There was a time when company founders would sooner lose a limb than sell a share in their business to raise finance. Times have moved on, however, and selling equity to investors is a normal step in many companies’ growth and development. Entrepreneurs now realise that investors can offer more than cash, bringing valuable expertise and established business networks to support the company on its growth journey.
Francois Rossouw, associate director of investment banking with Goodbody, agrees that the perception of equity finance has changed drastically.
“Times certainly have moved on, with terms like ‘angel’, ‘seed’ and ‘series A,B,C’ funding rounds being commonplace in a company’s capital cycle,” says Rossouw.
Is it ever too early for a company to use equity to raise funds? Fergal McAleavey, corporate finance partner at EY Ireland, says no.
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“Although equity is typically considered more expensive, equity financing can be a very suitable option for early-stage companies, particularly when they require growth capital and have limited access to debt finance due to a lack of trading history to get lenders comfortable, assets to secure the loan against or profits to service the interest and capital repayments associated with the debt,” says McAleavey.
Rossouw agrees. “It is never inherently too early to raise equity and it’s a core component of any capital structure,” he says. “While equity can be internally generated, at an earlier stage raising equity externally is more likely.”
The decision to issue equity to raise funds depends on several important factors, notes McAleavey. These can include the strategic goals of the founders, the company’s stage of development and/or the capital market conditions at that point in time.
“A key attraction of raising equity finance to a lot of early-stage founders is that it typically brings investors who provide not only growth capital, but also valuable advice, sector expertise, industry connections and ongoing mentorship,” he says.
Rossouw stresses that it’s not a zero-sum game: “It is critical for an early-stage venture to find a partner that understands the business, is aligned with the owners and would be supportive to growth rather than obstructive.
“The right partner can bring more than just equity and could deliver significant value adds beyond funding. The key is to find the right type of equity at the right quantum as you will be giving up significant ownership and possibly control at lower valuations.”
Valuing an early-stage company can be tricky and is a complex process, according to Grit Young, EY Ireland valuations partner.
“At this early stage, investors are betting on the concept, market opportunity and management team, given there is limited trading history to analyse and apply traditional valuation methodologies to,” she explains. “It requires a balanced approach that incorporates qualitative insights, quantitative methods and an understanding of the inherent risks.”
Traditional valuation methods, which rely heavily on financial metrics such as revenues, profits and cash flows, are often not applicable in these scenarios. Young says investors and founders must turn to alternative approaches to ascertain a company’s worth and engage an experienced M&A adviser for assistance.
It is useful to use a combination of methods when taking a view on the value of a pre-revenue business, as one could inform the reasonability of assumptions in another, Rossouw adds.
“More often, though the valuation is rather the implied outcome of other considerations and at such an early-stage qualitative factors like the strength of the team, technology or product and barriers to entry are key considerations,” he says. “A good adviser will not only provide guidance on valuation, transaction terms and structure, but will also help prepare go-to-market materials.”
But finding the most suitable investors can be challenging and time-consuming, Rossouw points out, “even if you have good connections within your own network”.
He advises that the first step is to identify a “universe” of suitable investors by researching investor mandates, fund life cycles, and recent transactions. This will help founders pinpoint investors who are aligned with their business stage and investment size, have available capital, and are active in the market.
“It is crucial to have a clear understanding of your business plan and any relevant softer issues, along with compelling materials such as a teaser, information memorandum and financial model that effectively communicate your value proposition,” Rossouw explains.
“Other avenues to consider would be crowdfunding platforms, industry events and online platforms.”