To start or grow a business you need capital. Whether you’re building from the ground up, expanding operations or making a large scale acquisition, your business will need additional funds. But what happens if you don’t have enough? You raise capital.
Knowing when and how to raise capital is essential if you want to take advantage of timely opportunities for growth, without long-term disadvantages. When it comes to raising capital, there are two main options, equity financing and debt financing, but most businesses use a combination of both.
Equity Financing
Equity financing involves raising capital by issuing new shares or ownership stakes in a company. In essence, you are selling a part of your business to investors. These investors, in return for their capital injection, own a piece of the company and typically expect a return on their investment, which can come in the form of dividends or capital gain.
Pros:
- No Obligation for Repayment: The money acquired doesn’t need to be paid back like a loan.
- No Financial Burden: Without required monthly repayments, the company has more capital available for other business needs.
- No Interest Charges: Unlike debt financing, there’s no interest associated with the funds raised.
Cons:
- Loss of Ownership: Selling equity means giving up a percentage of your company, diluting ownership.
- Shared Profits: Profits must be shared with equity investors.
- Decision-making Influence: Equity investors gain a say in business decisions which can affect the direction and operations of the company.
- Costly Exit: Buying out investors in the future may be expensive.
Debt Financing
Debt financing means borrowing money that needs to be repaid over time with interest. This can take the form of loans from banks, bonds issued to investors, or other types of credit facilities. The borrowing entity promises to repay the principal amount along with interest over a predetermined period.
Pros:
- Maintained Control: Lenders do not get a say in how you run your business.
- Clear End to Obligation: Once the loan is paid off, the financial relationship ends.
- Tax Benefits: Interest on the debt can be tax-deductible.
- Predictable Expenses: Loan payments are fixed, making it easier to budget and forecast.
Cons:
- Repayment Obligation: Regular repayments can strain cash flows, especially if the business doesn’t perform as expected.
- Risk of Debt: Borrowing involves betting on future success. Economic downturns or business failures can jeopardize this.
- Potential for Personal Guarantees: Even with an LLC or other structures, lenders might require personal guarantees, risking personal assets.
- Potential Restrictions: Debt financing can come with covenants or restrictions which might limit company actions.
Common Challenges During a Capital Raise
Raising capital can be difficult and if done poorly, it can seriously hinder future business growth. Some of the most common challenges faced by businesses raising capital include:
- Rushed Business Plans
- Undefined Visions for the Business
- Limited Understanding of the Market
- Uncertainty Regarding Funding Requirements
- Lack of Proficient Leaders in Key Roles
Complete and Trusted Information
In the world of capital raising, financial transparency is crucial. When approaching an investor, you need to disclose all financial information. It’s always best practice to provide accurate, relevant financial data to all stakeholders.
Financial transparency plays a pivotal role in enabling investors to assess the level of risk associated with buy-in and assisting them to make informed investment choices. It also offers insights into the performance of their investments when compared to related securities, benchmarks and other assets. Most importantly, transparency fosters trust which is attractive to investors seeking a clear path to profitability and long-term growth.
This transparency should not stop after initial investment. It is essential that you maintain clear and consistent financial reporting after capital infusion to demonstrate to investors that their capital is being spent responsibly and contributing to sustainable growth.
Key Financial Considerations
Know Your Business and Your Market
Before you start to raise capital, you need to know where your business stands and what it’s capable of. A thorough and honest appraisal from an objective source, such as an accountant or business advisor, will give you a realistic assessment of where you are and what the market is like, so you can be transparent with investors.
Clean Up Your Books
Potential investors will ask you lots of detailed questions about your business and its operational costs, margins and profits. If you want to win favour, you need to have all the answers. The best way to do this is by cleaning up your books, familiarising yourself with them and then presenting them to your investors. Be prepared to answer difficult questions or arm yourself with a financial expert to answer them for you.
Prepare a Financial Projection
Investors will only put into a business what they can get out of it. While you can’t predict the future, you can create accurate projections that showcase how you will spend and return the capital. Your financial forecast should include:
- Monthly or quarterly projections for 3-5 years
- Industry specific growth drivers and prospects
- Alternative outcomes and risk factors.
Navigating Financial Due Diligence
Due diligence is the process of gathering information about a potential investment and is an essential part of any business transaction. It’s how investors minimise risk and ensures that the proposed transaction is beneficial to both the investor and your business. Be prepared to be asked questions about your management team, your market potential, your product or service and your business model.
Here are a list of questions you may be asked by investors:
- Who are the founders of your business and what are their backgrounds?
- Do they have relevant experience?
- Who is the key demographic of your product/service?
- What drivers are fueling current growth?
- How is your company positioned against competitors?
- What customer problem is being solved with your product/service?
- What unique technology and/or knowledge do you have as a business?
- Why is your product/service superior to the competition?
- Are there comparable companies/businesses to benchmark against?
- Which key market influencers should the business target?
- What are your financial requirements?
- Is your business model scalable?
- What are your anticipated margins?
Need to Raise Capital? Our Team Can Help
Whether you’re a budding entrepreneur or an established business, Vital Addition are here to assist you every step of the way. With a passion for startups and SMEs, we pride ourselves on providing tailored financial guidance for businesses of all sizes. Our team of experienced accounting and advisory professionals can provide an in-depth assessment of your finances, highlight areas of improvement and support to your business as you raise capital. Get in touch to find out how we can aid your future growth.