Very few business owners entirely self-fund their growth, especially if the growth is significant. While some are sufficiently profitable to fund growth through cashflow, in most cases, businesses use other funding sources to increase the speed of growth. There are various ways to do this, including offering equity to staff members. This can provide a sustainable model that offers additional benefits.
At a recent business growth summit held over a week in France, business owners discussed the various funding models available to them, along with the pros and cons of each.
One of the common themes that emerged during the discussions was the importance of raising funds early, even when they’re not yet needed. The challenges in raising money shouldn’t be underestimated. Often, by the time the business needs the funds, the opportunity is urgent; there’s no time to slowly build capital to take advantage of the opportunity. Businesses can benefit greatly from negotiating finance options before they’re required. They can then act immediately when growth opportunities arise.
It’s important to investigate all potential funding sources including bank loans, non-bank loans, invoice financing, equipment finance, private investors, and crowdfunding. One business in attendance had raised millions of dollars through crowdfunding in just a few months.
Another business owner took on significant debt in the form of a bond. While this was initially considered cheaper than selling equity in the business, the cash flow impact over three years of paying the interest was significant. In hindsight, that business owner suggested equity funding may have been a better option.
Providing equity to staff members can be an effective and beneficial way to fund growth. One of the key benefits can include the ability to attract the talent required for growth that the business would be unable to afford otherwise.
There are four key considerations for business owners to be aware of when considering offering equity to staff:
- Rationale. It’s important to have a very clear reason to offer equity because giving away part of the business can be expensive when considering how much that share will be worth when growth is achieved. Two key reasons include enabling growth by attracting expensive talent as well as retaining key talent.
- Agreement. It’s crucial to have a shareholders’ agreement that includes appropriate exit clauses. This is for everyone’s protection and avoids any misunderstandings in the future, especially if the business growth is more successful than anticipated.
- Valuation. In the share-sale agreement, it’s advisable to have appropriate evidence regarding how the business was valued. This can become important for tax reasons and is also a key part of due diligence.
- Payment. In most cases it’s advisable to sell the equity rather than gift it. In many cases this is for tax reasons. However, it’s also important not to de-value the equity. While it may feel “free” at the time, it is actually a very expensive gift. The payment model can be flexible, with the employee paying for equity through reduced salary or earnings for a period of time.
Business owners need to be creative and proactive when it comes to funding growth. Offering equity to staff can be a great way to go but it’s also important to make sure the deal is right for both the business and the staff member. Many companies have achieved successful growth through this model. Getting professional advice throughout the process is also key to its success.
Andrew Laurie, CEO, entrepreneur and business coach