Ways to raise equity capital

THE issue of equity capital raising has been a challenge when it comes to starting a business, expanding or undertaking various transactions.

Equity Capital refers to the amount of cash or other assets that owner(s) contribute to the business in its inception stage or throughout, say, annually. It is the amount of money the owner(s) would sacrifice to lose given the failure of the business.

At the same time, equity capital refers to the amount the owner(s) would get a refund should the company be sold or liquidated. With equity contribution, owner(s) of the business share profits and losses arising from the business.

When seeking external capital to expand businesses, apart from debt finance, owner(s) are supposed to contribute to the project. There is also a very mixed standpoint on whether one should first accumulate capital and think of a business to undertake or think about the business they would like to undertake and mobilize capital thereafter. In other cases, some business owner(s) are unaware of the various sources of raising capital. I will try to explain some of the aspects of capital.

Typically, the owner(s) may contribute to the company many times during the business’s life when a cash injection is needed, for example, when considering expanding the market or growing the business. There are many ways, investors may raise equity capital. The first way is, that the business owner(s) may put part of the assets owned by him/her as a contribution to the business. This could be actual cash or physical assets. The assets must be valued, and relevant to the type of business i.e. to assist the business undertaking. It is important to contribute assets that can be immediately put into use by the business, with minimum modifications/repairs.

The second way is through converting payment to the owner(s) as an employee as part of the equity capital. Most small businesses operate on owner(s) -manager relationships. This is when the owner(s) is also the manager of the business. In most cases, the owner(s) tend to forget to pay for themselves, even considering their benefits such as leave, transport, and other expenses. At the end of the year, they post a profit and forgot that they were employed with the business and hence they need to get paid or turn their contribution to buy more shares of the company. If the effort is not accounted for and paid for, the business may be benefiting from the financing from the owner(s) without consideration of their contributions.

The third way is for the owner(s) to act as a promoter(s) and put up a memorandum to raise private equity capital by issuing new shares and selling them to friends, angel investors, or relatives. Private companies can have a maximum of 50 owners. When owners of the business are more than 5, it is advised that the promoter should prepare a convincing document to invite other members. The document should be in form of a business case or business plan which will show how much is raised, for what purpose, how it will be managed and what results will the capital bring to the business.

The fourth way is where the company needs substantial capital and it has a track record and is qualified for listing in the stock market. The promoter(s) can consider inviting more shareholders through issuing Initial Public Offering (IPO) whereby the company needs to meet conditions set by the Stock Exchange. To find out if your company can raise equity through the IPO, the promoters need to consult a licensed financial advisor and licensed dealing member of the Stock Exchange for advice.

The fifth way of raising capital is through consultation with strategic investors and angel investors. If such investors are in agreement they will issue equity capital in the form of preference shares – meaning, they will be paid a fixed dividend which is carried over, even if the business is not making a profit. Preference shares holders when it comes to bankruptcy they are paid first before the common shareholders, but also they do not have voting rights in company affairs.

It is also important to understand that contributed equity can increase or decrease depending on whether the business firm is making a profit or loss. For instance, when the business makes a profit, and owner(s) of the business do not want to distribute the profit among themselves inform of dividend, it will increase the owner’s equity. It is thus, advised not to consume all the equity contributed but rather plan to retain a percentage of it ~ normally 60 per cent of the profit should be retailed to finance the company’s needs for capital. When the company makes enough profits, it may decide to buy out preference shares and build its reserve for equity capital.

Author: Dr Tobias Swai is a Senior Lecturer and Head of the Department of Finance at the University of Dar es Salaam, Business School. Email: tobias@udsm.ac.tz Telephone: +255 75 4300 495.

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