Equity Financing

Equity financing is a financial strategy of selling a portion of the ownership (equity) of the entrepreneurial venture to investors to whom partial ownership of the company is conveyed and dividends may be paid out at the company’s discretion. These investors exercise partial control on the strategic direction of the organisation.

This can be divided into internal (as directors’ loans or from family and friends) and external equity. Since creditors are entitled to repayment before equity holders in the event of liquidation, equity investors assume a higher risk than debt financiers. Consequently they expect higher returns as well.

Sources of equity financing for entrepreneurial bankers included the entrepreneur’s friends and family, private investors, employees, venture capital firms, investment banking firms, and institutional investors (insurance companies, large corporations, and government-backed organisations e.g. NSSA, SEDCO[1] and IDC[2]). Venture capital firms were viewed as being too controlling and too conservative in their approach.

Strategic alliances with institutional investors, whereby the investor acquired huge equity, proved useful to entrepreneurial bankers in a number of ways. Kingdom Bank gave up a major stake of its equity (25%) to Meikles Africa. This provided Kingdom with an opportunity to establish in-store banking in all Meikles brand stores and led to the establishment of a financing arrangement through Meikles Financial Services which offers credit to Meikles Africa’s customers. This strategic alliance also increased the liquidity position of Kingdom Bank in the turbulent years (2003-2004) due to its ability to mobilise deposits from the TM supermarkets. In fact at the height of the cash crisis, Kingdom gained market share as it was able to mobilise huge deposits from the supermarkets after a directive from Meikles’ Head Office instructed all Meikles’ subsidiaries to deposit their revenue with Kingdom Bank. Similarly Century Bank established a strategic alliance with OK Supermarkets which allowed it to establish similar in-store banking outlets in exchange for equity holding.

In 2004, when entrepreneurial banks were under siege, Kingdom Bank established another strategic alliance whereby Econet Wireless acquired a significant stake (10%) in the bank. This was a vote of confidence in the bank as well as a source of critical deposits. During a rights issue which took place in January 2005, both Econet and Meikles Africa followed their rights and also increased their stakes. It is therefore evident that these strategic alliances also serve as cheap sources of finance through recapitalisation by equity holders.

Advantages of Equity Finance

The main advantage is that equity finance, in contrast with debt finance, is easily accessible at both the concept and early stages of the business. A significant number of banks were able to obtain commitments to equity uptake well before the licensing of their banks. However this changed when the new banking regulations required that funding be available before the RBZ granted the license. This is why banks which were formed after 1998 had challenges in raising equity finance. Examples are Royal Bank and RFHL which, unlike those who went before them, could not access this source of funds.

The investors sometimes become good sources of counsel, contacts and credibility. For example most entrepreneurial bankers in Zimbabwe sought Old Mutual, First Mutual and NSSA as investors as these gave credibility to their ventures. Nigel Chanakira had counsel and support from both Strive Masiyiwa and Meikles Group CEO who were significant investors in KFHL. In fact in 2006 these seem to have successfully lobbied the regulators to allow Chanakira to return as an executive director and Group CEO of Kingdom Financial Holdings.

Another advantage of equity financing is that there are no obligations to monthly repayments at the critical early stage when cash flow is constrained. In times of critical resource shortage dividends can be deferred in an effort to conserve capital. This strategy was manifest during the years 2004-6 when most banks deferred dividend pay-outs. In contrast debt repayments would still have been due irrespective of cash flow problems.

Equity financing implies sharing the risk of the venture rather than absorbing all the risks. This enables the entrepreneur to reduce the amount of his own resources placed at risk. It also means sharing the profits.

Equity finance is well adapted for an uncertain world like Zimbabwe.

Disadvantages of Equity Finance

The entrepreneur gives up a measure of control as well as the sole right to chart the strategic direction of the organisation. Differences of opinion concerning the strategy may cause conflicts among shareholders. In Century Bank the founding MD, Jefta Mugweni, was ousted by his major equity partner and deputy after a dispute on strategy.

Similarly William Nyemba, the founding CEO for NMB, was ousted by his deputy and major shareholder Julias Makoni after differences of opinion on strategic direction and levels of acceptable risk. In the event that initial public offerings are used as sources of funds, these prove to be complex and expensive to administer. As many bankers discovered a public listing provides cheap sources of cash but also increase the level of regulatory controls to which they are subjected.

[1] SEDCO- Small Enterprises Development Corporation

[2] IDC- Industrial Development Corporation

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1 Comment

  • Reply backlink October 10, 2011 at 6:38 am

    I dont disagree with this article

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