Top 3 Keys to Raising Capital & Financing for Small Businesses or Start-Ups
Introduction
To grow your business, overcome the political and economic challenges of recent and effectively develop your business model, most businesses will need “growth capital” to execute on the growth initiatives.
Raising capital as an Entrepreneur/Founder can be challenging in that especially in the current times, banks, lending institutions, private capital and equity investors are very risk averse. That risk profile accelerates when the Entrepreneur/Founder doesn’t have a proven track record, collateral, or the proper governance in place provided by skilled professionals to provide an unbiased perspective and positively influence the business.
So, what types of capital are available to your business and how can Entrepreneur/Founder increase the probability of success on fund raising and financing initiatives?
To effectively answer the question; one must be knowledgeable of the following:
The current Private Capital Landscape
The types of Capital available and the set of requirements for each type of capital source
Top 3 Keys to Raising Capital/Financing for Small Businesses or Startups
The Current Private Capital Landscape
There are $3.2 trillion dollars of “Dry Powder available” from Private Capital Providers at the close of Q2 2022, this excludes banks and traditional lenders.
Said differently there is plenty of capital available for Entrepreneur/Founder that are looking for “Useful Capital and Financing" to grow their business, take advantage of their market opportunity, and develop a wealth-creating business.
The Types of Capital Available for Small Business
There are 3 types of capital available for businesses: debt, equity, or a combination of the two, or hybrid.
Debt Financing
Equity Financing
Hybrid Financing
For Entrepreneur/Founder to take advantage of the significant “Capital Supply Imbalance” there are 3 keys to success in Raising Capital for Small Business Startups.
Have a Highly Defined Target Market and Business Model process that enables significant “Execution Capabilities’
Have a Plan: Be Prepared and Be Proactive
Choosing the Best Type of Capital and Capital Partner or “Useful Capital” that “fits’ your specific situation
The Top 3 Keys to Raising Capital/Financing for Small Businesses or Startups
Key No. 1: Have a Highly Defined Target Market and Business Process Model
In today’s economic environment, the reality is that a business needs to illustrate momentum, scalability, and productivity improvements to attract investors. Momentum can mean a variety of things, but what is clear is that Entrepreneur/Founder can no longer use a napkin and a brilliant idea to raise capital. There must be pragmatic “proof” of Execution Capabilities.
Therefore, defining the Market Opportunity and having a proven business process and execution plan on how their business model will meet the market demand is a crucial element in fundraising.
Furthermore, Identifying the Gaps in the current business model that need to be addressed and the resources needed such as talent, technology, and the amount of capital needed to execute its plan, is required for the business to take advantage of the market opportunity.
Creating wealth is about building a proven, scalable, and economically efficient business model. Below are the major components of a highly defined Market Opportunity, Business Model, and Execution Plan that capital providers find attractive to lower their risk aversion.
A Well-defined Market Opportunity includes sizing the Total Addressable Market and the total revenue potential that the company can acquire with a “clear and documented” path on how to acquire it. The target market must be of sufficient size to rapidly grow, doubling, and tripling in size every year, and that your firm can be the dominant player in your market or niche. Investors will invest to rapidly transform a small business into an emerging enterprise.
The Company has a Unique competitive advantage a portfolio and set of unique products/services across various target market verticals representative of “ideal customer profiles “that are established. That competitive advantage must be durable, repeatable, and non-transferable.
The Exit Opportunities and Strategic alternatives have been identified and created to maximize the shareholder value, aligning the business model and its capabilities to be attractive to both financial and strategic buyers. Strategic positioning is about mitigating competitive threats and substitutes while positioning the company’s Business Model for maximum enterprise valuation.
Additionally, all equity investors are looking for emerging businesses that illustrate an experienced & proven leadership team, complimented by “outsider” influence and expertise to execute on the above strategy. Generally, valuations are based on what a company has done to date, not what it can or is going to do.
Key No. 2: Be Prepared and Proactive
A common misperception is small businesses must forgo a large portion of their equity to raise investment capital. This is only true if the business raises capital from a position of weakness. Entrepreneurs seek to raise capital often from a position of weakness due to poor planning, foresight, undefined business models, inadequate advisory support, and lack of knowledge in raising capital or simply do not have a capital raising plan or process.
For entrepreneurs that are currently or will one day soon will need to explore financing ng options for their business beyond money from friends, families, and bank. Below we have outlined a few critical guidance points to raise capital from a position of strength.
Don’t wait until you need it - The majority of funding come in times when cash is needed most so shareholders raise capital at its most expensive point. Sun-Tzu said, “The victorious only seek battle after the victory has been won, whereas he who is destined to defeat first fights and afterward looks for victory.”
All Shareholders need to agree: It is important that the company has “a clean cap table” - Negotiating from a position of strength means aligning all constituencies towards a shared vision. Capital should be raised to “balance all stakeholder’s interest”! Additionally, many times, additional funds are raised to enable earlier investors to exit however, that excludes these investors from future risk and reward.
Position yourself in a great Market: All businesses will need cash to capitalize on emerging market opportunities. If a business does not need to grow to claim customers and market position before competitors or substitutes, then the industry sector is most likely unattractive to investors
Only raise capital when a “happy ending” for owners has been clearly delineated and an action plan of milestones, assumptions, tasks has been developed to guide the way. Without a shared vision and defined business model, the capital in the business al is being treated as a commodity which erodes the long-term value of the business.
Key No. 3 Targeting the Best Type of Capital and the Best Capital Partner for Your Business
Often capital raising is difficult because Entrepreneurs/Founder and their potential future investors simply do not speak the same language, nor have the same long-term interests. Often, they have disparate perspectives on everything from what defines success to operational management efficiency.
The ability to create a growth, capable, productive, and scalable business model, and the resulting wealth is, at the end of the day, a marriage of the leaders’ skill and capital sources that conterminously and collectively “adds value” to the business model and its stakeholders.
Stated slightly differently, wealth creation from an emerging business and successful business models is an outcome of an effectively planned and executed business strategy, coupled with the knowledgeable and experienced skill set of the leadership, and the deployment of the right capital and capital partner or “Useful Capital” at the right time!
The Types of Capital Available and Requirements
Types of Debt Financing
Traditional Debt Financing
Traditional business loans are financing provided by traditional banks and other lenders. This type of financing is the most common form of debt financing used small and mid-sized companies. Below are a few of the financing banks can provide.
a) Bank Financing
b) SBA Loans
c) Lines of Credit
d) Structured Financing by Non-Banks
2. Asset Based Financing
An asset-based lender will allow you to borrow money against your business’s assets, like equipment and inventory. These lenders are more interested in what your business owns than what it owes. There are also asset-based lenders that will lend against your accounts receivables/or invoices also called factoring companies. Since they are putting up collateral against your assets, they typically offer lower interest rates than banks or traditional lenders.
a) Accounts Receivables
b) Unbilled Revenue
c) Invoice Factoring
3. Venture Debt Financing
Venture debt is a type of financing offered by typically nonbank lenders that is designed specifically for early-stage, high-growth companies. It is typically used to fund working capital, operating expenses, and growth initiatives. Unlike typical traditional bank lending, venture debt is available at all stages of company development from startups to expansion stage, to high growth companies that do not have positive cash flows or significant assets to use as collateral. The following are typical types of venture debt available:
a) Revenue Royalty Financing
b) Structured Debt & Equity Combination
Types of Equity Financing
Equity financing is the process of raising capital through the sale of shares of the company. Companies raise money because they might have a short-term need to pay bills or have a long-term goal and require funds to invest in their growth. By selling shares, a company is effectively selling ownership in their company in return for cash.
a) Friends, Family, and “Fools”
b) Angel Investors
c) Venture Capital
d) Private Equity
e) Mezzanine
Types of Hybrid Financing
Mezzanine financing is a hybrid of debt and equity financing that gives the lender the right to convert the debt to an equity interest in the company in case of default, generally, after venture capital companies and other senior lenders are paid. Mezzanine debt has embedded equity instruments. often known as warrants, attached which increase the value of the subordinated debt and allow greater flexibility when dealing with bondholders.
a) Types of Hybrid Financing
Mezzanine Lead Debt:
Warrant Coverage
How to Increase the Probability of Raising Funds?
Build a Business Model with Recurring Revenue, Consistent Revenue Growth, and Recurring EBITDA
Have a repeatable Customer Acquisition process that Lowers “Customer Acquisition” cost in addition to alternative distribution channels.
Build in more variable cost structures in the business model
Outsource as many of the “non-core competencies” as possible (i.e. Back Office, Accounting, HR)
Increase in Productivity and Scalability year over year and have ways to measure it
Inflationary times pose unique challenges for businesses, but they also present opportunities for those equipped with the right resources and support. “Useful Capital” becomes a crucial component for businesses seeking to thrive in inflationary environments.