In 2022, the digital capital raising market showed remarkable growth, reaching $65 billion. By the end of 2023, it’s forecasted to reach $66.26 billion. However, the traditional market still dominated, accounting for almost 90% of the total capital raised in 2022, reaching a staggering $541.8 billion. Still, by the end of 2023, the traditional capital raising market is expected to decrease to $498.9 billion.
However, the landscape is evolving, influenced by trends like technology and biotech shifts, digital platforms, and changing investor preferences. With potential challenges on the horizon, such as the Silicon Valley Bank collapse and a projected drop in capital availability, it’s crucial to approach the process of raising capital with careful preparation.
This guide serves as a roadmap for entrepreneurs, startups, small businesses, and established companies alike, shedding light on the importance of raising capital for fostering growth and driving innovation.
What does it mean to raise capital?
Capital raising refers to the process by which a company secures funds from external sources to finance its operations, innovation, or expansion initiatives.
Capital raising strategy is critical for both startups and established businesses looking to scale their operations.
Here are the six key advantages of raising capital for business:
- Business expansion opportunities. Raising capital provides the financial means to expand operations, enter new markets, and access previously untapped customer segments.
- Innovation and research. It enables businesses to invest in research and development, driving innovation and the creation of new projects, products, and services.
- Talent acquisition. With increased resources, companies attract and retain top-tier talent, fostering a skilled workforce that contributes to business growth.
- Competitive advantage. Adequate capital allows businesses to stay competitive by upgrading infrastructure, technology, and operational efficiency.
- Risk management. Capital serves as a cushion during economic downturns or unexpected challenges, helping businesses maintain stability.
- Strategic acquisitions. Raised capital funds acquisitions of complementary companies, technologies, or assets, accelerating growth and market presence.
Methods of capital raising
There are three main methods of raising capital.
1. Equity financing
Equity capital raising refers to the process of acquiring funds by selling ownership shares to external investors. This method of financing allows the company to raise funds without incurring debt and provides private equity investors with an ownership stake in the company, potentially granting them a share of profits and influence in certain matters, such as voting on company decisions.
Examples of equity raising include:
- Venture capital
Venture capitalists provide capital to startups and early-stage companies with high growth potential. In return, venture capital firms often acquire a portion of the company and may offer expertise and mentorship.
- Angel investors
These are individuals who invest their personal funds in startups. They may also offer mentorship and industry connections in addition to their financial support.
- Equity crowdfunding
This involves a large number of people collectively investing in a startup or an early-stage company through crowdfunding platforms like Kickstarter, AngelList, or IndieGoGo, allowing smaller investors to participate and potentially gain equity ownership.
- Seed funding
This is the initial capital raise that supports the development of a business concept, which often comes from angel investors, friends, or family.
- Initial public offering
In an initial public offering (IPO), a private business becomes a public company by issuing shares to the general public on the stock market. This provides access to a large investor pool and can raise substantial capital.
- Institutional investors
These include mutual funds, pension funds, hedge funds, banks, and insurance companies. They invest large sums of money, favoring established businesses for a greater assurance of return.
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2. Debt financing
Debt raising is when a company raises funds by borrowing money that needs to be repaid over time with an interest rate. Here are its main types:
- Bank loans
Businesses borrow from banks or financial institutions, agreeing to repay the principal amount with interest over a set period. Loan terms and interest rates vary based on the company’s creditworthiness and the lender’s terms.
- Corporate bonds
Companies issue bonds to investors, promising to pay interest and return the principal upon maturity. Bonds provide investors with a fixed income stream and allow businesses to tap into debt markets.
- Merchant cash advance
Merchant cash advance (MCA) provides businesses with immediate funds. Repayment involves deducting a fixed percentage from daily sales, along with a fee, until the advance is fully paid. This quick-access financing option suits businesses with steady sales.
3. Hybrid financing
Hybrid financing refers to a financial approach that combines elements of both equity and debt financing. Potential sources of hybrid financing include:
- Preferred shares
They offer advantages over common shares, such as dividends and liquidation priority. Some preferred shares are convertible to common shares under specific conditions, allowing investors to benefit from potential growth while enjoying fixed-income payments.
- Convertible debt
Companies often use a convertible debt raise, which starts as a loan but can be converted into equity shares. This financing option typically suits companies with a low credit rating but high growth potential.
How to select the best method of raising capital for a business
There are several critical factors to consider when selecting the best method of raising funds. Here’s a 3-step guide.
1. Assess your business needs and goals
Start by evaluating the business’s current financial needs and identifying why the company requires capital. Is it to fund product development, facilitate corporate growth, expand operations, or address cash flow issues? Clearly define the business goals and determine how much money is needed to achieve them.
2. Analyze the pros and cons of different methods
Consider the advantages and disadvantages of each method in relation to the business’s needs, goals, and risk tolerance. For example:
- Equity financing can bring experienced investors and strategic partners but may lead to loss of control
- Debt financing provides immediate capital without diluting ownership but requires repayment
- Hybrid financing offers flexibility in balancing potential returns and security but introduces complexity and risk of eventual equity dilution.
3. Tailor the method to the industry and growth stage
The best method of raising finance varies depending on the industry and business growth stage. For example, tech startups might opt for venture capital, while mature companies might prefer traditional bank loans. Consider what’s common and successful within the industry.
Capital raising process in 11 steps
Here’s a general overview of the capital raise process:
- Assess how much capital is required and for what purpose. This involves creating a detailed budget and financial plan to understand the funding requirements.
- Identify the most suitable method of raising investor capital for the business.
- Prepare a business plan and pitch. This should outline the company’s goals, financial projections, analysis of market conditions, and the potential return on investment for funders.
- Consider legal and regulatory compliance. For example, if going public through an IPO, the company must comply with securities laws and regulations, such as The U.S. Securities and Exchange Commission (SEC) or the Sarbanes–Oxley Act of 2002 (SOX).
- Seek out potential investors or lenders who align with the business’s goals and values. This may involve networking, attending investor conferences, or engaging with venture capitalists or banks.
- Facilitate the due diligence process by preparing all necessary documents in advance. Consider using a virtual data room as a secure tool for sharing confidential information.
- Negotiate terms and agreements once investors or lenders are interested. Negotiations include discussing the valuation of the company, interest rates, equity stakes, and other terms and conditions.
- Secure the necessary funds and sign legal contracts. Equity financing may involve issuing shares, while debt financing involves disbursing loans or bonds.
- Utilize the raised capital for its intended purpose: operational expenses, expansion, research and development, or other specific projects. Otherwise, you might simply fail to reach the set objectives.
- Manage the funds post-raising, fulfill any repayment obligations for debt financing, and work toward achieving the goals outlined in the business plan.
- Regularly provide updates to investors and lenders on the company’s financial performance and progress toward set milestones in an agreed way, if that was required by investors and lenders.
Challenges and solutions in raising business capital
To ensure successful capital raising, entrepreneurs need to be ready to address various challenges.
Challenge 1: Investor alignment
Finding investors whose goals, values, and expectations align with the business’s mission and growth capital plans.
Thoroughly research potential investors, communicate the business plan clearly, and seek investors who understand and share the same long-term objectives.
Challenge 2: Valuation
Overvaluing or undervaluing the business deters potential investors or leads to unfavorable equity raise terms.
Challenge 3: Dilution of ownership
Equity financing leads to loss of control and ownership as more investors come on board.
Negotiate favorable terms, consider hybrid financing or convertible securities to delay dilution, and retain a sufficient equity stake to maintain decision-making authority.
Challenge 4: Investor due diligence
Investors must perform due diligence to assess the business’s financial health, management team, and growth potential, which is time-consuming.
Prepare comprehensive documentation, including financial statements (the balance sheet, income statement, and cash flow statement), business plans, and legal agreements. Streamline the process by addressing potential concerns proactively.
Capital raising for technological innovation
To foster innovation, tech companies often turn to innovation funding as a means to fuel their growth and stay competitive. Let’s explore some critical aspects of capital raising for technological innovation, with a focus on the considerations that tech companies must keep in mind:
- Intellectual property protection
Tech companies often rely on proprietary technologies and intellectual property (IP) assets. Before seeking innovation funding, it’s crucial to have a strong IP strategy to safeguard innovations and make them more attractive to investors.
Tech innovations must have the potential for scalability. Investors are drawn to growing ideas, so demonstrating a clear path to scale your products or services is essential.
- Team expertise
The team behind a tech company is often a critical factor for investors. Highlighting the expertise and experience of the team members instills confidence in potential investors.
- Regulatory compliance
Tech innovations are subject to various regulations and compliance requirements, especially in fields like fintech, healthcare, and biotechnology. Understanding and addressing these regulations is crucial in attracting investment bankers.
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Role of innovation in attracting investment
Innovation and capital raising are closely connected in the tech industry. Here’s why:
- Competitive edge
Innovative tech solutions give companies a competitive edge as investors seek opportunities that stand out in crowded markets.
- Market potential
Innovation opens up new markets or expands existing ones. Investors are more inclined to support companies that have the potential to access untapped markets.
- Long-term viability
Innovative tech solutions are future-proof. Investors are more likely to commit capital to companies that demonstrate long-term viability by addressing evolving market needs.
- Return on investment
Tech innovations have the potential for high return on investment (ROI), making them attractive to investors seeking substantial returns.
- Capital raising is the process of securing external funds to finance a company’s operations, innovation, or expansion efforts in the form of either debt or equity.
- The key reasons why companies raise capital include business expansion opportunities, innovation and research, talent acquisition, competitive advantage, risk management, and strategic acquisitions.
- The three main methods of raising money are equity financing, debt financing, and hybrid financing, each with its own advantages and considerations.
- The process of raising capital involves assessing capital needs, identifying suitable methods, preparing a business plan, considering legal compliance, seeking investors, facilitating due diligence, negotiating terms, securing funds, and managing post-funding.
- Challenges in raising capital include investor alignment, valuation, dilution of ownership, and investor due diligence, each requiring careful consideration and proactive solutions.