Business leaders must learn how to raise capital or they could risk failure. Fortunately, there are many funding paths to take. As a leading business lender, we feel it is important that you understand the players, the process and the pitfalls of securing capital for your business. This article will get you started on the road to successful fundraising.
Why raise capital for your business
Raising capital is a crucial activity for many companies on the path to long-term stability and success.
While the specific objectives and context can vary greatly from one business to the next, the general goal is clear: Funding can support an organization as it secures opportunities for development, growth and continued relevance in the future.
From startup through the growth stage of any enterprise, raising money is necessary. However, the funding players change from your friends and family to savvy angel investors and institutional investors that will need a sophisticated proposal covering factors such as management experience, financials and the plan for profitability. Understanding where to find capital investment for your business is the first step.
Your business is an investment opportunity
Before reviewing the methods for raising capital, it's important to know the different types of investors, which can help you make a more informed decision about the best path forward for your business.
Where’s the capital for your business?
The two principal groups of capital available to your business are through debt or equity. Each group has different types of investors. Keep the basics of each in mind throughout your business journey.
Small business lenders
There are governmental and private investors that focus on small business generation and expansion, including the Small Business Administration (SBA), private and public group lenders, banks, and credit unions. Small business lenders provide cash to your business in return for regular interest payments. Often, a lender requires collateral or asset (i.e. a bond or real estate) for the lifetime of the loan.
Bank loans for small businesses range from $10,000 to $1 million with terms and conditions suitable for business owners growing and reinvesting much of their profit back into their business. If you are looking for a loan that does not require collateral, check in with the nearest SBA office.
Unlike small business lenders, an angel investor is typically a high-net worth individual who can offer cash for a piece of your business profits or equity. A wealthy angel investor is looking for early-stage companies with the potential to become profitable. The investment can be in the hundreds of thousands (or higher) and it typically is not a long-term relationship. Depending on the angel investor, business owners may also receive mentoring, though that is not guaranteed.
Another potential investor that will take a greater interest in building a relationship with a business’s leaders are venture capitalists. Venture capital typically involves a collection of entrepreneurs, bankers, product developers and so on. Their goal is to find business owners and companies that might go public. Venture capital funds manage portfolios in the hundreds of millions, but their equity stake in a company tends to be relatively small. Your company could receive multiple rounds of equity investment from venture capital lasting years.
Public companies able to sell shares can raise capital from institutional investors. These types of equity investors include mutual funds, public and private pension funds, hedge funds, banks and insurance companies. Institutional investors pool large sums of money and look for established businesses that can provide a greater assurance of return. Typically, enterprises raise capital on the stock market, but institutional investors like banks can offer you lines of credit, corporate bonds and business loans.
There are potential investors throughout your business journey once you know where to look. How to raise capital requires a fundraising roadmap to guide you along the process and help avoid capital raising pitfalls.
The process of raising capital for your business
Business opportunities require capital. The promise of significant return that comes from growth — bringing new technology to market, expanding product lines, opening new manufacturing locations, acquiring a competitor or complimentary business — requires some form of investment to get started. In times of expansion, financial capital might be required to take action.
Moving forward with a strategy that aims to limit risk and maximize rewards in such circumstances is usually in your organization's best interest, and that is true for new as well as mature companies. Financial institutions, not to mention private investors, may look more favorably on a business that has demonstrated continued competency and positive results.
Moreover, organizations with a long track record of consistent and stable operations often find it easier to secure funding than a new venture because they have a fundraising roadmap.
Selecting the most relevant and effective option to raise capital for your business can make the path forward more certain. Due diligence is non-negotiable, but with these steps you will spend less time worrying about repayment obligations and more time focusing on turning the investment into positive progress.
Capital raising requires leadership and trusted employees take the following critical steps:
- Develop an informative plan that describes how capital raised will lead to positive outcomes.
- Create financial projections that a lender, investor or another contributor will likely want to closely review.
- Identify the most effective options to fund the proposed diversification or development.
Selecting the best method for your business
In the best case, your company has a variety of options for capital raising, including equity capital, which is raised by sharing ownership in exchange for payment, or debt capital, which provides funding in exchange for repayment with interest later on.
Corporate bonds are a type of debt capital. In simple terms, corporate bonds involve a few key actions:
- The company seeking funds issues the bond.
- Buyers pay the cost of the bond to the business, providing funding for current or future activity.
- The business makes interest payments to the bondholders, either at a fixed or variable interest rate (but generally on a schedule).
- After the last scheduled interest payment, at the bond’s maturity date, the company pays back the initial investment.
Corporate bonds avoid sharing equity in the business with a single investor or group of investors. While the interest rate can vary, creating some uncertainty about the total amount owed to bondholders, it is possible to estimate these costs and create a business plan that accounts for them.
Bank loans, a type of debt capital, are frequently used for a variety of financial needs by businesses. That includes raising capital. In this arrangement, a business applies for a loan and, if approved, receives a lump sum payment from a financial institution. In return, the company pays both principal and interest over a previously agreed-upon timeframe until the debt is settled.
Bank loans, assuming approval, should offer predictability and clear expectations. Companies with a customer base and revenue may find them easier to secure than startups and ventures with less robust revenue.
Syndicated debt, also referred to as a syndicated loan, is a specific type of bank loan. The unique quality that distinguishes syndicated debt is the participation of a group of lenders, as opposed to just one. Syndicated debt is a practical approach if a standard loan does not seem to address your needs.
A syndicated loan distributes the risk and commitment of funds presented by the loan across several providers. While a single bank may not have the risk tolerance to take on a loan or may not be able to dedicate a substantial portion of available funds to it, a group of investors can mitigate these risks.
Private placement involves the sale of stock or corporate bonds to specific outside investors instead of through a public market available to all. A fundraising approach using stocks is a form of equity capital. This strategy allows a business to raise funding from a carefully selected, pre-qualified group and carries fewer regulatory requirements than an initial public offering (IPO) does.
Identifying and preparing for fundraising can feel overwhelming for a business owner. The following are some fundamental errors many businesses make while seeking investment.
Pitfalls to avoid when seeking investor funding for your business
Potential investors understand that an entrepreneur or CEO may not know how to raise capital. However, they do want to know that your business is fundamentally prepared to turn money into profit. The more you know about your business underlying financials, the better chance you will have to find and get a suitable investment for your business.
Avoid neglecting the following critical factors of raising capital for your business:
- Debt. Personal or business debts do not automatically cut you off from funding, but it can adversely affect your loan conditions or shrink your investor pool to only those with a higher risk tolerance.
- Liquidity. A potential investor or lender looks at your cash flow and available sources of cash to help determine how much to invest or loan your business.
- Collateral. Match your collateral — shares, real estate or equipment — to the lending method to avoid wasting time on the wrong strategy.
- Business plan. A crucial part of raising capital is your business plan. Investors want to know how you intend to make money from their investment and approximately when you might reach your business goal.
- Financial statements. The three most important financial statements for investors and lenders are the balance sheet, income statement and cash flow statement.
Most importantly, look for a partner to support your business goals for raising capital.
External funding and financing support continued success for companies aiming to grow and diversify.
Determining the best method to secure this capital is vital for the best chance at success. Comerica Bank can empower your business to raise the capital it needs to realize key objectives. Learn more for details about working with our experienced and knowledgeable business financing specialists.