What actually is equity?
Definition: Equity consists of those funds that founders, shareholders or investors allow flow into a company. It can be used by the company for an unlimited period and is free of repayment. For start-ups, the equity is part of the start-up financing. Here, the term equity is understood to mean the founder’s own funds.
Equity is owned by the company or the investors. This distinguishes it from outside capital, which is largely made up of bank loans. Without a certain equity ratio as security, start-ups do not receive any outside capital (see: How much equity does a company need?).
One characteristic of equity is that it must be permanently available to start-ups. Due to its liability function, it is used to cover losses if necessary.
How much equity does a company need?
The total investment sums of equity and debt vary depending on the company, location, business space, required fixed assets, liquidity planning for the start-up phase and much more. Experience has shown that banks require an equity ratio of 15 to 25% of the total amount for loans. This equity is used as collateral for the lenders.
- See also the following video “How to start a business with little money”
What does equity cost?
The question only sounds paradoxical at first glance. When one speaks of the cost of equity, one does not mean a real “purchase price” or additional financial expense. Rather, it is used to describe the expected profit shares that will be distributed to equity providers such as dividends to shareholders. The term capital interest is also used for this.
Borrowed capital is cheaper than equity, says business administration – and that only sounds illogical at first. The cost of equity cannot be deducted for tax purposes. The interest deductions on the debt capital loan, on the other hand, do. Therefore, the cost of equity is usually calculated as higher.
The advantage of investing purely from equity is the independence from financial backers and of course the elimination of interest or investments. One disadvantage, however, is that liquidity bottlenecks can arise without greater financial flexibility. Examples are a temporary lack of income, bad debts, higher costs or necessary investments for expansion or to maintain operations. Starting a business entirely with equity can ultimately be more expensive – especially if the equity is insufficient to bridge liquidity gaps.
- See also the following explanatory video “What types of financing are there? Crash course IHK exam!”
What does equity count?
A founder’s equity includes, among other things, cash and savings, but also real assets. For this purpose, the banks accept, for example, real estate, land, securities, larger objects of value or some life insurance sums.
The equity of a company also includes the liable capital of co-shareholders, if available.
- See also the following video “Types of Financing – Equity vs Debt: Accountant Examination”
Where do I get equity from?
The existing equity can be topped up with grants (see start-up grant) as well as subsidies such as the KfW Entrepreneur Loan or Equity Aid (EKH) or the “ERP capital for start-ups” from the federal subsidy program.
Other options include venture capital, fundraising / crowdfunding or business angels.
How much equity does a franchise founder need?
For franchise founders, too, the banks want the above-mentioned equity ratios as security.
What must be invested?
In most franchise systems, licensees have to raise five or six-digit investment sums. To open a business, you need a complete set of capital goods and operating resources so that your operation corresponds to the specifications of the original or pilot operation, for example. This and the often five-digit entry fee can add up to a six- or even seven-digit total investment. Franchisors who expand a model company into a franchise system need even more financial leeway: Just setting up a system center and acquiring a sufficient number of partners and paying their fees to breakeven can take years.
The following applies to those interested in franchisees: The required equity is a key factor when looking for a suitable franchise offer. In the convenience search at FranchisePORTAL you can search specifically for franchise systems that correspond to your available equity.
In order to make it easier for franchise founders to start their own business, some franchise systems also offer options for setting up a business without equity capital or with low capital requirements.
Comment from Rolf G. Kirst, long-time franchise consultant, on the subject of equity
Why do franchisees need equity? As a broker of international franchise systems, I very often receive inquiries either without any information on equity or with equity of up to € 10,000. If an interested party is planning to become self-employed and thus wants to become an entrepreneur in the future, why the reluctance to provide financial resources? A franchisor has to see whether the applicant can afford to join a certain franchise system.
I have also read several times that interested parties want to become self-employed, but the necessary capital is lacking, which is why they would now want to take over a franchise license. Does that mean that you see franchising as a substitute for capital? No, the reality is very different.
It’s an old experience: only those who can invest can expect corresponding income. And the principle is that if you don’t want to or can’t invest little, then you shouldn’t raise your expectations too high. However, if you are able to invest in areas beyond € 500,000, you can also expect 6-digit annual income.
Self-employment with a franchise is therefore undoubtedly associated with investment and capital. Offers that advertise with little or no equity and that promise large profits should be viewed with caution.
How much do you need and what can you consider equity? If you consider the entire investment including working capital, the entrepreneur should bring at least 15 to 20 percent equity. Equity not only includes the cash assets in the account, but above all real estate, investments, shares and other securities.
So if you want to take over a franchise license in which you have to invest around 500,000 euros, you should be able to provide a bank with values of 75,000 to 150,000 € as security. Of course there are KFW funds and the help of the guarantee banks, but these are good additional aids, but they should not completely replace the equity.
Good advice to finish off. Anyone who does not have experience in financing issues should definitely seek advice from a specialist. This investment is definitely worthwhile and is even subsidized by the state.
More information on equity