When more debt is not an option - raising capital through equity finance

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Businesses of all shapes and sizes are being pushed to the brink. As the revenue drops and the outgoings continue, even businesses with strong balance sheets and healthy working capital accounts are feeling the pinch. The old saying that ‘cash is king’ has never been more relevant.

For those that are watching their cash reserves dwindle, advice, at a basic level, has been to consider borrowing more - speak to your bank about refinancing, access one of the Government’s stimulus packages for business (many of which, so far, are focused on providing finance through loans and helping businesses to retain their employees).

But for some businesses, taking on additional debt is undesirable, and for others, simply not an option. More debt means more liabilities on the balance sheet, making it more difficult to satisfy the all-important solvency test.

So, instead of raising money through debt, what about equity?

What is equity finance?

In simple terms, equity financing is the process of raising capital through the issue of shares. Further ownership interests in a company are offered to new or existing shareholders in return for cash.

The major benefit of raising equity capital is that, unlike debt, the company is not required to repay the shareholder’s investment.

When thinking about equity financing, many people think of a complex and costly process reserved for large and established companies: like entitlement offers, private placement to institutions, angel investors or venture capital investment.

However, there is no need to be put off by the perceived complexities involved in raising funds through equity. It is a tool which can be used by companies of all sizes, and can be as simple as approaching family and friends, your community or customer base, or that wealthy neighbour who has always taken an interest in your business.

Types of equity financing available to all companies

  1. Current / existing shareholders

    The first available port of call is always to ask current shareholders to contribute more capital. This needs to be an offer to all shareholders on the same terms, at a price agreed by the board. The process for this type of issue will likely be set out in the company’s constitution or shareholders’ agreement (if there is one) and involves a few fairly simple documents. Typically, the company must give all existing shareholders the option to buy any newly issued shares and can’t just pick and choose those the board thinks will be interested. This is called a shareholder’s "pre-emptive right". If the shareholder declines to buy the newly issued shares, then the shares can be offered to outside buyers.
  2. New shareholders / small offerings

    If a company wishes to widen the net by getting new investors onboard or needs to raise more money than is possible through its existing shareholder base, there are some other factors to consider.

    The Financial Markets Conduct Act 2013 (FMCA) governs offers of shares to the public and can be difficult to navigate at the best of times. Helpfully, it contains a number of useful exclusions from ‘regulated offers’ (which require the preparation of a product disclosure statement) which are targeted at small to medium enterprises that can’t bear the burden of the onerous disclosure requirements.

    The exclusions include offers made to relatives of the directors of the company and close business associates, employees under an employee share scheme, and offers to wholesale investors. The final, and perhaps most common exclusion that is relied upon for equity financing purposes, is the ‘small offers’ exclusion. In order to rely on this exclusion:
    1. the offers can only be made to certain people to ensure they are ‘personal offers’ and cannot be advertised in any way;
    2. there must be a maximum of 20 investors accepting the offer in a 12-month period;
    3. the amount raised must be less than NZ$2 million;
    4. a prescribed warning statement must be included in the relevant documentation; and
    5. the Financial Markets Authority must be advised of the small offer within one month of the end of the relevant accounting period.

      Bringing in new shareholders might sound complicated, but with the right advisor assisting you to navigate the FMCA exclusions and to leverage their networks to find potential investors, it can be a lot easier than you think!
  3. Crowdfunding

    Crowdfunding is a popular way to find potential investors who back your vision, mission and passion. Crowdfunding offers in New Zealand can raise up to NZ$2 million in any 12 month period, and can be promoted to the general public under a reduced disclosure regime. Companies offer shares to their “crowd” of customers, suppliers, fans and supporters, often using an online platform like Snowball Effect or PledgeMe. This option is for more established companies that can show how they have grown, how they have used previous funds, and their plans for growth using the funds to be invested by the crowd.

    A great example of a company using crowdfunding during the COVID-19 pandemic is popular fashion retailer, Ingrid Starnes. The company is aiming to raise a maximum of $500,000 which would equate to new investors owning just under 20% of the company. The minimum investment is $250 so it really is open to any and all types of investors. According to the company they have built up a loyal following over the years so have gone to their community to see if they would be interested in becoming shareholders in the company. You can see more details and observe a live crowdfunding event (as at the date of writing) here.

Further considerations for equity capital raising

As the company is issuing new shares, this typically means some form of dilution for current shareholders. Giving away a chunk of the business you have worked hard to build and in turn owning less of it is something you will need to manage. However, an equity raise does not mean that you necessarily need to ‘lose’ control as well. The type of shares offered can be a different class to those held by the founders or existing shareholders which attract different rights, such as non-voting rights. This means that decision making and the general direction and strategy of the company is still in your hands.

There may be some regulatory compliance and corporate governance hurdles that need to be overcome when bringing in new shareholders, but with the right advice, these can be overcome. In our view, there are certain associated benefits with equity that debt solutions simply cannot match. Those with ‘skin in the game’ are more likely to stick with you during difficult times.

Before embarking on an equity raise, establishing the value of the company and resulting price per share can be cause for contention and often requires specialist advice. Engaging a good accountant or financial adviser who can assist you with this exercise and provide the relevant financial information which you are confident will stand up to the market is crucial.

Conclusion

Equity capital raising is a great tool to raise money, not just for working capital or paying off debt, but it can also be used to expand, carry out research and development into other markets or new products, purchase new equipment or undertake that marketing project the directors have always seen potential value in - all with the added benefit of not having to worry about paying it back or being subject to burdensome security arrangements (such as personal guarantees from directors).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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