I want to talk through with you the advantages and disadvantages of a share issue for ambitious small businesses.
If you’re just starting to think about giving shares and equity away, and want to get your head around the basics, read this article first.
Why you might do a share issue
The most obvious reason for a share issue is to bring in some cash for your business. By selling some of your shares to an investor or your staff, you bring in some much-needed money. Increasing the share capital so you can invest in growing the company.
This extra share capital could be to pay for more marketing, more staff, or developing a new product which will make you more money further down the line.
You might also want to raise money through a share issue so that you can pay off some company debt. If you set up your business with a big bank loan, or you took out a loan to invest a few years ago, you might be tired of making those regular payments to the bank which drain your cash flow every month.
Maybe you also want to issue shares to employees to include them in the company. And maybe raise some cash at the same time.
And you might want to offer some shares to family members. This might be to encourage Uncle Harold to give you some cash. Or it might be to give shares to your partner so you can both take dividends out of the business.
The advantages of a share issue to an investor
The big advantage of a share issue over a bank loan is that you don’t have to pay the money back. This is preferable to a bank loan that has to be repaid, and the cheeky bank manager wants interest on top of the repayments.
When you issue shares to an investor, it’s a different setup. Instead of the regular repayments, you get an injection of share capital you can purely use to build up the business.
The investor doesn’t expect any money to come back to them in the short term. They’re waiting to see if you can grow the company big enough for it to be worth serious money later. Eventually, of course, the investor will want their money back, but this is usually when you sell the company,
A share issue has a very positive effect on your company’s cash flow, which means that you can get on with growing the business and pay for the resources you need to build it more quickly.
The advantages of a share issue to staff
When you issue new shares to employees, you might also be bringing in some extra cash if they are willing and able to buy into the company. But you also make them feel that they are part of the company and align their long-term goals with yours if you give shares to employees.
Disadvantages of a share issue
Business owners often worry that they will lose out by issuing shares to someone else. It’s your business, and you don’t want to share it with anyone else. Why would you? And of course, if you’re planning to sell your business in 5 years’ time, and you’ve sold 30% of it to an investor, then there will be 30% less of the sale price for you.
Or will there?
This is the key issue to work out. Will your business grow faster with the extra investment? And will that mean that the total size of the company is so much bigger, that you will end up with a bigger sale price than you would have done if you hadn’t had the investment?
If you have plenty of money in the bank, and you don’t have to worry about cash flow, you probably don’t need a share issue to bring cash in, and you can already afford to take on more staff or pay for marketing to increase sales.
But this is rarely the case in small businesses. We’re either investing all our profits back into the company, so there’s never any extra for spending on the areas which will give us that big step up.
You have to think about what the impact of that extra cash will be. If you already know the return on investment for developing a new product, employing a new salesperson or doing more online marketing, you’ll have a good idea of what you could do with some investment and if that’s worth it.
Here’s a more specific article about the advantages and disadvantages of angel investment
Other disadvantages of a share issue
One problem that can come when you issue shares to other people is that the investor, employees or even your partner start to get more interested in the business. And making suggestions as to what you can do to improve it. This can be great of course; these could be exactly the kind of ideas you want.
The situation you want to avoid is where the investor (or more likely, Uncle Harold) starts telling you what to do. They have their pet schemes.
I’ve occasionally come across this situation where a client has experienced pressure from a shareholder to do something which is quite different from the strategy we’ve carefully worked out for the company. Or investor shareholders come up with great ideas and expect you to instantly implement them.
This can add pressure to your workload and increase your stress levels. The ideal situation here is where someone comes up with a great idea, wants to know if you agree, and then gets going to set it up. That’s shareholder engagement.
Maintaining control of the company
It’s worth remembering that giving someone shares is not the same as making them a director of the company. The company is run by the directors, so you don’t have to do anything that a shareholder suggests.
If you have shareholders who own more shares than you, they can theoretically remove you as a director of the company if they feel that you’re not working in the best interests of the company or the shareholders. In practice, for a small business, this is only likely to happen if you have repeated share issues and end up having your shareholding diluted down to a small minority shareholding.
You may want to issue a different class of shares to other people (I talk about this in more detail in this article) so that you don’t have to issue dividends unless you want to, and to avoid giving voting rights to the other shareholders.
And of course, you must make sure that you have a shareholder’s agreement to protect yourself and the company. I insist on this one because I’ve seen too many companies where the directors and shareholders haven’t got round to having a shareholders agreement, and when something bad happens, nobody knows what to do.
The paperwork involved in a share issue
The paperwork can range from a simple return of form SH01 to Companies House, to let them know that you’ve transferred share ownership to someone else, plus a shareholder’s agreement, through to much more complex situations
Growth shares, EMI share options schemes are all more specialist areas where you will need a lawyer and an accountant to help you draw up the paperwork. Make sure that you budget for this in the amount of money that you’re seeking to raise. There’s no point raising 50k if you then have to pay 10k to a lawyer.
Alternatives to a share issue to think about
If you’re weighing up the advantages and disadvantages of a share issue to raise cash, you should also think about some of the alternative options open to you.
Why not get a bank loan? I know, I’ve said above that a share issue has the advantage over a bank loan of not having to pay it back. However, a bank loan can be a quicker and less hassle to raise money for your business. Check out this article about how the bank will view your loan application. And think about this option if you need less than, say, 100k of investment. Most angel investment deals are for more than 250k.
If the main reason to issue shares is to ease cash flow, rather than to make a big investment in growing the business, it might be easier to go for invoice financing or factoring as an alternative, at least in the short term.
Use organic cash flow to invest, rather than share capital
Go on a money diet
It might sound like I’m nagging at you, or advising the opposite of everything you’re working for here. But it can be useful to think about how much money you really need to take out of the business. Take a look at Mr Money Mustache and see if you can apply some of his thinking to your personal spending and reduce your dividends so you can invest more now, to maximise the amount you can take out later.
Increase your prices
Sometimes people look for investment because they’re not making the most of the potential of their business to make the maximum profit. Making sure that you’re charging the right price is usually where I start with this in discussions with my business mentoring clients and is the single biggest change you can make to your business. And this can be a lot more simple than issuing shares.
Make sure you’re at what I call your sweet spot pricing and that you’ve read my sweetspot pricing book for small businesses at the same time as weighing up the advantages and disadvantages of a share issue.
Don’t let this distract you from running the business
It’s all too easy to allow dreams of investment and thoughts of share issues to distract you from the hard grind of running a business. The single biggest disadvantage of a share issue is the amount of time that it takes to set up, and the opportunity cost of this for the growth of the business.
Once you start the process of actively seeking investment or discussing shares, dilution and share issues with potential investors and staff, this can pull you away from running the business. It’s entirely possible for this to take over your life and that kind of distraction puts your company back, rather than moving it forward.
Take a lesson from one of my clients, a guy called Shane, who went about this the wrong way, failed to get the investment, and nearly ended up losing his business. Read Shane’s story here…
Is this a challenge your business is facing?
Working through the advantages and disadvantages of a share issue is an area I work with people all the time.
You can book a one-off online session with me to go through all of this, and we’ll spend a couple of hours working out the best way forward for you and your business. Here’s how to get some help, so you can get on with running your business…
Other helpful articles about how to give shares to others
You might want to also read these articles about shares and equity:
Photo credits to work wheel from pxhere; Val Vesa, Artur Rutowski, Pable Heimplatz and cytonn photography on Unsplash; Liz Finlayson from Vervate