Equity Story

What is an equity story?

Equity story (German: roughly Investitionsbegründung, investment rationale) denotes the coherent line of argument with which a company or its shareholders set out why an investment or an acquisition on the intended terms makes economic sense. It combines market, competitive position, growth levers (the measures that are meant to carry future growth) and the evidence for them into a statement on how the company's value is meant to develop.

The equity story is not a document of its own but the substantive core of all documents of a transaction: teaser, pitch deck, information memorandum, management presentation and business plan. In the pitch deck it often appears condensed on a slide of its own with the main reasons for an investment (investment highlights). It is used in funding rounds, in company sales and in an initial public offering (IPO). Investors, buyers and their advisers test it in due diligence, the thorough review before contract signing, by tracing every statement back to its evidence.

The equity story is most closely linked with two other foundations of a transaction. The business plan describes strategy, organisation and implementation in detail. The financial model calculates the plan through into earnings, balance sheet and liquidity. The equity story holds both together: it says in a few sentences why an investment is worthwhile, and each of these statements must be found again in the plan and be calculable in the model.

The building blocks of an equity story

Market

The market describes how large the reachable business is and why it is growing. Convincing is a derivation from number of customers, willingness to pay and route to access, supplemented by the drivers that change the market: regulation, shortage of skilled workers, technological change or changed purchasing habits. A total market size (total addressable market) without a derivation of the share that is actually reachable does not support an investment decision.

Position

The position explains why precisely this company wins and keeps a part of the market. Verifiable arguments carry weight: a product lead that shows in win rates against competitors, switching costs that show in a low cancellation rate, network effects, exclusive access to customer groups, intellectual property rights or approvals. Competitors are named and classified, not concealed.

Growth levers

Growth levers are the measures that the new capital or the new owner is meant to finance. Organic levers are, for example, building up sales, new products, price increases, new customer segments and new countries. Inorganic levers are acquisitions, among financial investors often as a platform strategy: one company serves as the base to which further smaller acquisitions are attached. A lever belongs to the equity story only when it can be translated into roles, months and amounts.

Evidence

Evidence turns assertions into verifiable statements. This includes revenue time series, win rates in sales, customer references and contribution margins per customer. Also meaningful are cohort analyses, which show how the customers of a starting month develop over time, and the development of the unit economics, that is, the profitability per customer. If a lever is new and evidence is therefore lacking, the equity story says so openly and shows which results of a pilot project would confirm it.

The investor's perspective

For financial investors, this includes how they can later sell their investment: to a strategic buyer, to another financial investor or through an IPO. For strategic buyers, the company's contribution to their own strategy takes its place. Added to this is the question of which synergies arise, that is, benefits that become possible only through the combination of the two companies.

Tailoring to investors and buyers

The same facts carry different emphases depending on the audience. The figures stay the same; what changes is the weighting and order of the arguments:

• Venture capital investors look at market size, speed of growth and whether the company can reach a multiple of its present value.
• Growth investors and financial investors who acquire majority stakes weight profitability, the conversion of earnings into liquidity, predictable revenue and, in majority acquisitions, the ability to service debt.
• Strategic buyers ask about the contribution to their own business: technology, customer access, market share and cost synergies.
• Investors in the capital market compare the company with listed comparable companies and expect a story that can be confirmed over several reporting periods.

Different versions for different audiences are unproblematic as long as they rest on the same figures. Contradictions come to light at the latest when advisers of both sides know several versions or investors talk to each other.

Equity story and valuation

The equity story helps determine how a company is valued. In a DCF valuation, which discounts future cash surpluses to today, it translates into growth rates, margin path and investment needs. The risk that investors see in the story is reflected in the discount rate, the interest rate for this discounting. Multiple-based valuations determine the enterprise value, the value of the operating business, as a multiple of revenue or earnings. Here the equity story helps decide which comparable companies are used. Whether a company is classified as a software provider with recurring revenue or as a service provider with project business shifts the range of multiples considerably.

This classification cannot be chosen freely. Buyers and investors check whether the revenue actually recurs, whether the gross margin fits the classification and whether the claimed competitive advantages show in the figures. An equity story that classifies the company higher than the data support leads to price discounts in a late negotiation phase, in which the seller side has often already turned away other interested parties.

Worked example: equity story of a software provider

A provider of maintenance software for industry generates annual recurring revenue (ARR) of EUR 4.0 million from 160 customers, that is, EUR 25,000 per customer. Net revenue retention is 110%, so existing customers expand their contracts by more than others cancel. So far, two people win new customers through referrals.

In a few sentences, the equity story reads: industrial companies lose production time through unplanned machine downtime. The software is in use at 160 companies, and customers extend their use year after year. New customers have so far come only through referrals; a sales team of six additional people is meant to bring ARR to over EUR 7 million in two years.

The calculation tests this lever; new customers from referrals are additional. For simplicity, net revenue retention applies in each case to the ARR at the start of the year:

• ARR from existing customers after twelve months: EUR 4.0 million × 110% = EUR 4.4 million
• New customers in the first year: 6 people × 10 closed deals per year × 50% productivity due to onboarding = 30 new customers
• New ARR in the first year: 30 × EUR 25,000 = EUR 750,000
• ARR after twelve months: 4.4 plus 0.75 = EUR 5.15 million, growth of around 29%
• Second year at full productivity: 5.15 × 110% = EUR 5.665 million from the existing base plus 60 × EUR 25,000 = EUR 1.5 million, together EUR 7.165 million, growth of around 39%
• Cost of the lever: 6 × EUR 110,000 full cost (salary, employer contributions, travel, workplace) = EUR 660,000 per year
• Sales cost per new customer in the second year: EUR 660,000 divided by 60 = EUR 11,000
• Payback per customer at 80% gross margin: 25,000 × 80% divided by 12 = around EUR 1,667 gross profit (revenue after direct costs) per month
• Payback period: 11,000 divided by 1,667 = 6.6 months, after which the sales cost for this customer has been earned back

The calculation reveals which assumptions carry the story: ten closed deals per person per year, half productivity in the first year, constant contract value and stable net revenue retention. Each of these assumptions sits in the financial model and needs evidence, for example the win rates of the existing sales staff. If the new people achieve only six rather than ten deals, the same calculation gives EUR 4.85 million after the first year and EUR 6.235 million after the second. Sales cost per new customer then rises to around EUR 18,300, and the payback period lengthens to around eleven months. That is close to twelve months, a common upper limit for the payback of customer acquisition costs. The story remains viable but then has hardly any room left.

Distinctions: equity story, pitch deck and investment case

• Pitch deck: a form of presenting the equity story for funding rounds. The deck arranges the arguments on slides; the equity story is the argument itself.
• Investment case: the investment rationale from the investor's point of view, usually for its own investment committee. It takes up the equity story and supplements it with valuation, return expectations and the risks from the investor's perspective.

Common mistakes

• Product features instead of investment logic. A list of functions does not explain why customers pay, stay and buy more.
• Growth as use of proceeds. If the lever is not broken down into roles, dates and amounts, it remains open what the capital is meant to achieve.
• Superlatives without evidence. Terms such as “market-leading” or “unique” reduce credibility if market shares or comparative data do not support them.
• A story with no counterpart in the model. If the equity story speaks of internationalisation while the financial model contains no costs for foreign markets, both lose credibility.
• No statement on the later sale. Financial investors have to sell their investment again. If a plausible group of buyers is missing, they form this assessment themselves, usually more cautiously.

Frequently asked questions

How long is an equity story?

A few sentences, spoken in about a minute. It is set out in full in the pitch deck, the information memorandum and the management presentation. If it cannot be summarised briefly, it has as a rule not yet been thought through.

Who formulates the equity story?

The management, because it has to stand behind the statements in every conversation. Advisers help with structure, evidence and reconciliation with the financial model. A story formulated entirely by others rarely withstands investors' follow-up questions.

Does a company without a long track record need an equity story?

Yes. The starting position is then smaller, and early signals such as pilot customers, usage data or pre-contracts serve as evidence. The story must then claim nothing that these data do not support.

Does the equity story change from round to round?

As a rule, yes. With each round the emphasis shifts from potential to evidence. In early rounds the market opportunity is in the foreground, in later ones the efficiency of growth and the path to profitability. What was announced as a lever in the previous round must by now show in the figures.

How is the equity story used in an IPO?

As the basis for the entire marketing of the offering. Issuing banks, analysts and institutional investors assess the company on the basis of the equity story, and the presentations must be consistent with the securities prospectus. After the IPO, the story is measured against the published figures in every reporting period.

The Roemer Capital view

In our mandates, the equity story emerges together with the financial model and before all documents that investors or buyers receive. We formulate it with the management in a few sentences and place next to each statement the evidence and the line in the financial model that supports it. If one of the two is missing, the statement is deleted or the evidence is obtained.

In doing so, we distinguish whether a company is capital-ready or investor-ready. Capital-ready is a company that can service loans; investor-ready is one that is structurally able to grow disproportionately with external capital. The equity story must prove this difference, through the four pillars of runway, KPIs (the most important metrics), unit economics and governance. For buyers in a sale process, we weight the arguments differently than for investors in a funding round; the figures underneath stay the same.