Introduction
Raising capital is a crucial aspect of growing and scaling your business. Whether you're an early-stage startup, an established company looking to scale, or even preparing for an exit, raising the right type of capital can be the key to achieving your goals.
In this finance fundamentals article, we'll touch on key methods of raising capital and provide an overview of each approach.
These aren't basic-level explanations; they’re designed to give you a higher-level understanding, and as with most aspects of business, you can always dive deeper into each of these topics. We’ll also explore modern avenues and touch on how certain methods have evolved with trends in the market today.
1. Shareholders’ Funds (Equity Investment)
When we talk about shareholders' funds, we're referring to the equity capital in the business - the ownership stake of the business’s shareholders.
For a small business owner or a director with a few partners, this is often the first source of capital. This might include your personal funds or that of co-founders and investors who have a direct stake in the company.
Equity capital has no immediate repayment schedule, unlike debt, but it dilutes ownership, meaning the more you raise, the less control you have.
As the company grows, investors and partners will be looking to see how well you're managing their money to secure growth and future returns.
2. Traditional Borrowings (Debt Financing)
Traditional borrowings typically include options such as bank loans, overdrafts, or director’s loans. These are common early-stage funding options, especially for businesses that have established financials and a proven track record.
However, taking on debt can be tricky, while it allows you to retain control of your business, it also means regular repayments.
It’s important to manage cash flow effectively to avoid falling behind on debt obligations, especially during growth periods when expenses are rising but income is still scaling.
In recent years, invoice financing or invoice discounting has gained popularity for businesses that sell goods or services on credit.
It helps you unlock cash tied up in unpaid invoices, providing liquidity while waiting for payments. This option is more accessible than traditional loans and can be a lifeline for businesses looking to scale quickly.
3. Angel Investment
If your business is at the early stages and has a unique or disruptive product, you might seek out angel investors. These are individuals, often high-net-worth (HNW) individuals, who invest their own money into startups in exchange for equity.
Angel investors typically get involved when a company has little to no revenue or is just getting started with its minimum viable product (MVP). Solving product market fit (PMF) is usually a key part of use of funds for angels.
They bring more than just money, they often provide mentorship and connections that can help get your business off the ground.
With the rise of online platforms like AngelList, it’s easier than ever for entrepreneurs to connect with angel investors who specialize in their industry.
As a result, the landscape of angel investing and employing capital is expanding, with individuals offering both capital and expertise, often for smaller stakes than traditional venture capitalists.
4. Venture Capital (VC)
Venture capital (VC) is typically deployed at a stage where your business has demonstrated some level of traction and revenue, a market fit, and paying customers.
VC firms invest in high-growth companies with the potential to scale rapidly and provide outsized returns on investment.
Venture capital firms tend to focus on scaling businesses rather than providing seed-stage capital. In exchange for their investment, VCs typically take a significant equity stake (often 10-20-30%) and are highly involved in the company’s strategic direction.
This can include appointing board members or helping refine business models and go-to-market strategies.
The VC model is inherently high-risk: out of 10 investments, a typical VC firm might expect one to two to become big successes, the others may break even, and some will fail.
This model works well for businesses poised for explosive growth, particularly in tech, SaaS, or biotech.
5. Growth Capital
Growth capital usually comes in when a company is well-established and needs capital to expand or scale rapidly.
Unlike venture capital, which often focuses on early-stage businesses, growth capital is intended for companies that have a proven business model and are looking to accelerate growth, whether it’s through acquisitions, geographic expansion, or ramping up operations.
This form of capital might come from venture capital firms, private equity funds, or specialized growth investors.
These investors often provide capital in exchange for a significant equity stake but are more likely to take a hands-off approach compared to early-stage VCs.
Growth capital is typically deployed toward expanding sales teams, marketing efforts, or entering new markets, investments that will provide the company with a higher return on investment as they continue to grow.
6. Private Equity
Private equity (PE) firms invest in established businesses or those on the cusp of a strategic shift. These firms typically buy controlling stakes or entire businesses and look to implement strategic changes to increase profitability.
Private equity investments are much larger in scale and involve bigger deals than venture capital or growth capital.
PE firms usually look to exit their investments through either a public offering (IPO) or a sale of the business within 5-7 years, aiming to significantly increase the company’s value in the process.
They may employ aggressive strategies such as cost-cutting, restructuring, or international expansion to achieve rapid growth.
7. Security and Collateral
When raising capital, security is required at different stages, particularly with debt financing. This might include personal guarantees, mortgages, or assets such as equipment or intellectual property.
For angel investors, VCs, and private equity firms, their security will be in the form of equity and preference shares.
Having appropriate collateral increases your chances of securing capital, as it gives lenders or investors assurance that they can recoup their investment if the business doesn’t succeed.
8. Cap Tables and Dilution
A cap table is a crucial tool for tracking your company's ownership structure, including shares, options, and other securities. It details who owns what percentage of the company, which becomes essential as your business raises funds through various stages.
As you raise capital, the ownership stakes of existing shareholders will become diluted. This happens when new shares are issued to investors.
For example, if a company has 1,000,000 shares outstanding and issues 250,000 new shares, the total shares increase to 1,250,000. The percentage ownership of the original shareholders decreases, even though they retain the same number of shares.
Funding Stages and Their Impact on Dilution
-
Seed Stage: At the early stage, you might be raising money from angel investors or seed funds. Valuations are typically lower, leading to more significant dilution for founders.
-
Series A: In this round, venture capitalists invest, raising the valuation but also continuing dilution as new shares are issued.
-
Series B and Beyond: With each subsequent funding round, more investors come on board, leading to further dilution.
How to Manage Dilution
-
Set a High Valuation: By ensuring a higher valuation in each round, you can reduce the percentage of ownership new investors will receive.
-
Issue Different Classes of Shares: Issuing shares with varying rights (e.g., voting vs. non-voting shares) allows you to retain control while offering investors a stake in the business.
-
Plan Ahead: Structuring your cap table to anticipate future funding rounds will help minimize unexpected dilution and ensure long-term sustainability.
For a better understanding of dilution’s effect over time, check out the helpful infographic provided by Finerva, which clearly shows how ownership percentages change across different funding stages.
Conclusion
Raising capital is an essential part of growing your business, and it’s important to choose the right method for your current stage and goals.
Whether you’re seeking angel investment to fund an MVP or looking for growth capital to scale your business, there are a variety of options to explore.
The key takeaway here is that capital raising requires careful planning, understanding of your financial needs, and a solid business strategy to present to potential investors who will want a strong distribution returns.
And always be prepared to offer security if needed, to show investors that you’re committed to the growth and success of your business.
View MoreFinance Fundamentals Articles:
Always here to help you start, grow, and thrive. Let me know how I can support your next big move.
