What are equity funds?

The UK equity finance market represented £8.8 billion for small businesses in 2023, but do equity funds make up a portion of this and if so, how can your small business get involved? 

What are equity funds? 

An equity fund is a collection of stocks put together to achieve a specific investment objective. A collection of investors get together, usually with the support of a fund manager, to invest in a range of stocks and shares with the goal of growing their money. This collection can mean there is less risk if a specific share performs poorly, as opposed to a single investor investing in a single business. 

How do equity funds work?

An equity fund works by gathering together a range of investors and investing in a wide variety of stocks. The first step is forming a fund, which is usually spearheaded by a fund manager who takes a fee or percentage as payment for managing the fund.

The fund manager then gathers together the investors, which could include private investors, high-net worth individuals, and corporations. The fund manager will then use the gathered funds to invest in a portfolio of stocks that they believe will grow. 

Some funds have specific purposes or values that the fund manager must stick to, for instance, a fund could have the USP of being environmentally and health friendly – in which case, the fund manager may be prohibited from investing in oil companies or cigarette businesses. 

Performance will usually be evaluated on a regular basis, with the fund manager reporting earnings and percentages to any investors and dividends being shared out among the investors. 

Is an equity fund the right choice for my business? 

It might be. Below we’ve listed some ways you can decide if an equity fund is right for your business.

Equity funds as an investment

If you’re considering investing in an equity fund, there are some questions you may want to ask yourself. 

• Do I have a lump sum of money or a regular surplus of money that I want to invest in something other than my business? 

• Do I want to diversify the investments my business is involved in? 

• Am I happy to pay corporation tax on anything I gain from my investments?

• Am I comfortable with the possibility that I may lose money, rather than gaining money? 

• What kind of fund do I want to invest in? 

• Am I happy to pay a fee for someone to manage my investments? 

• Am I comfortable with letting a fund manager decide which businesses I invest in? 

Beyond asking yourself these questions, ensure you do plenty of research into the fund, the manager, and the types of investments they are proposing. When in doubt, speak to a financial advisor. 

Equity funds as a form of funding

This is a little more complex. Equity funds usually invest in much larger businesses, meaning getting an equity fund to invest in your SME may not be possible. Fund managers like to be able to stay flexible – they want to be able to trade shares and stocks quickly, which isn’t always possible when working with smaller businesses. 

There is something called a small-cap fund, which is a fund that invests a percentage of its money in small-cap stocks – but even those are publicly traded companies with a market cap of between 250 million to 2 billion dollars. In the UK, small cap stocks are companies that are not large enough to be included in the main FTSE indexes, but again, those are still pretty large businesses objectively. 

If you don’t fit the criteria for equity funds, there are plenty of other options available to you if you’re looking for funding. We’ve listed some of these below. 

What are my other options if I’m looking for funding? 

Debt financing and equity finance are the two main options. We’ve outlined below the benefits of each, and if you’re interested in gaining access to debt financing, you can check your eligibility here.  

There is however, a third option that sits somewhere in the middle. A merchant cash advance is a way to gain access to funding which you repay based on earnings, rather than installment schedules, without giving up equity. 

This form of funding is where you are given a lump sum in exchange for a percentage of future revenue. You then repay the advance plus fees until the full amount is repaid, at which point the agreement can be closed out or, in some cases, you could decide to use the option to renew again. 

Benefits of equity finance for SMEs

Equity finance is the most similar to an equity fund as a possible source of finance for SMEs. The benefits are listed below.   

No strain from regular repayments 

Unlike debt financing, equity finance doesn’t require you to make regular monthly payments set to a strict timeframe. This could reduce the pressure on cash flow and performance that can come with debt financing. 

A new team member 

Investors are often savvy business owners themselves. Some may have worked extensively in your industry, others may have a deep network of connections, and still others may have grown and sold their own businesses. This means equity finance can come with the added benefit of an invested third party with the knowledge and experience that could help you grow. 

A detailed strategy 

Gaining access to equity finance often includes needing to put together a detailed strategy to demonstrate to investors how you plan to grow. There is also then the additional pressure to live up to that strategy and deliver on what the investors bought in for. This could help build your motivation and keep you accountable. 

The possible risks and drawbacks of equity finance 

With equity funding, you are trading away a piece of your business, which means you have less ownership in your business, a smaller percentage of your total profits, and depending on your agreement, possibly less control over how the business is run. There is also now additional pressure to perform well as you now have additional parties who are fiscally invested in your business – this can create added stress. 

Benefits of debt finance for SMEs

Debt financing has a range of benefits, including some of the below.  

A range of options 

There are many different types of debt finance available for SMEs. From purchasing your company premises with a commercial mortgage, to buying a portfolio of rental properties with buy-to-let property finance, to auction finance to help you snap up a property fast – debt financing can help you secure a property you could be proud of. 

Alternatively, if you’re looking to facilitate growth or smooth out seasonal bumps in cash flow, a working capital loan can give you that boost you need to purchase inventory before the winter stock run, while invoice finance could help you pay suppliers while waiting the standard 30, 60, or 90 days for clients to pay. 

Retained ownership 

You do not need to trade a portion of your business for funding with debt finance. Once you have fully repaid the loan, including all fees and interest, the agreement is usually closed out, so the lender will not get a percentage of your future profits. 

Keep control in your business 

As mentioned, you don’t need to trade shares in your business for debt financing, which means you get to keep control of your business. While an investor could help you strategise for the future, they could also decide to take your business in a direction you are uncomfortable with. Depending on how much equity they have in the business, that conflict may present an issue long-term. With debt financing, you retain more control over your business. 

The possible risks and drawbacks of debt funding 

Debt financing is usually repaid in regular installments, often monthly. This can add pressure to cash flow. Not to mention, missing payments would have a negative impact on your ability to gain access to funding in the future. 

The interest rates and fees, which are added in addition to the original amount borrowed, can also eat into profits – less profit can mean less money to invest and grow. Some business lenders ask founders to put a personal guarantee or asset as collateral for the loan, which can make some founders uncomfortable. 

Looking for finance now? 

Becoming part of an equity fund can be a complex process and is often only an option for businesses traded on the stock market, as equity fund managers like to be able to buy and sell stock with more speed than may be possible when purchasing equity in a small business. 

If you’re looking for finance now, we may be able to help. We connect eligible borrowers to our network of over 120 lenders offering between £1,000 and £20 million in funding. Just click the link below and submit your information to find out more. 

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Please note that the information above is not intended to be financial advice. You should seek independent financial advice before making any decisions about your financial future.

It’s important to remember that all loans and credit agreements come with risks. These risks include non-payment and late-payment of the agreed repayment plan, which could affect your business credit score and impact your ability to find future funding. Always read the terms and conditions of every loan or credit agreement before you proceed. Contact us for support if you ever face difficulties making your repayments.

Funding Options, now part of Tide, helps UK firms access business finance, working directly with businesses and their trusted advisors. Funding Options are a credit broker and do not provide loans directly. All finance and quotes are subject to status and income. Applicants must be aged 18 and over and terms and conditions apply. Guarantees and Indemnities may be required. Funding Options can introduce applicants to a number of providers based on the applicants' circumstances and creditworthiness. Funding Options will receive a commission or finder’s fee for effecting such finance introductions.