Equity and private equity, and the exit you are agreeing to

What equity funding is

Equity is money invested in exchange for a shareholding. It is not a loan, there is no repayment schedule, and nothing has to be paid back if the plan takes longer than expected. That sounds like the easiest money in the deal, and it is the most expensive, because the investor is paid out of the eventual sale of the business rather than out of its trading.

The market runs from an individual investor putting in their own money, through family offices and regional funds, to small-cap private equity houses building groups by acquisition. They differ in size, in how involved they expect to be and in how patient they are, but the underlying question is the same for all of them: who buys this business in a few years, and for how much more than it costs today.

What an investor takes comfort from

Not security. An equity investor has none, and cannot enforce anything if trading disappoints, which is precisely why the assessment is different from a lender's.

They are underwriting three things. The growth case: not whether the business is sound, but whether it can be worth materially more. The management team, because they cannot run it themselves and their money depends on people they are not employing. And the exit: a credible answer to who the eventual buyer is, what sort of business they are, and why they will want this one.

A business that is profitable, stable and unlikely to grow much is a good business and a poor equity investment. That is not a criticism of it. It is a reason to fund it with debt instead.

What you are agreeing to alongside the shares

Most of the substance of an equity deal is not the valuation. It is in the shareholders' agreement and the articles, and buyers routinely negotiate hard on the first and quickly on the second.

Preference. Investors commonly hold shares that are paid before ordinary shares on a sale, often with a preferred return on top. On a strong exit this hardly matters. On a modest one it can mean the ordinary shareholders receive very little, which is the outcome nobody models.
Ratchets. The split can move according to performance, in either direction. Understand which way it moves and against what measure.
Reserved matters. A list of things the company cannot do without investor consent: borrowing, hiring above a level, capital spending, acquisitions, changing the plan. This is where control actually sits, more than in the percentage held.
Board composition, and what an investor director can and cannot do.
Drag and tag rights. Whether a majority can compel a sale, and whether a minority can insist on joining one.
Leaver provisions. What happens to management shares if someone departs, and the difference between leaving well and leaving badly. Read this before signing, not on the way out.
Warranties from management, which are personal and are a different thing entirely from the company's obligations.

The costs of the process are real too. Legal work and due diligence are usually substantial, and in many structures they are borne by the company being invested in, including where the deal does not complete.

Where it fits in an acquisition

Equity earns its place where the plan needs more capital than the trading cash can service. Buying a business and then buying two more, entering a new region, or funding a step change that will take years to pay back are all cases where debt alone would break the business simply through the repayment schedule.

It also fits where a buyer has the sector expertise but not the money: a buy-in candidate with a strong record and a modest amount of capital is exactly what a search-style investor is looking for. What the buyer is expected to contribute in that case is covered in equity contribution.

Where the shortfall is smaller and the aim is to keep ownership, mezzanine fills a similar space in the structure without giving away shares, and money left in by the seller through vendor and seller finance is usually cheaper than either. Those two are worth exhausting first.

When this is the wrong answer, and it often is

For most of the acquisitions in the sectors covered on this site, equity is not the route. A trade services business with a solid maintenance base, or a professional practice with recurring fees, is fundable with senior term debt and a deferral from the seller, and the buyer keeps all of it.

Bringing in an investor there means selling part of the upside, accepting a timetable set by somebody else's fund, and taking on reserved matters, in exchange for money the business could have borrowed. It is the right answer when the ambition genuinely exceeds what debt can carry, and the wrong one when it is simply the first door that opened.

What goes wrong

The exit timetable belongs to the investor. Funds have lives, and the pressure to sell arrives whether or not the owner is ready. Agree the expected horizon out loud at the start.

The preference stack swallows a reasonable outcome. A sale that would have been a good result for the founder returns very little once the preferred amounts come off the top.

Reserved matters catch ordinary decisions. A list drafted for a large business applied to a small one means consent is needed for things that used to take five minutes.

Ambitions never matched. One side wants a solid business paying dividends, the other wants a sale in a few years. Both are legitimate. Together in one company they are a slow argument.

Diligence costs landed on a deal that failed. Where the company carries the cost, an aborted process is expensive and there is nothing to show for it.

What an investor will want to see

A business plan with a growth case that is argued rather than asserted.
A financial model with the funding structure in it, and a downside case.
The management team, their track record, and how much of their own money is going in.
An exit thesis: the kind of buyer, and why the business will be attractive to them.
Clean, organised information, because diligence is heavier here than on any debt facility.

Terms that appear in a shareholders' agreement and nowhere else are in the glossary.

Getting a straight answer about which route you need

An equity investor will tell you whether they want to invest. They are unlikely to tell you that the business would have been better funded with debt and a deferral, because that is not the question they were asked.

What we know is this market, and which businesses in it get funded by debt and which genuinely need capital, which is the reason to start here rather than at whichever door is nearest, and it is set out plainly in why Reads. Tell us what you are buying and what you want it to become, and we come back to you having spoken to the right people.