05.02.11 | Primer on How to Raise Business Capital
For many start-ups it is difficult for them to determine how much money they will need to raise for their business. It should not be a difficult question if you have already put together real world financial forecasts for cash flow, net income and capital investment. A detailed financial statement forecast would provide all the information you would need. However, if your question is really about how much you should try to raise and the level of difficulty, then the answer depends on various factors. Let’s go through each question in detail.
How much money should I try to raise?
Again, the basis of the answer to this question are your financial statement forecasts. As the funding seeker, you must be familiar with your forecasts and the key assumptions that hold your forecasts together. At the end of day you are asking for others to invest in your business and they need to be comfortable that you know what to with that investment. Common questions a potential investor would ask include:
- When will the business start making a profit?
- How long will you be able to sustain the business before needing additional cash investments?
- What will the money invested be used for?
- How does your business compare financially to other businesses in your space? (i.e. competitor analysis)
Earlier I alluded to the fact that the amount your financial statements reflect that you need to run your business differs from how much money that should be raised. For example, Company A has a start-up service business that financial forecasts show a net loss of $1 million in the 2nd year of operations and thus the business will need $1 million cash infusion to keep the business viable. The forecasts also show that after year 2, the business is profitable. Initially you may think that you only will need to raise $1 million; however, you need to take into account the key assumptions of your financial forecasts. What happens to your financial projections if some key milestone is delayed and raises year 2 net loss to $3 million. You need to take into account risk factors of achieving key financial milestones in determining the amount of capital you need to raise.
How hard is the capital raising process?
The skill sets needed to raise capital differ by funding round category. The categories are as follows:
- Friends & family
- Credit cards
- Home equity loans
- Selling investments and other assets
- Borrowing against retirement assets such as your 401K
$100K – $1 million
- Angel investors
- Commercial lenders
- Small Business Association (SBA) loans
Series Funding – $1 million +
- Venture Capital/Private Equity firms
- Investment banks
- Initial public offering (IPO) via stock market
- Sell business to another firm
Each category has pros and cons and only you can determine what fits your situation best. The difficulty level of capital raising depends on the level of funding you are seeking as well as the industry you are in. The lower the level of funding the easier it tends to be. For example, the under $100k funding round is people you already know and should be able to get funds from. As you go up the funding ladder, you have to find people who are specifically interested in your business area. For example, many private equity funds focus on particular market segments such as online gaming. A online gaming fund will not be interested in a widget manufacturer. In addition, the higher the funding the more control of the company you will have to give up.
After the $100,000 funding level, each level will require the following steps:
- Finding interested investors
- Due diligence process
- Filing SEC (for IPO only)
Depending on how long each of these steps take, the process could be as short as a month or many months.
In summary, decide how much funding you really need to remain viable by getting to know your financial forecasts including risk factors, determine what funding method works best for your business and for the level of control you want to maintain and then line up potential investors that fit your parameters as well as your industry.
Loftis Consulting is a Chicago-based firm that helps start-ups with custom built financial models and reviews of pre-existing financial models for increased funding success through credible financial models. Visit our financial modeling page to learn more.