Checklist Description
This checklist outlines how companies can raise capital through equity and the differences between public and private equity fundraising.
Definition
Many publicly listed companies needing to raise funds for investment choose not to offer shares or issue bonds on the open markets, but instead look for capital on the private equity markets. In the former case, funding comes from a publicly listed company looking to invest in other companies that offer synergy, as well as good financial returns. In the latter, the funds come from institutional investors who invest their wealth indirectly through private equity funds—private equity being a class of assets that are not publicly traded on the exchanges. Institutional investors provide such capital with the aim of achieving risk-adjusted returns that exceed those possible on the stock markets.
In both cases, a percentage stake in the company is surrendered in exchange for the investment, and the deal usually includes one or more seats on the board of directors as well. Companies seeking equity funding may use a financial intermediary to broker the best deal for the investment.
Companies that raise investment capital in this way can usually expect to deliver a return on investment through one of the following routes: Recapitalization, in which the company distributes dividends or cash to its stakeholders; a merger or acquisition, in which the company may be absorbed by or merged with its public equity investor, or sold for either cash or shares in another company by its private equity backers; a buy-out, in which the equity investor agrees to pull out in exchange for a cash sum from the company, which thereupon regains its independence; or an initial public offering (IPO), whereby company shares are offered to the public on a stock exchange, which offers the equity investor both an immediate partial cash return on its investment, in addition to a public market in which additional share issues can be placed at a later date.
Advantages
-
Raising capital through equity can be a good choice for companies that are not ready for an IPO or are unwilling to finance expansion through debt.
-
An equity deal means that the company has access to business experts through its investors, who can help to steer the business strategically as well as financially.
Disadvantages
-
Taking the equity route can lock a company into an agreement over a long time frame.
-
The company may have to surrender a large stake in return for investment, possibly as much as 50%, and also provide seats on the board.
-
Investors may interfere with the company’s business plan and other areas of strategic importance.
-
With either type of equity deal, there needs to be chemistry between the counterparties. Lack of chemistry can lead to board disagreements and other problems, souring the relationship.
-
It can be difficult for a company to extricate itself from an equity investment arrangement, depending on the terms of the deal.
Action Checklist
-
Look for synergies if choosing the equity investment route, as the relationship with investors is likely to be more fruitful and less fraught if the counterparties feel they want the same things for the business, and can agree on essentials such as direction and strategy.
-
Private equity firms are more likely to be concerned about the long-term relationship in terms of ultimate financial return, whereas a public equity investor may be concerned only with the bottom line.
Dos and Don’ts
Do
-
Hold talks with a range of potential investors to compare the deals on offer.
-
Look at other possible financing options—an equity deal may not always be the right solution.
Don’t
-
Don’t enter into an equity deal if you feel pressured to give away a greater stake in the business than you want to. You may regret it later.
-
Don’t be afraid to bargain hard at the negotiating stage of the deal.
www.qfinance.com