In the final session of our IdeasTap Spa series on finance, ArtCo Projects Director Mary-Alice Stack talked about building a creative business through equity investment…
What is equity finance?
Mary-Alice defines it as, “A means of raising funds to support the development of a business through the issue ofshares in return for money.” Unlike a loan, you don’t have to pay the money back – and the investor may bring added value to the company through their expertise and contacts.
However there are other risks, most notably a potential loss of control. When an investor puts money in, they may well want to influence the direction your business takes in order to maximize their opportunity to see a return on their investment. Also, once you've sold shares in your company to an investor, you may not have any control over how those shares are subsequently sold on.
Equity finance is usually the only viable source of funding for:
Production-based enterprises, such as films, where you require big upfront finance over a period of months and won’t generate revenue until the production is complete.
Early stage start-ups that need a cash injection to bring a product to market, where the product is highly innovative or where the company has no track record.
What is an investor looking at?
Growth potential– your business must be scalable.
Market opportunity – is there a market for it? Here, timing is everything. Investors want to be in at an early stage, so when the product peaks they can cash-in and sell.
Protection of assets – is value being created in the business through the development of intellectual property? If so, how is this being protected?
You – who are the people behind the business? Gut instinct plays a significant role in investors’ decision-making.
Return on investment – the overriding consideration for them is, “Will this business make money?” An investor isn’t necessarily interested in whether your business is sustainable, they want to know whether investing £100,000 in it is going to be more or less profitable than putting it in the bank.
Risk – all investments carry risk. The greater the risk, the greater the potential level of return. If the investment is very risky, the investor will seek to maximize their equity return by getting a higher percentage share in the business.
Know the lingo
Equity describes the ownership of any asset after all debts have been paid off.
Stock ownership is determined by the number of shares owned compared to the number of outstanding shares. This is described as your % share. A holder of stock has a claim to part of that business’s earnings.
Angel investor is an investor that personally puts money in. They are usually empathetic to the business’s aims.
Venture capitalists (VCs) manage the pooled money of other investors and invest it in a portfolio of businesses. They take a management fee. This is the most common form of equity-investment model. Typically VCs invest they will be looking for a 25% return within five years and may well take a 50% share in the business to enable them to have more control.
Valuation determines the price shares are sold to an investor. There are established processes by which businesses can be valued.
Due diligence refers to the care a reasonable person should take before entering into a transaction. Where investments are concerned, this can be time-consuming and costly for both investor and investee - but it’s an important part of the process and you should be prepared for this if you want to sell shares in your business.
Exit strategy is a company’s approach for providing the investor with the opportunity to cash in and get their return.
Remember, for the investor this is not a lifetime commitment. They are in it to make money, so it’s all about growth – although there will be people who back your business because they like what you do, rather than because they want an aggressive return. Convincing investors is hard. You have to figure out what makes them tick and why a stake in your business might be attractive for them.
Miss any of the Spa events in this series? Download the...
Down to Business: When does a creative idea become a business and how?
Intro to Grant Funding for Creative Businesses
Powerpoint (ArtCo Projects)
Powerpoint (Arts Council England)
Handout on Grant Funding Opportunities
Ins & Outs of Loans for Creative Businesses
Podcast and Powerpoint
A Slice of the Pie: Equity Investment for Creative Businesses
Podcast and Powerpoint
More articles from the Creative Industry Finance series:
Loan finance - things to consider
Loan finance - key terms
Image: Two Dollar Shirts by Fun in NH on a CC BY-NC-SA 2.0 license.
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