Equity Finance for Businesses: How It Works and When to Use It

Equity finance allows a business to raise capital by selling shares to investors rather than borrowing money and repaying it with interest.

In return for their investment, the investor becomes a shareholder and receives an ownership stake in the company.

Equity financing can be used to fund business growth, expansion, new products, acquisitions and other significant investments. It may be particularly useful where a business needs substantial capital but does not want, or is unable, to support additional debt repayments.

However, raising equity means sharing future ownership, value and potentially some control of the business.

This guide explains how equity finance works, the different types of equity funding available to UK businesses and when bringing an investor into your company may make commercial sense.

What Is Equity Finance?

Equity finance is a method of raising money by issuing or selling shares in a company to investors.

Unlike a business loan, equity funding does not normally have to be repaid through scheduled capital and interest payments.

Instead, the investor receives part ownership of the business.

For example:

Company valuation before investment: £4 million
New investment: £1 million
Post-investment valuation: £5 million

In a simplified scenario, an investor providing £1 million could receive a 20% shareholding in the company.

The existing shareholders would collectively retain 80%.

The precise percentage depends on the valuation and terms agreed between the company and investor.

How Does Equity Finance Work?

A typical equity financing process involves several stages.

1. The business decides how much capital it needs

The company first identifies:

• How much funding is required
• What the capital will be used for
• What commercial outcome is expected
• How much equity the existing shareholders may be willing to give up

For example, a company may want £750,000 to expand its sales team, invest in technology and enter a new market.

2. The business is valued

A valuation is needed to help determine how much ownership the investor receives in exchange for their capital.

Suppose a business is valued at £3 million before investment and raises another £1 million.

The post-investment value would, in a simplified example, be £4 million.

The new investor could therefore own:

£1 million ÷ £4 million = 25%

Valuation negotiations can be one of the most important parts of an equity funding process because they determine how much of the company the existing shareholders retain.

3. Investors assess the opportunity

Potential investors will carry out their own assessment of the business.

Depending on the investor and company, they may consider:

• Historic financial performance
• Revenue growth
• Profitability
• Market size
• Competitive position
• Management team
• Business model
• Customer base
• Growth potential
• Financial forecasts
• Exit opportunities

Investors are generally looking for the potential to increase the value of their investment over time.

4. Investment terms are negotiated

The discussion is not limited to how much money is being invested.

Terms may also cover:

• Shareholding percentage
• Voting rights
• Board representation
• Investor consent rights
• Dividends
• Future fundraising
• Management incentives
• Exit provisions
• Information and reporting requirements
  
  

5. Due diligence is carried out

Before completing the investment, the investor will normally investigate the company in more detail.

This can include financial, legal, commercial and operational due diligence.

6. Shares are issued or transferred

Once the investment completes, the investor receives the agreed ownership interest and the company receives the capital.

The investor is then a shareholder in the business.

What Are the Different Types of Equity Finance?

Equity funding is available from several types of investor.

The most suitable source depends on factors including the company's size, stage of development, funding requirement and growth plans.

Angel Investment

Angel investors are individuals who invest their own money into businesses.

They are often experienced entrepreneurs, executives or high-net-worth individuals.

Angel investment is commonly associated with early-stage and growing businesses.

As well as providing capital, an angel investor may bring:

• Commercial experience
• Industry expertise
• Contacts
• Mentoring
• Strategic advice

This can be valuable for companies whose owners want more than financial investment alone.

The relationship between the founders and investor is important because they may work together for several years.

Venture Capital

Venture capital firms invest money from professionally managed funds into companies with significant growth potential.

Venture capital is particularly associated with:

• Technology
• Software
• Life sciences
• Innovative products
• Rapidly scaling companies

However, it is not restricted exclusively to these sectors.

Venture capital investors typically look for businesses capable of achieving substantial growth and increasing significantly in value.

They will normally expect an eventual exit through an event such as:

• Sale of the business
• Sale of their shares to another investor
• Management buyout
• Public listing

Venture capital therefore tends to suit companies with ambitious growth plans rather than businesses aiming primarily to generate stable long-term income.

Private Equity

Private equity generally involves investment into more established businesses.

A private equity firm may acquire:

• A minority shareholding
• A majority shareholding
• The entire company

Private equity investors often target profitable businesses where they believe there is an opportunity to increase value through growth, operational improvement, acquisitions or strategic change.

Depending on the transaction, the existing owners or management team may retain a meaningful shareholding.

This can align their interests with the investor because both parties benefit if the company's value increases.

Equity Crowdfunding

Equity crowdfunding allows a company to raise investment from multiple investors through an online platform.

Rather than one investor providing the entire amount, many individuals may each contribute smaller sums.

In return, investors receive shares in the business.

Equity crowdfunding can be particularly relevant for:

• Consumer-facing brands
• Early-stage businesses
• Companies with engaged communities
• Businesses with a proposition that is easy for individual investors to understand

Equity crowdfunding should not be confused with reward-based crowdfunding, where supporters receive products or other rewards rather than shares.

Corporate or Strategic Investors

An established company may invest in another business where there is a strategic reason to do so.

The investor might be:

• A supplier
• Customer
• Competitor
• Large company in the same industry
• Business operating in an adjacent market

Strategic investors can potentially provide more than capital.

They may offer:

• Distribution
• Technology
• Customer access
• Industry expertise
• Commercial partnerships

However, accepting investment from another company can also create strategic considerations around control, confidentiality and future competition.

Existing Shareholders

A company can also raise additional equity from its existing shareholders.

Existing owners may contribute further capital rather than introducing a new external investor.

This can simplify some aspects of the process because the shareholders already understand the business.

However, additional investment can still alter the ownership percentages if different shareholders contribute different amounts.

What Do Equity Investors Get in Return?

Equity investors do not generally receive fixed repayments in the same way as lenders.

Their return is linked to their ownership of the business.

Investors may benefit through:

An increase in share value

Suppose an investor puts £1 million into a business at a £5 million post-investment valuation and receives 20%.

If the company is later sold for £15 million, that 20% shareholding could theoretically be worth £3 million, subject to the investment terms and capital structure.

Dividends

Profitable businesses may distribute some earnings to shareholders through dividends.

However, many growth-focused companies reinvest profits rather than paying substantial dividends.

Sale of the business

Investors may realise their return when the company is acquired by another business or investor.

Sale of the investor's shares

An investor may sell its stake to another shareholder or incoming investor.

The exact rights and restrictions relating to share sales are normally governed by the company's legal agreements.

Does Equity Finance Mean Giving Up Control?

Not necessarily.

Raising equity means giving up some ownership, but that does not automatically mean losing control of the company.

For example, a founder who owns 100% of a company could issue 20% to an investor and retain 80%.

The founder would still own a substantial majority.

However, share percentage is only part of the picture.

An investor may negotiate rights relating to:

• Board appointments
• Major expenditure
• Acquisitions
• Additional borrowing
• Issuing new shares
• Selling the company
• Changing senior management
• Business plans and budgets

Minority shareholders can therefore sometimes have significant influence over important decisions.

Business owners should understand the complete investment agreement rather than focusing solely on the percentage of shares being issued.

What Is Equity Dilution?

Equity dilution occurs when new shares are issued and an existing shareholder's percentage ownership decreases.

For example:

A founder initially owns 100% of a company.

The company raises investment and issues shares giving a new investor 20%.

The founder now owns 80%.

If the business later completes another funding round, the founder's percentage could reduce again.

Dilution is not automatically negative.

Owning a smaller percentage of a substantially more valuable business can be financially better than owning 100% of a company with limited growth.

For example:

100% of a £1 million business = £1 million

whereas:

50% of a £10 million business = £5 million

The important question is whether the capital and support provided by investors can create enough additional value to justify the ownership being given up.

What Is the Difference Between Equity Finance and Debt Finance?

Equity finance and debt finance are the two main ways businesses raise external capital.

Debt may be preferable where the business has stable cash flow and the owners want to retain their equity.

Equity may be preferable where:

• Significant investment is required
• Fixed debt repayments would create pressure
• Growth is difficult to predict
• Investors can provide valuable expertise
• Existing shareholders are comfortable sharing ownership

Many businesses use a combination of both.

Read Debt Finance vs Equity Finance: Which Is Better for Your Business? for a full comparison.

Advantages of Equity Finance

Equity funding can offer several advantages.

No conventional loan repayments

Because the investor receives shares rather than providing a traditional loan, the business does not normally make regular capital repayments.

This can preserve cash for growth.

No conventional interest payments

Equity investment does not normally carry an interest rate like debt.

Access to substantial growth capital

Equity can provide significant funding where taking on the same amount of debt would be difficult or inappropriate.

Investor expertise

A good investor may provide:

• Strategic guidance
• Sector knowledge
• Management experience
• Recruitment support
• Introductions
• Future funding contacts

UK government business guidance specifically identifies expertise and contacts as potential advantages of equity investment alongside access to capital.

Greater financial flexibility

Without fixed loan repayments, the company may have more flexibility during periods of rapid investment or uneven growth.

Disadvantages of Equity Finance

Equity financing also has important drawbacks.

You give up part of the company

The most obvious cost is dilution.

Existing shareholders own a smaller proportion after investment.

You share future value

If the company becomes extremely valuable, the investor participates in that upside.

An equity investment that initially appears expensive can ultimately cost more than debt if the business grows substantially.

Investors may influence decisions

External shareholders may have voting rights, board seats or consent rights over important decisions.

Raising equity can take time

Finding an appropriate investor, negotiating valuation, carrying out due diligence and completing legal documentation can be a substantial process.

UK business guidance notes that securing equity finance can be an involved process and may take several months.

Reporting may become more demanding

Professional investors commonly expect regular financial and operational reporting.

This may increase the administrative requirements placed on management.

When Is Equity Finance a Good Option?

Equity finance may be particularly suitable when the business:

Has strong growth potential

Investors generally need the opportunity for the company to become significantly more valuable.

Needs substantial capital

Equity can support larger growth initiatives without creating equivalent debt repayments.

Has limited debt capacity

A company may already have borrowing or may not generate sufficient predictable cash flow to support additional debt.

Would benefit from an experienced investor

Sometimes the investor's experience, contacts and strategic input can be nearly as valuable as the funding itself.

Is making a major strategic move

Equity can help fund:

• International expansion
• New products
• Major acquisitions
• New facilities
• Transformational growth

When Might Equity Finance Be Less Suitable?

Equity funding may be less attractive where:

• The owners do not want to dilute their shareholding
• The company can comfortably finance the investment using debt
• The business is not aiming for significant growth
• Existing shareholders do not want external influence
• The valuation available would require giving away too much equity
• There is no clear path for an investor to realise a return

For a stable, cash-generative company with a modest funding requirement, borrowing may be simpler than bringing in a new shareholder.

How Much Equity Should You Give an Investor?

There is no universal percentage.

The amount of equity depends primarily on:

• Business valuation
• Investment amount
• Investor type
• Growth opportunity
• Negotiating position
• Risk
• Investment terms

A simple way to understand the relationship is:

Investor ownership = investment ÷ post-investment valuation

For example:

Pre-money valuation: £4 million
Investment: £1 million
Post-money valuation: £5 million

£1 million ÷ £5 million = 20%

In reality, investment structures can be more complex, and valuation is only one part of the negotiations.

Businesses should also consider rights attached to the investor's shares.

What Do Investors Look for Before Providing Equity Funding?

Different investors have different criteria, but they commonly consider:

• Management team
• Historic performance
• Market opportunity
• Competitive advantage
• Growth potential
• Profit margins
• Business model
• Customer concentration
• Scalability
• Financial forecasts
• Valuation
• Exit potential

An investor needs to understand why the business could become more valuable after receiving the funding.

GOV.UK guidance similarly notes that businesses raising investment should be able to demonstrate how the additional capital is expected to increase sales and profitability and how the associated costs affect cash flow.

How Do You Raise Equity Finance?

Although every transaction differs, the process commonly includes:

1. Define the investment requirement

Understand:

• How much capital you need
• Why you need it
• How long that capital should support the business
• What milestones it should achieve
  
  

2. Prepare your financial information

Investors may expect:

• Historic accounts
• Management accounts
• Forecasts
• Cash flow models
• Revenue assumptions
• Ownership information
  
  

3. Establish a realistic valuation

The valuation affects how much equity needs to be issued.

An unrealistic valuation can make raising investment more difficult.

4. Prepare an investment proposition

Your proposition should clearly explain:

• The business
• Market opportunity
• Competitive advantage
• Management team
• Growth strategy
• Funding requirement
• Expected use of proceeds
• Financial projections
  
  

5. Identify suitable investors

Look for investors whose:

• Investment size
• Sector experience
• Business-stage preference
• Geographic focus
• Strategic approach
  

fit your business.

6. Negotiate terms

Evaluate more than just valuation.

An investor offering the highest valuation is not automatically the best partner if the wider terms are unsuitable.

7. Complete due diligence

Expect investors to test the assumptions and information you have provided.

8. Complete the legal investment

Once terms and due diligence are agreed, the transaction is legally documented and the investment can complete.

Government Schemes Supporting Equity Investment

Some UK businesses may be able to raise equity through schemes designed to encourage private investment.

These include tax-advantaged venture capital schemes such as the Enterprise Investment Scheme and Seed Enterprise Investment Scheme, subject to company, investor and investment eligibility conditions.

Government-backed programmes also exist to increase access to equity capital in parts of the market. For example, the Enterprise Capital Funds programme combines private and public investment to support eligible high-growth early-stage businesses.

Eligibility and scheme rules can change, so businesses should check current requirements and obtain appropriate professional advice before relying on a particular scheme.

Can Equity Finance Be Used to Buy a Business?

Yes.

Equity investment can form part of the funding structure for a business acquisition.

For example, suppose a buyer wants to acquire a company for £2 million but does not want the target to carry the full amount as acquisition debt.

A simplified funding structure could be:

The equity investor may receive shares in the acquiring company, target business or another transaction vehicle depending on how the deal is structured.

Using equity can reduce the amount of debt required, but it also means sharing ownership and future returns.

Buyers need to consider:

• Who controls the company after completion
• How much equity each party owns
• Investor voting rights
• Future dividends
• Management incentives
• What happens when either party wants to exit

For the wider funding options available when acquiring a company, read our guide to financing a business purchase.

Equity Finance for Management Buyouts

Equity funding can also play a role in a management buyout where the existing management team does not have enough capital to purchase the business outright.

Management may contribute its own money alongside:

• Private equity
• Acquisition debt
• Seller finance
• Deferred consideration

An external equity investor can provide additional capital while the management team retains a stake in the company.

The eventual ownership structure depends on the size of each contribution and the terms negotiated.

Read our guide to MBO vs MBI for more information about management-led acquisitions.

Choosing the Right Equity Investor

If you decide to raise equity finance, the amount offered should not be the only consideration.

An investor can remain involved with the business for several years.

Consider:

• Their sector experience
• Track record
• Reputation
• Investment horizon
• Expectations for growth
• Desired level of involvement
• Ability to provide follow-on capital
• Network
• Approach to management
• Exit expectations

The best investor relationship is generally one where both parties understand what they are trying to achieve and how the company will be managed.

Is Equity Finance Right for Your Business?

Equity finance can provide businesses with growth capital without adding conventional loan repayments.

It can be particularly valuable where substantial investment is required, the business has strong growth potential or an investor can contribute expertise alongside capital.

However, investment is not free money.

The cost is a share of the company's ownership and potentially a share of its future value and decision-making.

Before raising equity, consider:

• How much funding you genuinely need
• What the investment will achieve
• What the company is realistically worth
• How much ownership you are prepared to give up
• What rights an investor will receive
• Whether debt could achieve the same objective
• Whether the investor is the right long-term partner
• How and when the investor expects to exit

For businesses that can comfortably support repayments while retaining ownership, debt finance may be preferable.

For businesses requiring substantial growth capital or greater financial flexibility, equity may offer a better fit.

Explore our Business Funding Guide for an overview of the wider funding landscape, or read Debt Finance vs Equity Finance for a direct comparison of the two main funding routes.

Use Equity to Help Fund Your Next Business Acquisition

If you are considering equity finance because you want to buy an established business, bringing in an investor can sometimes make a larger or more ambitious acquisition possible.

At Valius, we help buyers discover established businesses for sale and navigate the wider acquisition process, including valuation, due diligence, funding and deal structure.

Equity investment can form part of a broader funding package alongside your own capital, acquisition debt, seller finance or deferred consideration. This can reduce the amount of borrowing required while giving you access to additional capital and, potentially, an investor with useful commercial experience.

The right structure depends on the business, the purchase price, your own contribution and how much ownership you are prepared to share after completion.

Understanding those factors early can help you focus your search on opportunities that are both commercially attractive and realistically achievable.

Ready to explore your next acquisition opportunity?

Browse Businesses for Sale or Create Your Free Valius Account and start searching today.