Raising Capital for Business
The need for capital and running a business go hand in hand – you can’t have a business without capital. Whether you’re starting a business or running an existing business, there’s always a need for raising capital for business. It’s well-known that too little financing is one of the main reasons businesses fail.
To avoid failure, business owners are always looking for ways to raise funds. In this article, we’ll discuss the different types of capital that can be raised and how to go about it.
What is capital?
Capital is the money a business has available to continue its operations, but it includes more than money. The term also applies to assets like property and equipment, intellectual property like patents, and financial assets like stocks, bonds, mutual funds, and bank deposits.
The term is mostly used to refer to money and its functions in business, such as being used for business operations.
Where does capital come from?
Business capital is generally derived from the operations of the business, and debt or equity financing. The four main types of capital are working capital, debt, equity, and trading capital. Let’s dig a bit deeper into the different types of capital that can be raised to fund the operations of a venture and evaluate the pros and cons of each.
Debt capital is the most common way for businesses to raise capital. During the pandemic, business debt surged and stood at about US $17.7 trillion at the end of 2020. This was due to some businesses being forced to increase debt funding to keep operations running. Others had to invest in remote work technology, and still others like, those in the technology and healthcare industries, needed capital for expansion.
Debt capital is money that has been borrowed, so it must be paid back. When you use your credit card, you are raising debt capital. Other methods include bank loans, online lenders, and federal loan programs.
For small businesses that are just starting out, friends, family, and contacts are typically sources of capital. An established business, on the other hand, typically borrows from banks or other financial institutions or by issuing bonds.
In order to be considered for debt capital, businesses must have a good credit history. In the case of a new business, the owner’s personal credit score will suffice. The business must make regular payments to repay the debt.
Large corporations often choose to issue bonds to raise debt capital, especially in times of low- interest rates.
- You are not sacrificing part of the ownership in your business.
- Interest is tax-deductible.
- Lenders have no claim on future profits.
- Potentially higher interest rates.
- High debt repayments.
A company can raise capital by selling common shares or preferred shares in the business. Common shares afford shareholders voting rights but, if the company fails and is liquidated, they will be the last to receive payment.
Holders of preferred shares receive dividend payments before payments are made on common shares. Preferred shareholders have no voting rights.
With equity funding, a company gives investors a share of the business in exchange for the capital they provide. Investors then share in the profits as the business grows.
Both private and public companies can enter into equity deals, with private equity being ownership of shares in a private company and public equity being ownership of shares in a public company.
- Equity is not a loan, so there are no repayments – investors earn returns through the payment of dividends and stock valuation.
- Risk is reduced.
- The business can benefit from the expertise of investors.
- You share ownership of your company.
- You have to satisfy your shareholders, keep the company profitable and pay dividends.
- Equity investment is extremely time-consuming, detracting from your business.
A startup company usually raises capital by selling equity to angel investors and venture capitalists. The aim is for these companies to eventually go public through an initial public offering (IPO) when they issue shares on the open market.
Net earnings capital
A company can raise funds by increasing its net earnings. In other words, the company takes steps to increase its productivity and sales and earn more revenue. This step usually means the company already has investment capital from investors, which it applies to increase output, or it finds other ways to fund its efforts. If a company can find a way to expand, it can increase its net earnings capital.
- You are not parting with any ownership.
- You are not taking on any debt.
- This implies that the company is growing.
- Not easy to achieve.
- Increased taxes.
How to prepare your company for fundraising
Apart from having to decide which funding option to go for, raising funds for a business involves quite a lot of preparation. It is an arduous and time-consuming endeavor – careful preparation can smooth the process considerably. Here are some steps to get the process off to a good start.
- Improve your personal credit score
If you own a new venture that doesn’t yet have any notable assets or transaction history, it would be difficult to illustrate its creditworthiness to lenders and investors. In this instance, your personal credit score can help to at least establish your own creditworthiness. Banks and investors will want to see how you handle money.
Creating a good credit score doesn’t happen overnight, so you need to plan this aspect of your fundraising effort well ahead of time. Aim for an excellent credit score of 740 or higher to prove your financially savvy and responsible.
- Choose your funding method
As noted before, both debt and equity financing have pros and cons and you’ll have to weigh them carefully to know which one will be best for your business. Factors that you need to take into consideration include the structure of your business, your long-term business goals, current interest rates, loan repayment terms, whether you are prepared to surrender part ownership of the business, and whether you can gain access to the equity market.
It may be prudent to obtain the services of a financial expert to fully understand the implications of each funding option.
- Calculate the value of your business
For an established business, the business value is calculated by subtracting liabilities from assets. Business assets comprise anything that has value and can be converted to cash, including machinery, equipment, real estate, and inventory. Liabilities include debts, like a commercial mortgage or a bank loan.
For a new venture, the process is somewhat different because it won’t have many assets to speak of. There are six methods to evaluate a new business venture. You need to know the value of your venture so you can determine how much equity you can afford to give up in exchange for funds, should you decide to go for equity funding.
- Prepare a solid business plan
Apart from the fact that potential investors and banks will require a business plan from you, having one makes good business sense anyway. It sets your business up for success. Research has shown that companies that prepare a business plan grow 30% faster than companies that don’t, and 71% of fast-growing companies have business plans.
Your business plan should clearly indicate how you operate your business to generate real profits.
Preparing a solid business plan takes time and effort. Producing one shows investors and lenders that you have a grip on financial ramifications and what it takes to run a business. It illustrates your commitment to running a successful business. A solid business plan will also reveal how much capital you need and how you would afford to make back payments.
- Focus on financials
Lenders and investors require financial statements and all manner of financial details to determine whether providing your business with capital would be a prudent decision.
In the first place, you need to provide three to five years, but at least three years of financial information. For each year your company has been in business, you need to provide income statements, balance sheets, and cash flow statements. You’ll also need to prepare projected financial figures for the next five years.
So important are financials that some experts regard it as more influential than a business plan when it comes to deciding whether to fund a business or not.
How to clinch your funding effort
Sell your competitive edge
You must be very clear on how you stand out from the competition and you have to find a way to articulate that very clearly to lenders and investors. Investors are primarily interested in high-potential companies that they can clearly see will give them a sure and massive return on their investment sometime down the line.
Convince them of your stellar management team
You have to provide evidence that you have a top-rate management team. If you don’t have one, get one together because, without one, your business doesn’t stand much of a chance to be funded. Investors want to be reassured that the company they plan to invest in, is in good hands. They realize that they are really investing in the people running the company.
Hone your pitch
When preparing your pitch, don’t focus on your business exclusively. Put yourself in the shoes of your potential investors and lenders and answer all the questions they might have. Do your pitch to some of your connections to find out what questions people might come up with. Be prepared to answer questions about your field, your competition, the history of your industry, and the present state of your field.
While presenting your business in the best possible light, keep the people in front of you and why they are listening to you, in mind. What is in it for them? Make that very clear to them.
Choose the investors you want to pitch to with care
Increase your company’s chances of success by targeting investors that have experience in your industry. Chances are that they will also be passionate about your innovation in an industry they have skin in. Such investors will be in a position to offer expertise and guidance to your business in addition to capital.
Know what you need from investors
Investors can be a pivotal aspect of a company’s future success. For instance, if one of the reasons for a funding request is your plan to expand to other markets, you will benefit from investors with the right connections to help you achieve that goal. Consider what experience and expertise you need to take your company to the next level and try to find investors that have that kind of expertise, and the time to help you realize your goal.
Securing the investment
Focus on what investors want, not what you want. Investors like to grow their money – huge profits are their bottom line. Your job is to show them how they can reap considerable financial benefits later if they invest in you now. But, you have to be sure of yourself, based on an honest appraisal of your business and the capabilities and commitment of your management team.
Present investors with the hard numbers and accurate projections with no fluff or pretty stories about the utopia you are creating. Show that you are an expert in your field and have done your due diligence in terms of your target market and the competition.
Investors may be impressed by your innovative product and services, but they will be convinced by your commitment to create a successful business.
Debt and equity capital are the two primary ways to raise capital for your business. To make this a successful endeavor, make sure you have prepared all relevant documents and a killer pitch before you approach any lenders or investors.
Don’t be disheartened if you don’t hear back from investors. They are very busy people and are continuously being solicited for funding. Use your business connections and online resources to find more investors to pitch to.