Equity

When financing investment projects, possible financial partners usually require a share of equity of at least 20 to 30 percent. In most cases, start-ups have to rely solely on financing through equity.

Equity can result from a company's own business activities or is acquired by finding new shareholders. Most commonly capital is then raised through:

• Business Angels
• Venture Capital
• Private Equity
• Initial Public Offering (IPO) which is the first public sale of shares on the stock exchange by a private company

With the provision of money, shareholders usually acquire certain company rights which can range from controlling and participating rights to a share of profits.

Apart from these equity forms, money resulting from public funding to promote investment projects in Germany (usually in the form of cash incentives) is also considered equity by financial partners.

Business angels are wealthy individuals, often self-made and with considerable business background and industry expertise, who allocate some of their resources to invest knowledge and seed money in new ventures.

During a company's seed phase, business angels are often the only source of external financing for a project. For first-time entrepreneurs and young companies, it is almost always easier to raise money through angels than it is through traditional venture capital firms.

This start-up support provides the entrepreneur with enough capital to fund initial product development and sales so that the company can later raise additional capital through other sources.

Business angels also often act as mentors by tapping into an extensive, worldwide network to help finding customers and other business partners for an investment project.

Venture capital (VC) is often required for the financing of high-tech, high-risk projects. VC is provided by VC companies who manage funds from private, institutional, and public investors.

Generally, VC fund investors accept a higher risk of failure than is normally the case for other more conservative investments. This is because young companies rarely have significant assets or revenue history. In return for taking on this risk, VC companies expect to recoup their investment as a result of increased market potential resulting from a perceived unique selling proposition.

VC participation is limited to a specified period of time, at the end of which the VCs "cash out" by selling their shares and realizing profit at a margin of between twenty to thirty percent. These shares are usually sold as part of an "initial public offering" (IPO) - the first sale of stock by a company to the public. Where an IPO is unrealistic or holds little promise, VC companies can realize their shares through a so-called "trade sale": the selling of shares to another company.

Companies can approach VCs directly to apply for VC money. In Germany, the appropriate financial partner can be found through the German Private Equity and Venture Capital Association (Bundesverband Deutscher Kapitalbeteiligungsgesellschaften e.V., BVK). Special conferences and events like the German Equity Forum (Deutsches Eigenkapitalforum) provide an opportunity for young enterprises to come into direct contact with VC companies.

Private equity is privately traded capital provided by private equity companies financed by institutional funds (e.g. pension funds) and private investors. As a broader term it also comprises venture capital.

Private equity, in the literal sense, is an appropriate instrument for established and growing companies. Private equity firms usually concentrate on companies with a sales threshold in excess of EUR 20 million. For deals above EUR 50 million, the market proves highly competitive.

Like venture capital companies, private equity companies provide funding to a company for a fixed period (usually three to seven years). The participation of a private equity firm is often concluded by a trade sale (i.e. the selling of shares to another company).

The German Private Equity and Venture Capital Association (Bundesverband Deutscher Kapitalbeteiligungsgesellschaften e.V., BVK) and the German Equity Forum (Deutsches Eigenkapitalforum) are good starting points for identifying the appropriate private equity partner.

The IPO is the first time a company approaches the public capital market to finance its business by selling shares at the stock exchange. IPO provides the right option for companies wishing to avoid dependency on a select few private investors.

There are two ways to gain access to capital markets in Germany:

• The Regulated Unofficial Market or Open Market (Freiverkehr), offers an appropriate first entry point for small or recently founded companies.
• The Regulated Market (Amtlicher Markt), governed by EU regulations, requires higher entry, reporting, and transparency standards.

Investors can call upon a wide range of public funding in Germany. There is a large selection of programs available which are designed to support business activities at all stages of the investment process.

One of the main instruments are cash incentives usually provided in the form of grants. Promotion rates can account for up to 50 percent of investment costs. They are usually regarded as equity by financial partners.

Other public funding instruments, such as interest reduced loans, are usually debt oriented.

For further information on how to profit from incentives in Germany, please refer to our chapter on incentives.