Caution tips when dealing with equity finance

The last decade has seen a flurry of activity in the rise of private equity financing. Large institutional investors and high net worth investors have actively increased their stakes in buyouts of companies listed publicly. The high returns for the investors in emerging markets have made the case more compelling. Also start-ups looking for financing have found new avenues which were unavailable couple of decades ago. Though most would argue a win-win situation, to proceed with caution would be imperative, with adequate checks, so that there are no adverse fallouts.

Equity finance has its own risks, as equity funds use two approaches to invest the available fund. The first approach is a direct method in which the equity house invests in markets and niche areas based on their analyst research. The spread of their investments depend on the timeframe and incentive of the returns; and once they have achieved their returns they may exit. They necessarily do not possess knowledge or intricacies of the investing targets but at a higher level are convinced on the targets’ capabilities. Since these types of equity financing are purely a capital investment there is absence and lack of visibility in areas of corporate governance. Also there is bound to be irrational exuberance by group of investors in their quest to reach their targets and inflate their investments of the equity that they have brought into. This turns into a cycle which draws other equity financers to invest in these at higher rates, bloating the original investment to irrational levels. Hence, though direct funding equity financing could be a short term option there is equally a huge potential for high rewards or risk of no returns.

The second option is when equity finance is raised through venture capitalists that have fair knowledge of the business they are going to support. Also they would be privy at the operational level since they could be part of the governance board. Such venture equity financers with knowledgeable resources have a greater say and could steer around the fortunes of both the ideation and the investors.

In succinct, the following tips need to be exercised in equity financing when dealing with equity finance be it direct investing or venture capitalists.
Management- Equity financers have to be seasoned professionals who know how to invest and where to invest and when to exit.

Investment Type- Past record of investment types and strategies of equity financiers can throw light on their future plans.

Value – underlying assets of the investments would be a critical factor.
Geography- There has to be an excellent knowledge of the local market conditions and environment. Also the markets being invested in have to be fairly stable.

Ownership - Investments in companies where there is high ownership indicate strong incentive of value creation.

Finance stability – Equity finance investments in targets having high liquidity and no debt would be an attractive proposition.

In short, equity financing like others has its own risks but careful planning and caution can help reap huge benefits.