The Funding Landscape For Small Businesses Part 2
Equity finance represents funds invested by investors who will take a proportionate slice of your future profits assuming you are successful. While the investor may not be taking the pound of flesh on the way through they will take it – usually at the end when your business is very successful. For this reason it is regarded as the most expensive form of funding.
Venture capital sounds very exciting but the truth is the number of venture capital deals that actually close is tiny, less than 2% according to the National Venture Capital Association. The reality is that venture capital is reserved almost exclusively for businesses that are in high growth sectors with high returns. They invest big at the start and capitalize on innovative businesses, usually through the launch of a brand new product or idea with associated patents. They go after the shooting stars in the investment area and typically won’t be interested unless the investment needed is upwards of ~$4m and the 3 years sales projections are in the hundreds of millions. As mentioned above they take ownership stakes in companies and have a well-defined exit strategy. A well-constructed business plan is an absolute must for these investors. They have teams of people analyzing the plan to highlight risks and assess the respective rewards. If the Return on Equity ratio (amongst others) doesn’t meet the hurdle they won’t even read the plan. Not the best option for most small businesses.
These investors can operate alone or in syndicates. They are typically made up of high net worth individuals and are sometimes referred to as “Angel Investors”. Generally speaking they have the same investment mandate as venture capitalists in that they seek high growth with high return but the level of investment is usually lower as is the level of ownership in the business. Angel investors are likely to invest in businesses where they have expertise and will look to scale the business in preparation for exit.