October 18, 2022

Everything You Should Know About Raising Capital For Your Business

Raising capital for your venture is no mean feat. We break down the A-Z of fundraising so you can build a profit-churning business.

Do you ever wonder what the Achilles heel of many growing businesses is? You guessed it right- it's raising capital.

Figuring out the right funding option and how to raise funds for your business can become an arduous task for founders, but it doesn't have to be.

In this article, we will be shedding light on the different types of fundraising, methods to raise capital, and what the normal process of raising finance for a business looks like. Without further ado, let’s dive right in!

Raising capital: what does it mean?

Raising capital is a means by which a business can launch, expand, and oversee daily operations and is done by approaching investors or lenders. Businesses can raise finance through debt or equity capital, with debt typically costing less than stock because debt has recourse.

However, a capital raising strategy cannot be generalized — it all boils down to the stage and size of your company, the amount it needs to scale, the time frame, and your short-term and long-term goals for the business.

Equity, debt, and non-equity: the 3 different types of fundraising

There are three basic ways to raise capital: equity financing, debt financing, and other alternative non-equity options.

Let's have a look at these three types and how they work:

1. Equity financing

When you raise capital in exchange for equity, investors stand to receive a share of your company's future earnings in return for their current investment. Unlike debt financing, you do not need to pay back the amount to the shareholder or investor. This makes equity-based fundraising a popular option to get a business off the ground.

Equity= Total assets- total liabilities

How does equity fundraising work?

Equity shares denote the percentage of a company that an investor will own.

You might have come across this method in the business reality TV series Shark Tank, where owners raise funds for business in exchange for equity by pitching to the sharks.

For example, Company A is a business ready to dilute 10% equity at 1 lakh, which means that it will be valued at 10 lakhs after the fundraising. If the investors agree with this, they will own 10% equity of the company. Quite possibly forever.

So when should you raise equity?

A) When bootstrapping is out of the question

Bootstrapping, or raising finance for a business by yourself, becomes difficult after a point, especially when you've either run out of cash or need a massive amount to get your business going. Opting for equity-based funding makes sense since the early phase of minimal dilution can be compensated for later.

B) When you do not have collateral

Collateral is a sellable item that you offer to the banks in case things go wrong. If you're out of assets to pledge as collateral, equity-based funding makes for a viable option in your capital raising strategy.

C) When you wish to dilute equity in the long run as opposed to repaying loans

For businesses with massive growth potential that need a supply of capital for long before expecting profits, equity dilution can be worth the early price.

Equity funding is usually done by angel investors, and venture capitalists, with the help of family and friends, or by enrolling in incubators or accelerator programs.

Things to watch out for in equity-based financing

A. There will be high ROI expectations

When investors invest in your company for stakes, they expect a high return on investment - much higher than what they would get by offering that money as a loan. Be prepared to be overwhelmed with high expectations of results.

B. It takes time

Raising funds for business via equity can take anywhere between 3-6 months simply to find the right investor. If time is of the essence for you, equity fundraising may not be the first option you'd want to look out for.

C. Equity financing is a competitive domain

Raising capital is a highly competitive business. After all, investors are willing to invest their money in an idea. They usually go through hundreds of deals before closing in on one, so you need to ensure your business model stands out.

D. Loss of ownership

If someone owns 10% of your company, they own it forever. Equity dilution is one of the biggest drawbacks of this method, for once you lose full ownership of your business, the investor becomes a part of your business for life.

2. Debt financing

Debt funding is when businesses raise capital by borrowing money, with a promise of returning at a later date with interest. Loans are borrowed from a lender, while debt money is raised through bonds or debentures.

Debt is offered by banks, non-banking financial institutions (NBFIs), Government Loan Schemes, etc.

Debt funding is usually secured against collateral - something tangible and sellable that you can give to the lenders in case things go south and you cannot repay the loans. More the collateral you own, the better your chances of getting more money.

When should you opt for debt financing?

A. When you need a small amount of capital

Giving up equity for small amounts is not feasible, and hence debt financing makes for a great option in this scenario. Moreover, all ownership is retained.

B. If equity dilution is not an option

For companies that grow at a high rate and do not wish to dilute equity, debt financing makes for a cost-effective type of financing as the interest on debt is tax-deductible.

Watch out for the lack of collateral and high interest in debt financing:

Banks need to be 100% sure that the lender can return the loan, and hence, they prefer owners with a good amount of collateral and credit score for security. Moreover, when things go south, valuable business assets can be at potential risk.

3. Alternative Non-Equity Financing Options

Convertible Debt

Convertible debt is a hybrid of debt and equity: you borrow money from investors with the expectation that the loan would be repaid or converted into a share at some point in the future. For example, after another round of fundraising or when the company reaches a specific valuation.

It allows investors to have the best of both worlds and gauge the company's progress before committing to stakes.

Revenue-Based Financing/Subscription-Based Financing

Revenue-based financing and subscription-based financing have been a welcome deviation from traditional methods for raising finance for business. Entrepreneurs don't need to dilute any equity, and they can get capital within one week!

Companies with recurring revenue streams can simply exchange their future revenue for upfront capital and raise funds through platforms like BridgeUp. This allows founders to grow at their own pace without any restrictive debt, decisions, or fear of equity dilution.

What are the methods to raise capital?

Bootstrapping, asking friends and family, approaching angel investors and venture capital firms, taking bank loans, crowdfunding, or opting for alternatives like revenue-based financing are the usual funding options that you can use to raise capital.

Listed below are the methods to raise capital based on your company size:

FOR START-UPS

Bootstrapping
Friends and family
Incubators
Seed or angel investors
Crowdfunding
Grants and bank loans

FOR SMALL AND MEDIUM-SIZED COMPANIES

Angel groups
Venture Capital
Bank Loans

FOR LARGER BUSINESSES

IPO
Investment managers
Hedge funds
Private Equity
Late-stage VCs

Why do companies need to raise money for the business?

Raising capital is essential for production, expansion, marketing, operations, and the plethora of needs a company has to scale its growth. A few common reasons why companies need to raise capital are:

To create a prototype
To assemble a team and hire quality professionals
To procure raw materials and equipment
To deal with administrator expenses and office space
For product development
For legal and consulting services
For licenses and certifications
For mergers and acquisitions
For marketing and sales
As working capital

Unfolding the fundraising process

Knowing the fundraising steps might increase your chances of landing a successful deal with a prospective investor. Let's understand the steps involved in an ideal fundraising scenario for a founder:

1. Assessing the need for funding

First, businesses need to have a milestone-based plan with a clear timeline in sight to know how much capital they will need, and whom they should approach.

There are different stages in raising money for a business, like seed funding, Series A, B, C, D, and IPO- the choice of which depends on the company’s profitability stage. Building an MVP, trying it out on customers, determining the product market fit, and then using that data to convince investors of your idea's potential is the way to go.

2. Preparing a pitch deck

A pitch deck is a presentation that includes a detailed overview of your business strategy, pain points, product overview, market size, team details, current traction, funding needs, exit options, etc.

A winning pitch deck is the key to catching investors' attention: it should tell a story that convinces investors enough to be convinced of your capital-raising strategy.

3. Targeting the right investors

Finding the best investors for your business that align with your vision is what you need. Platforms like AngelList, CrunchBase, and LinkedIn can help you figure out and connect with such potential investors. Research their past experiences and target only those investors that you deem fit.

Ideally, investors should be:

- In the same domain and have industry networks relevant to you
- In a similar geographical location
- Assessed based on the engagement and mentorship they provide to investee startups

4. Negotiating and carrying out due diligence

After you've approached the investors of your choice, you may have to sit for a few meetings to come to a mutual agreement. Investors will examine your business for due diligence and scrutinize your claims, the startup's past financial decisions, team credentials as well as background.

5. Drawing up a term sheet

A term sheet is drawn up after due diligence and contains exhaustive details about the investment structure, management structure, valuation, and changes to share capital. Term sheets are non-binding agreements converted into legally binding agreements after further detailed due diligence.

6. Closing the deal and transferring funds

After all the legal documents have been signed, the deal is closed, and the funds can now be transferred to the respective party.

The bottom line

Raising funds for business is far from a one-size-fits-all approach. Having a genuinely good source of capital in your early days can help accelerate the business and allow you to focus on what's most important i.e., building your product, without having to deal with financial constraints.

If you're a business that has been earning 12 months of recurring revenue, reach out to us at BridgeUp to see how we can assist in making raising capital a piece of cake for you.

You can call us at +91-9819660287 or drop us a query in this form here.

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Zeus Dhanbhura

CEO at BridgeUp