In a Nutshell (VI). Finance (II)

EQUITY

Equity, consists of the issued share capital and reserves of various kinds. It represents the amount of money that shareholders have invested directly into the company by buying shares, together with retained profits that belong to shareholders but which the company uses as additional capital.

Ordinary shares form the bulk of the shares issued by most companies and are the shares that carry the ordinary risks associated with being in business. Ordinary shares have no fixed rate of dividend.

Preference shares get their name for two reasons. First, they receive their fixed rate of dividend before ordinary shareholders. Second, in the event of a winding up of the company, any funds remaining go to repay preference share capital before any ordinary share capital.

Class A and Class B shares are cases where categories of shareholder are singled out for more or less favorable treatment.

Reserves means profits of various kinds that have been retained in the company as extra capital. Reserves come from retained profits over many years but are reinvested in buildings, equipment, stocks or company debts, just like any other source of capital, and are rarely held in cash.

SOURCES OF EQUITY CAPITAL

There are two broad sources of equity: private equity, (usually put in by individuals who for hopefully the prospects of greater returns will take on greater risks) or public capital through a share issue on a stock market.

Private equity:

• Business Angels: One likely first source of equity or risk capital will be a private individual with his or her own funds, and perhaps some knowledge of your type of business. In return for a share in the business, such investors will put in money at their own risk.
• Venture Capital: Venture capital providers are investing other people's money, ofte from pension funds. They have a different agenda from that of business angels, and are more likely to be interested in investing more money for a larger stake.
• Corporate venturing: Venture capital firms often get their hands dirty taking a hand in the management of the businesses they invest in. Another type of business is also in the risk capital business, without it necessarily being their main line of business.

Private capital preliminaries. Two important stages will be gone through before a private investor will put cash into a business.

• Due diligence: Usually, after a private equity firm signs a letter of intent to provide capital and you accept, it will conduct a due diligence investigation of both the management and the company. During this period the private equity firm will have access to all financial and other records, facilities, employees etc to investigate before finalizing the deal
• Term sheet: A term sheet is a funding offer from a capital provider. It lays out the amount of an investment and the conditions under which the new investors expect the business owners to work using their money

PUBLIC CAPITALStock markets are the place where serious businesses raise serious money.  Going public will enhance the status and credibility of your business, and it will enable you to borrow more against the ‘security’ provided by your new shareholders, should you so wish. 

Your shares will also provide an attractive way to retain and motivate key staff.

IPO: Initial public offer
AIM: Alternative Investment Market

HYBRIDS
A number of financing methods straddle the debt and equity boundary.These try to mitigate taking a bit more risk for the potential of a bit more return than would be usual with debt financing.  But they also limit the upside that might be expected from pure equity, which would retain all of any increase in value from the outset.  Mezzanine finance and convertible preference share.

GRANTS
Government agencies offer grants, effectively free or nearly free money in return for certain behaviour. Grants are constantly being introduced (and withdrawn), but there is no system that lets you know automatically. You have to keep yourself informed.