for expansion and this type of investment may be a candidate to be ‘matched’ by Development Capital funds depending upon the geography, sector and stage of development of the business concerned.
To find out more about “qualifying individuals”, “eligible shares” and “qualifying companies” just get in touch.
Seed Enterprise Investment Scheme (SEIS)
The Seed Enterprise Investment Scheme (SEIS) offers generous tax relief to investors who subscribe for equity shares that equate to a stake of less than 30% in the company.
The new scheme is similar to the Enterprise Investment Scheme (EIS) but the SEIS focuses solely on direct investment into start-up companies with the intention of making it easier for these companies to grow and become established.
The Seed Enterprise Investment Scheme explained:
What are the investment amounts?
- Investors can input £100,000 in a single tax year.
- Maximum of £150K, including any State Aid received by the company in three preceding years.
- Investors cannot control the company receiving their capital.
What can the investor expect?
- Income Tax relief at the rate of 50% in the tax year the investment is made.
- Disposal of the shares will be exempt from Capital Gains Tax once they have been held for 3 years.
Which companies qualify?
A qualifying company must be:
- UK based with 25 employees or fewer.
- Have gross assets of up to £200K.
- Have not received any previous EIS or VCT investment.
- Trading less than 2 years.
- Carrying on, or preparing to carry on, a new qualifying trade throughout the three year period from the date of issue of the shares.
Which trades do NOT qualify?
Most trades do qualify but there are some exceptions. A trade does not qualify if it consists wholly, or substantially, of “excluded activities”. A list of the “excluded activities” can be found by clicking here.
To find out more contact our experienced corporate finance team who will be happy to provide more details on the Scheme, advise on its suitability for you, and assist should you wish to pursue this further.
The following activities are excluded from the SEIS:
- dealing in land, in commodities or futures in shares, securities or other financial instruments
- dealing in goods, other than in an ordinary trade of retail or wholesale distribution
- financial activities such as banking, insurance, money-lending, debt-factoring, hire-purchase financing or any other financial activities
- leasing or letting assets on hire, except in the case of certain ship-chartering activities
- receiving royalties or licence fees (though if these arise from the exploitation of an intangible asset which the company itself has created, that is not an excluded activity)
- providing legal or accountancy services
- property development
- farming or market gardening
- holding, managing or occupying woodlands, any other forestry activities or timber production
- coal production
- steel production
- operating or managing hotels or comparable establishments or managing property used as an hotel or comparable establishment
- operating or managing nursing homes or residential care homes, or managing property used as a nursing home or residential care home
- generating or exporting electricity which will attract a Feed-in Tariff, unless generated by hydro power or anaerobic digestion, or unless carried on by a community interest company, a co-operative society, a community benefit society or a Northern Ireland industrial and provident society
- providing services to another person where that person’s trade consists, to a substantial extent, of excluded activities, and the person controlling that trade also controls the company providing the services
Business Angel Investment
Business Angels (sometimes known as ‘Dragons’) are typically high net-worth individuals who have often made their own wealth by building up a business that they have then sold or floated. These high net-worth individuals look to invest part of that wealth into the equity of a small number of private companies.
Business Angels are notoriously difficult to find but there is an increasing number of Business Angel Networks (BANs) operating around the UK who seek out prospective angel investors and help to bring together angel investors and the companies/management teams that are seeking angel investment funds.
These networks act much like a dating agency to connect prospective Business Angels with potential investment opportunities that meet the profile that the Business Angel has specified. Some BANs encourage Angels to invest in the form of syndicates where a number of Angels will take a smaller stake in the business concerned; this is especially true of larger investments (£500k upwards). The BAN will often charge for the service that they provide and the level of charges varies from network to network.
Business Angels are often looking for more than just an investment opportunity. Not untypically these individuals have a huge amount of experience, knowledge and contacts that they can bring to the table (in addition to their hard cash) and they will often be looking for investment opportunities where they can ‘add value’ and contribute to the development of the companies in which they invest.
Business Angels typically invest between £10,000 and £500,000 in any individual investment (although investments at the higher end of this scale are infrequent). Larger amounts tend to be syndicated by groups of Angels investing together.
Many Business Angels will look favourably upon investment opportunities that offer Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS) tax reliefs and some will invest through EIS or VCT funds.
You need to make sure that the Business Angel is right for your company. The management team and the Business Angel need to be able to work together and the Business Angel’s skills, experience and personality must match your companys needs.
Our corporate finance professionals have considerable experience of working with Business Angels and we have formal/informal relationships with most of the Business Angel Networks operating in the UK as well as many individual Business Angels. We can help you to:
- prepare an approach to the Business Angel community (including the Investment Proposal)
- negotiate the terms with the BAN if one is engaged
- prepare your presentation to the Business Angel or syndicate
- negotiate the terms of investment with the Business Angel
- navigate through the process of securing funds from a Business Angel.
Equity Crowdfunding is a way of raising finance by asking a large number of people each for a small amount of money.
Equity Crowdfunding is typically undertaken via an Internet platform where the business seeking investment will post up a short video, a pitch deck and a financial forecast model. Prospective investors are encouraged to review the investment pitch and invest via the platform.
Popular Crowdfunding investors include CrowdCube and SeedRS.
Most fundraising rounds that are promoted via Equity Crowdfunding platforms will offer prospective investors some form of UK tax relief typically either Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS).
From a business owner/entrepreneur/fund-raiser perspective an Equity Crowdfunding platform offers an excellent opportunity to promote your product or service, the opportunity to engage loyal customers/followers as stakeholders in the business as well as the opportunity to raise finance. However, it is important to note that there are some drawbacks to this form of equity finance. Many Crowdfunding platforms will often discourage a listing of a project until at least 30% to 40% of the investment rounds has been pledged and owner/managers will be encouraged to invest a good deal of time/effort in the fundraising efforts. In addition to the time/effort invested, the cost of PR and a professional video all Equity Crowdfunding platforms will charge fees for the funds they raise.
From a Private Equity Investors perspective, great care needs to be taken. Any investment in the equity of a start-up/early stage SME is obviously risky but investments via Equity Crowdfunding platforms often come without even basic investment protections (like voting or pre-emption rights).
If you think an Equity Crowdfunding investment opportunity might be right for you; or you are contemplating raising investment through an Equity Crowdfunding platform; consider taking advice and contact us.
*This is increased to £2 million provided that anything above £1 million is invested in knowledge-intensive companies. There is no limit on CGT deferral.