The Right Way to Raise Capital
Regardless of the business model or talent that a business possesses, it must find a way to make its vision a reality by raising the necessary funds. This can be one of the most challenging obstacles facing an entrepreneur and an extremely timely and expensive task. As such it is imperative to have a strategic process when raising capital for your business.
There are three major stages in preparing for raising capital:
I An evaluation of your needs
II Identifying the fit of sources of capital to your needs
III Preparing your business and pitch to external stakeholders
Following these three steps will help an organization identify the best path to raising the finances it requires. Let us explore each stage in more depth.
Stage 1: Identification of needs
The first step is to identify what your business needs money for, how much money it needs, and exactly when you need it.
A growing business demands money in a variety of areas, so determining which areas can have the greatest impact on success is vital. What the money is needed for is often a function of the life-stage the business is in or a bottleneck in operations. For example, a newly launched landscaping business will need money to purchase equipment like trucks and lawn mowers, that is the necessities of doing business. A more mature company like a car parts manufacturer will need financing for a wholly different reason such as to buy more production materials to match surging demand levels.
Ultimately, there are three categories of needs a company has:
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Administrative: relating to personnel and non-production technology.
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Business development: efforts to grow business through sales and marketing campaigns.
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Production: relating to investments in material, equipment, and other assets for operations.
Companies need to choose the best use of money based on their current operations and growth ambitions. By identifying and taking care of the most pressing needs a company can be assured it is on the path to efficiency.
An organization also needs to understand how much money it needs and when it needs it. The cost structure of such businesses can be as varied as the purpose of the expenditure. Some investments like production equipment will require a one-time payment, while hiring new staff requires recurring payments for which the total sum is not required at the outset. Thus, the timing and price point of investments will also have major implications on a company’s raising of capital.
Stage 2: Sources of Capital
After determining what the money will be used for, an organization should now investigate how it can access the capital it needs. There are four main ways in which a company can raise funds: bootstrapping, debt, equity and other varied sources. The optimal source will depend on the subjective situation and risk profile of the company.
Bootstrapping:
Before looking to external sources of capital, companies should look internally to see if they can raise the necessary funds. The idea of raising funds internally through a self-starting process is called ‘bootstrapping’ and is appealing since no control of the company is given up to external stakeholders. However, as the name ‘bootstrapping’ suggests this is a difficult feat (just like pulling oneself up by his or her own bootstraps). Examples of internally generated funds may include personal or business savings, investments from friends and family, proceeds from the sale of any unused assets. Bootstrapping is appealing because it is the cheapest source of money (relative to debt and equity) and keeps control within the organization, but it is also the most time and effort consuming means to generate capital and is not an effective vehicle for generating larger quantities of funds.
Debt Financing:
Raising capital through debt is when a company borrows money from external sources with contractual obligations. Obligations include repayment of the amount borrowed and interest payments. Additionally, companies may be forced to agree to certain covenants or promises as to how the business will be operated. For example, a company that just borrowed a large sum of debt from its bank will be forced to agree not to take on any more debt from other sources. Lenders can also ask for collateral or a personal guarantee from the owners, which means that personal assets may be taken from the owners in the event the company is unable to pay back its loan.
Examples of debt financing include:
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Mortgages and lines of credit
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Overdraft on bank account
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Bank loans
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Credit cards
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Loans from friends and family
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Leasing assets instead of purchasing
Debt is an appealing vehicle when trying to raise large sums of cash quickly, however, poorly managed debt can close a business and personally ruin investors. The implications of taking on debt must be well understood by management before proceeding.
Equity Financing:
Financing through equity means exchanging shares of ownership in the company for capital. The major difference with debt financing is that a company is not required to directly repay investors as it would with debt. However, the downside of equity financing is that it gives away ownership and possibly control of a company.
Some benefits of using equity is that it indicates confidence in the business by outsiders. The fact that someone outside the business is willing to exchange their hard-earned money for shares in the company signals to others there is the belief that the business will be successful. This in turn may make raising capital in the future easier. Ultimately, the degree of this benefit depends on who the investor is and the scale of their investment.
There are many sources of equity but the main ones are:
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Venture capitalists
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Angel investors
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Other companies
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Incubators
Equity is useful because it has very little downside since the company can use the capital it raises without having to pay it directly back. However, in the long run giving up ownership in the company can have major repercussions in future organizational decisions. Thus, an organization should carefully examine whether it is in the right stage to give up equity.
Stage 3: Preparation
Raising capital is a process where you need to make sure your business is prepared with the information and answers bankers and investors will be asking. Having data about operational processes and up-to-date financial data and forecasts is imperative. Additionally, you need to identify and start tracking your business key performance indicators (KPIs) and sales and marketing efforts. Finally, calculate your customer acquisition cost and other key industry metrics. Having this information will help investors and bankers analyze your company in a standardized manner allowing for comparisons with other investment opportunities.
The final step becomes crafting your pitch to prospective investors. Tailor each presentation to the specific investor you will be presenting to. It is good to have your business’ story which highlights its success and future aspirations. Focus on being genuine since investors invest in people as much as ideas and since this mitigates the risk of entering into a partnership with someone who does not match your vision.
As a final note, always stay focused on the objective of raising capital, know how much risk and uncertainty your company can handle and DO NOT BE AFRAID TO ASK FOR HELP. Raising capital is one of the most challenging and complex processes any business ever experiences, so why not reduce your difficulty navigating through it by getting the help of someone who has done it before.
If your company is looking to raise capital and needs advice, check out our VCFO service that can help you raise capital the right way.
