3 Mistakes Made When Raising Capital
Avoid headaches and frustration during your next capital raise by dodging these common mistakes.
Are you feeling anxious and apprehensive about your next capital raise? Don’t worry, many experienced business owners and executives feel the same way. Whether you are a starter business or a mature company, raising capital can be one the most difficult and complex tasks–and, for most, a very necessary task to grow and profit.
As business owners and commercial real estate advisors helping raise capital for real estate, we’ve also experienced frustration during the process when our interests didn’t align with our potential investors. We understand. You want to build and grow your business while remaining in as much control as possible, while your investors want a profit, less risk, and some control over your business to ensure their interest is represented.
Through our experience, we’ve learned that some common mistakes can be easily avoided by understanding the challenges of growth and primary types of capital.
The Challenge of Growth
The challenge of growth reminds us of the old ‘did the chicken come before the egg’ philosophical question. And, trust us, we’re not attempting to answer that specific question, in this blog anyway, because the reality is the chicken and the egg couldn’t exist without each other. Well, that same relationship exists between growth and cash – one can’t exist without the other. So, we find ourselves in this unproductive, circular way of thinking about growth: “I need more cash to grow faster but I can’t grow faster without more cash.” Here’s where capital raising steps in. It allows business owners and executives to obtain cash quickly so that they can invest in future growth.
Three Primary Types of Capital
Finding the right vehicle to raise capital starts with understanding the primary types of capital. There are many different types but we’ve found these are some of the most common avenues used by our clients.
- Debt – Debt capital is borrowed cash to be repaid at a later time and, most likely, with interest. Sources for debt capital include bank loans, personal loans, and credit card debt. Bank loans are a common source for debt capital and are paid back in full, plus a negotiated interest rate. However, many banks won’t take on a lot of risk especially in starter companies who can’t quantify the value of their company–meaning, starter companies can’t produce a financial statement because they don’t have one yet.
- Convertible – Raising capital through convertible is simple, less costly, and allows business owners to put off quantifying the value of their business. Convertible allows equity to be converted at a later date when the company can be quantified. This is great for starter companies since they can’t produce annual revenue. Investors are generally offered a discount as a return for putting cash in the business at the earliest and riskiest stage.
- Private equity – Private equity is capital raised from wealthy individuals or firms that invest into private companies. They typically purchase shares in private companies and then raise and manage shareholder funds. Rather than buying stock, private equity invests directly into your company. They generally sell their investment at around the five-year mark and expect a substantial profit, so mature companies are often a good fit. However, if that isn’t a part of your objectives and goals, then it’s probably not the right vehicle for you.
3 Common Mistakes
Below are some common mistakes we’ve found most business owners make when raising capital.
- Choosing the wrong type – Planning will help you the choose the right capital raise vehicle. Make sure you fully understand your goals and objectives, and the objectives of your investors. We can’t stress enough the importance of this. If you’re a starter company and don’t have a balance sheet yet, going to a bank for loan may not be your best option since your objectives don’t align. Knowing exactly what you and your investors want to accomplish not only helps you pick the right vehicle, but will also eliminate a lot of frustration during the negotiation stage.
- Not raising enough to meet objectives – So now that you’ve planned ahead, you should have a good idea on how much to raise, right? Well yes, but life happens. The unexpected happens, whether it’s new hires, higher employee benefit costs, or the unanticipated legal counsel. Try raising a little more to give you some cushion to deal with unexpected costs. Let’s say you planned to raise capital to grow software technology products over the next 12 months; maybe aim for 15 months instead. Raising capital is stressful and disruptive to your business, so plan ahead for the unexpected. It will save you time and money.
- Failure to plan for the next capital raise – Raising capital distracts you from your day-to-day operations so plan now for your next cycle. One way to start planning for your next capital raise is to identify your target investors now to begin qualifying them. Since raising capital is disruptive to your business, failing to planning early for your next cycle will hurt your business operations and your growth goals.
Most mistakes can be avoided by proper planning. Analyze your goals and objectives and put them into a business plan. Ask yourself things like: “What are my targeted growth and return objectives?”; “What is the investment timeline I desire?”, and “What kind of structure am I most comfortable with?” These are the same questions we ask ourselves and our clients when raising capital for real estate.
Raising capital is an important element for many businesses seeking growth. Planning early and understanding how to do so effectively will save you a lot of headaches and frustration, and get you where you want to go faster.
If you need more advice on capital raising for real estate investment deals, you’re not alone. Contact Verity to speak with an experienced real estate advisor.