All things being equity: When selling a stake can help firms grow

Equity means different things to different people, though essentially it means your percentage ownership of a company, says John O’Sullivan, managing director, Focus Capital Partners.

“If you’re a founder equity means control and likely a material amount of your net worth is tied up in the equity of the company,” he adds. “If you’re an investor, then equity will likely have a different meaning, viewed as a passive and or strategic investment, and in the context of professional investors it’s likely they have many equity holdings spread across an investment portfolio.”

Pros and cons of selling

The obvious con for businesses selling equity is that the current shareholders will be diluted to a smaller equity holding, says Anya Cummins, head of financial advisory, Deloitte.

“This means their percentage share of any profits which the company makes in the future will be lower and if the business is sold at a point in the future they will have a smaller stake in the business,” says Cummins. “Organisations also often use equity – options, growth shares or otherwise – as a means of giving partial ownership to key employees, which can be a highly effective retention and incentivisation tool.”

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On the other hand, Cummins says, one of the obvious pros to raising equity finance is that the company will receive cash which it can then invest.

“If the company invests the new equity well – for example, in new technology, by making an acquisition or in entering a new market – it should be able to grow its profits,” she adds. “Existing shareholders in such cases can drive higher valuations or returns from their shareholding, despite having a lower equity stake than prior to the equity raise – ‘a smaller stake in a bigger pie’.

“Bringing in new equity can also allow the company to add experience to its management team or board – the new equity investor may have knowledge which would be of value to the company, from working with similar companies, specific sector expertise or assisting other companies with specific strategies or on similar growth journeys (for example, M&A, internationalisation etc).”

When should business owners consider selling equity?

Businesses should typically consider selling equity when they have a growth plan which they could execute, and where the business could benefit from additional capital to scale or specific expertise and support to accelerate the plan, says Jan Fitzell, partner, mergers & acquisitions, Deloitte.

“In order for a new shareholder to invest, they will need to be convinced that the business will grow and they will see a return on their investment,” says Fitzell. “This growth plan could take a number of forms: an acquisition-led plan where the business will acquire companies and capture value this way; a new market entry strategy where the company will use the funding to invest in a sales team to capture a new market; or a technology investment which will improve the operational efficiency and profitability of the business.

“It is important that this equity story is articulated in a clear and concise way and in a manner which will appeal to new investors. Companies need to put themselves in the shoes of investors and draw out those factors which will drive investor demand. It’s also important that the company allows enough time to raise the equity as the process itself is not quick and can put some stress on a management team unless they have spent sufficient time in preparation.”

Choosing the correct time to divest some equity in your business is not an exact science, says Colm Sheehan, director, corporate finance, Crowe Ireland.

“If you raise equity too early in your life cycle you are likely to give away too much of your business,” says Sheehan. “If you wait too long there may be cheaper sources of finance available to you (ie debt).

“Increasingly, we are seeing business owners looking to bring in private equity to protect their financial future by taking some money off the table while continuing to grow the business. For many owners, their entire wealth may be tied up in the business. Realising some value along the way can be very motivating.”

Debating the value

Businesses are rarely objective when it comes to valuations and there are many variables that need to be considered, including current market conditions, investor appetite within their industry, trading performance, debt profile, concentration risks and growth prospects, says O’Sullivan.

“These are some of the variables that should be included when undertaking a valuation exercise,” he adds. “As an adviser, a key role we undertake is performing market valuations, helping management to have a clear understanding of the likely value at which equity can be raised.”

A private equity investor will be planning an exit strategy in advance of committing capital, says Sheehan.

“They will have predetermined hurdle rates that they wish to achieve in terms of return on capital employed. Their approach to valuing a company therefore tends to be systematic in nature and the emotion of owning (or part-owning) a business does not tend to be a factor in their decision-making process.”

Pulling the trigger

Having a robust business plan that clearly outlines the anticipated future trajectory of your business is critical, says Sheehan.

“Ensuring that you have an excellent management team in place to drive the business forward will provide comfort to a private equity investor, who will materially be a passive shareholder in the business,” he adds.

“Fundamentally, for the proposal to be attractive for private equity there needs to be a clear plan in terms of how the business is going to increase in value across an appropriate time frame. Illustrating market opportunity and management capabilities is paramount to a successful outcome.”