Whether you’re a startup founder or an entrepreneur expanding an established business, capital raising is critical for fueling growth and success. However, with a diverse selection of funding opportunities available, choosing which route to take can be overwhelming especially when your business is just starting to gain ground. Below, we discuss the most popular options for capital raising and how they can benefit your company.
What is Capital Raising?
Capital raising is the process by which companies raise funds from external sources to launch, expand, or transform their businesses. This can include injections in business development or investments in other assets like joint ventures and strategic partnerships.
Types of Capital Raising
Businesses, regardless of sector, size, or location, usually have a limited number of funding sources available. Some of the major types of capital raising include bootstrapping, retained earnings, debt capital, and equity capital.
Bootstrapping
Bootstrapping, also known as self-funding, involves raising capital using one’s personal savings, as well as borrowed or invested funds from family or friends, and income from the company’s initial sales. This approach reinvests profits from the business for controlled growth, which is less risky in the long run.
Bootstrapping is an ideal way to raise capital without relinquishing control of the company and avoid taking on debt. However, it may not be the best option for startups that require significant upfront capital or have limited resources.
Retained earnings
Companies typically aim to generate profit by selling products or services at a price higher than the cost of production. This is the most fundamental source of funding for any business and the primary method for generating revenue. After covering expenses and obligations, the remaining net income becomes retained earnings for the company.
Retained earnings are held by the company and are not paid out to shareholders as dividends. This is a crucial way of raising capital because as companies become more profitable, retained earnings also increase, giving access to a higher pool of capital.
This type of capital raising is cheaper as startups don’t owe anyone anything and the business becomes self-sufficient. Investing profits back into the business can also accelerate growth while boosting sales and share price, making room for better dividend payments. However, this also means less income for shareholders or investors and lower returns. Reinvesting profits takes time to pay off, which can limit capital, as there may not always be enough retained earnings to fund major growth projects.
Debt capital
Debt capital utilises one of the most traditional methods of capital raising—borrowing money through bank loans. It’s an excellent option for businesses with a strong history of revenue and profitability, especially those that can provide collateral. However, loans can be difficult to secure if the startup does not have a strong credit profile, and the interest rates can be high.
Another way of raising capital through debt is by using corporate bonds. These debt securities are issued by the business and sold to investors who then receive a series of predetermined interest payments, either at a fixed or variable rate. Once the bond expires or “reaches maturity,” the interest payments stop and the initial investment is returned to the investor.
Debt capital can be convenient for startups or companies that are deemed high-growth and need a lot of capital—fast. It gives tax incentives like deductions on interest payments made to loans and boosts corporate credit score, while also preserving company ownership. However, the business can go bankrupt if it does not generate enough income or profit to pay the principal and interest on the debt when it is due. Capital raising through debt may also mean the potential loss of important assets critical to business operations as many lenders require companies to offer assets as collateral for their loans.
Equity Capital
This type of capital raising involves selling company shares to investors in exchange for money or investment. It is also called equity funding.
In equity funding, investors, typically angel investors and venture capitalists, receive a stake in the company. Once the business becomes profitable and successful, a certain percentage of profits must be given to shareholders as dividends.
Equity funding for capital raising is a great choice for startups with massive growth potential but have limited operating cash to sustain the business before it starts turning a profit. Unlike the debt capital, there is no loan to repay nor a collateral in place, so businesses are not pressured to pay back shareholders immediately. In addition, investors lend their vast experience, business contacts, resources, and management expertise to the company, which can be crucial in the early stages of the business. However, there are no tax incentives, plus entrepreneurs must give up a portion of their ownership in the company, thereby diluting control. Shareholders might also expect massive returns for their investment, which can cause internal pressure on the startup to scale and perform.
Crowdfunding
More and more startups are favouring crowdfunding as an alternative way to raise capital as it democratises startup investment by allowing the business to raise small amounts of capital from a large number of investors. Unlike venture capitalists or angel investors, crowdfunders provide money in exchange for rewards and incentives, like early access to the products or services, instead of control or ownership stake at the company. However, one big disadvantage is that if you don’t reach the funding goal or target amount, the pledged money will be returned to investors, leaving the business with nothing.
Which Type of Capital Raising is Right for My Startup?
Raising capital for any startup or business involves carefully evaluating the available options. From bootstrapping to crowdfunding, there are various ways to raise capital, each with its own advantages and disadvantages.
Strategic thinking and meticulous planning are key. Before raising capital, it’s crucial to build a strong business case—backed by solid data that highlights your market, growth potential, and path to profitability—to convince investors to give you the money you need. Do your due diligence and prepare for tough questions that may come your way and ensure your financial records, legal documents, and operational plans are well-prepared before meeting with potential investors.
When raising capital, it is best to consult with a lawyer or legal firm who can assist you with any legal requirement to help you stay ahead of issues that may arise. Lawyers do not only review your documents but they can also help you negotiate better terms, especially if you are raising capital through equity funding. They can best protect your interests and ensure your business complies with the law.
By understanding your specific needs and objectives, you can select the type of capital raising that best aligns with your business goals. With the right plan, goal, and mindset, you can secure the funding you need and pave the way for success.
Sign up for our newsletter to stay informed about legal news, business trends, and more. For help with legal matters and requirements, contact us here.
