It takes a significant amount of time for any business to reach its full potential. There are likewise many variables which need to be addressed along the way. Examples include physical infrastructure, developing quality products, marketing efforts, and brand loyalty. Having said this, many experts will argue that raising capital is arguably the most challenging concept. Therefore, it pays to take a quick look at the critical role of liquidity before discussing how to raise capital in an effective and efficient manner.
The Fundamentals of Raising Capital
What is capital raising from a general point of view? The most accepted capital raising meaning involves the process of lenders or investors providing funds to a business. This liquidity can then be used to manage core operations and to ensure longitudinal growth within a potentially competitive environment.
Many entrepreneurs do not look favourably upon raising capital for business purposes, as this can often represent a laborious and frustrating process. However, the majority nonetheless agree that it is absolutely necessary. There are also some common approaches that can be used, each offering its own unique benefits:
- Equity financing
- Debt financing
- Convertible Debt
- Simple Agreement for Future Equity (SAFE) notes
Let us now discuss each of these fundraising strategies in greater detail.
Equity financing is generally preferred by start-up businesses and entrepreneurs, as this method can provide relatively quick access to capital. The primary principle behind this approach involves selling a portion of a business to investors in the form of shares. In return, investors will provide liquid capital.
Most types of equity financing are performed in a series of “rounds”. The first few rounds seek to attract angel investors (individuals who wish to become involved on the so-called “ground floor”). These individuals can often include family, friends and prior business partners. This core group is then expanded over time to include more stakeholders.
Note that the process of raising capital by issuing shares can represent a one-off strategy, or it may last for years. This depends upon the amount of money the company requires as well as its overall business model. For example, an additional round of equity financing may be required in the event that an organisation wishes to enter into a new marketplace or is involved with an upcoming merger. Simply stated, this type of equity raise can be moulded around the discrete business in question.
Debt financing is another relatively common option when raising capital. This type of financing may be chosen by an owner who does not wish to dilute the operations of his or her business through the issuance of shares. Debt financing instead involves approaches including:
- Credit cards
- Convertible notes
- Loans from banks and building societies
This capital raising strategy is therefore heavily dependent upon interest rates. These rates will need to be included as a portion of the initial money that was provided by the lender. Therefore, the organisation needs to make certain that it is capable of generating a sufficient amount of revenue so that the loans can be paid back without incurring a negative credit history.
Debt financing can come in more familiar forms. One example can include capital raising and re-mortgage strategies. Capital raising on mortgage-free property (known as let-to-buy) may likewise be employed.
It should also be noted that investors are much different from lenders. As investors have provided up-front capital, it is in their best interest for the company to succeed from a longitudinal perspective. Lenders are less interested in the future operations of a business. They are instead focused on receiving their funds in return (along with the accrued interest). Lenders are also not likely to provide any other type of assistance. This is nonetheless one of the most effective ways to raise capital for business purposes.
There is yet another option available for those who are wary about equity and debt financing. This is known as convertible debt. As the term may already suggest, this approach is associated with converting debt into equity sometime in the future. Raising finance through the generation of convertible debt will normally involve a number of stipulations which are outlined in a contractual agreement. Known as “triggers”, these rules will generally stipulate when and how the debt can be transformed into equity.
Appreciating how to raise funds for business purposes through the use of convertible debt will also entail highlighting the main benefits. These include:
- Lower interest rates will lessen the impact on ongoing operations.
- Firms can avoid the issuance of diluted shares to investors when raising capital.
- Companies may sometimes determine when this type of debt can be transformed into equity.
Due to legal obligations between the lender and the borrower, it is always crucial to seek professional advice if you hope to raise money for your start-up with this method. Legal issues and/or compliance concerns may otherwise arise in the future. The good news is that professional asset management firms will provide expert advice at the appropriate times.
SAFE (Simple Agreement for Future Equity) notes are yet a final possibility to consider. SAFE notes are issued by the company to an investor. This investor will thereafter provide liquid funds in exchange for access to future equity. When this equity is provided will depend upon which triggers are involved (one example may involve when a firm reaches a specific revenue milestone or capital increase threshold).
Although SAFE notes represent a powerful means when raising capital, appreciating the terms and conditions of any agreement is critical from the onset. This helps to ensure transparency between all parties involved. It can also help to lessen the chances that a company is unable to provide future equity as stipulated within the initial agreement.
Risks to Appreciate
It is finally important to raise investment management risks that may be associated with generating capital for a business. The Harvard Business Review points out several potential pitfalls:
- Negotiating a reasonable deal can be difficult.
- Unpaid loans will harm the credit of a company.
- There is no guarantee that investors will provide the capital required.
- Dealing with inexperienced advisers can place the operations of a business in jeopardy.
- Raising equity will often involve handing over personal financial statements, a privacy concern for some.
Ultimately, the process of raising capital can provide an entrepreneur with the liquidity required for future growth. The ability to get funds for a business will therefore involve analysing all of the options highlighted throughout this article as well as appreciating the potential risks. This is why working in tandem with a professional asset management firm is often the wisest choice that a company can make.