A large number of businesses fail during their first year of operation due to lack of funding. The journey from a brilliant business idea to a revenue-generating business needs to be fueled by capital. Entrepreneurs are often looking for ways to finance their startups. When and how you require funding would depend largely on the nature and type of business. Once you realize the need to raise capital for your established business, understanding these basics will help you get started.
Why Would A Company Need To Raise Capital
It is commendable if you have been able to start a business without venture capital, it is however not the right strategy for every new business. Here are a few reasons why you should consider raising capital.
#1 Scale Quickly
When you bootstrap money or try to get small loans your starting process might get delayed which gives your competitor a chance to beat you to the market. Slower forms of financing could cause you to miss an opportunity. Venture capital on the other hand can provide you with a large cash infusion which will allow you to scale up to a more visible size.
#2 You Gain Credibility
When a venture capitalist is willing to infuse your business with a substantial amount of funding, it lends credibility to your venture and shows that your business has potential and that your product is something of value. Stakeholders are immediately reassured that you have been approved, if your funding has been covered in the media, more people will see that a reputable investor is backing you and the coverage will be good for business.
#3 Tap resources beyond money
Most often when you raise capital, you will also get access to extensive resources like business expertise, legal and tax services, access to research and growth in your network. By yourself, you may not have been able to access such an extensive base of resources due to limited experience. The connections that you make from networking can also provide further opportunities for your business.
#4 Assistance with risk and strategic direction
An experienced venture capitalist can help a new business owner understand risk, strategy and tough decisions. When they have large amounts invested in your business they will be more than happy to serve as advisors to your company to ensure its success. They can assist in HR management, financial management and marketing.
What Are The Main Sources Of Capital?
When you are looking to raise capital for your business there are different types of financial capital that you can choose from.
Bootstrapping is basically self-funding. It is an effective way to get your business started when you are a first-time entrepreneur and are having trouble finding a financier. This can be done by investing your own savings or getting your family and friends to contribute. This kind of funding has fewer formalities and is usually flexible with interest rates.
Also known as “net worth” or “book value”, equity capital is basically a company’s assets minus its liabilities. Business owners can choose to fund their businesses entirely with equity capital in the form of cash invested by the shareholders or owners, with no offsetting liabilities. This is a more popular form of capital that does not need to be paid back, however, it is also very expensive and requires massive amounts of work to grow an enterprise funded this way. An example of a business using equity capital is Microsoft, it does generate high enough returns to justify this kind of capital structure.
When money is given as a loan to a business and there is an understanding that the amount must be paid back by a preset date, it is considered as debt capital. The lender of this type of capital is usually a bank, bondholders or a wealthy individual who will take interest payments in exchange for using their money. One could think of the interest paid as the cost of “renting” the capital to begin or expand a business. Debt capital is usually the easiest way to access finances for businesses just starting up. As long as a business owner earns more from the capital (return on capital) than the amount to be paid as interest (cost of capital) then the business can achieve a profit.
Speciality capital is considered as the gold standard. This form of capital has almost no economic cost and allows for the rapid growth of the business. Speciality capital includes two types of capital, the negative cash conversion cycle also known as vendor financing and insurance floats.
Negative cash conversion or vendor financing is when the capital that you may have otherwise tied up in inventory is collected from customers who pay you for merchandise even before you procure it. Dell Computers was known for its negative cash conversion cycle. This also happens when vendors retain ownership of their products while they are on the shelves at stores until such time as a customer buys it. At that moment the vendor has sold it to the store who has, in turn, sold it to the customer. This allows the business to generate a better income. Wal-mart was built on this principle.
Insurance floats are when insurance companies invest the funds that they collect and generate income which is then paid out as benefits to policyholders. This is money that a company holds but doesn’t own. It has the benefits of debt-equity but not the drawbacks.
Other sources of funding
Some other unconventional but popular funding options include:
It is like taking a loan from more than one person at the same time. This is done through crowdfunding platforms. An entrepreneur mentions his ideas, plans and goals and consumers can give money if they like the idea in terms of pre-buying the product or giving a donation. As it generates interest, crowdfunding also helps in marketing.
These are individuals or groups of people who are interested in investing in startups for a share of the equity. They offer to mentor along with the capital. Angel investors will take more risks in investments for higher returns and usually expect up to 30% equity.
There are many benefits to raising capital for your business as long as you are committed to delivering timely returns to your investors. Choose investors who understand your direction and overall financial objectives to create a mutually beneficial relationship
If you have a need to discuss ways to raise capital for your business, we at Accounovation are passionate about helping our clients grow profitably. Get in touch with us at Accounovation.com for a free consultation on how we can assist you with accounting services.