Raising Capital: What’s the Process?

Key Takeaways

• Unless requisite fundraising drains on time and money have been thought through and planned for in advance, the outcome could be less than desired.

• One of the first orders of business for a nascent company is raising capital, which requires attracting investors.

• Some startup companies prefer to assume debt rather than dilute founder or investor ownership through equity offerings.

Entrepreneurial ideas can be a dime a dozen, no matter how brilliant. What it usually takes to bring a concept to fruition is, well, money. The good news is that if the fundamentals are there – management team, operating systems – such funding is often available.

Garnering it can still be a challenge, though, in part due to a lack of understanding of the fundraising process, which investors also use for investing in real estate, private equity, venture capital, and for business. 

With that said, here is what should be known about the process of raising capital.   

What Does it Mean to Raise Capital?

Capital raising generally refers to the process of obtaining funds from investors for growing a business, new projects, or building a business. 

In exchange for capital from investors, the company must issue a share in the company such as stocks or bonds.

Who Would Need to Raise Capital?

Raising capital is something that many businesses and individuals must do for a variety of reasons.

• Business owners. One of the first orders of business for a nascent company is raising capital until they become profitable, which requires attracting investors. Companies also frequently need to raise capital to expand their business into new markets or geographic locations. Mature companies also at times need funds to expand or grow. 
• Private equity/venture capital. Venture capitalists are always seeking new investment opportunities. However, to invest, VCs must raise money from other investors. They often do this by holding events where they can pitch their opportunity, or they can use LinkedIn or other social media to connect with potential investors. 
• Real estate developers. Developers often use a mix of institutional loans and equity to finance development and purchases. There also may be government grants and incentives available.

Types of Capital Raising

Two primary types of capital raising include:

Equity financing. Essentially, this is the process of raising capital by selling shares. Whether the company needs money to pay bills or to cover a long-term project that will help it grow, selling shares in exchange for cash means it is basically selling ownership.

Debt financing. Also known as debt lending or debt funding, debt financing is basically when a company borrows money to fund their business. Such financing, which is often in the form of a small business loan, requires repaying the funds borrowed, plus interest, by a set date. Debt financing is commonly obtained from traditional lenders, “fintech” companies, or online lenders. 

Sources of Capital

There are several popular possible sources of capital, including through an initial public offering. Other common prospects include

• Angel investors. These are individuals – sometimes groups – that specialize in investing in early-stage startups, using their own money. They frequently learn about prospective investments through referrals from fellow investors, networks or trade groups, or a new business’s advisers.
• Banks. Some startup companies prefer to assume debt rather than dilute founder or investor ownership through equity offerings. The caveat is that it can often be challenging for early-stage companies to get a loan from traditional banks. However, that can open the door to venture lenders, who are often more open to risk in exchange for a possible higher return.
• Venture capitalists. These are private equity investors who, in exchange for an equity stake, provide capital to companies. The company could be a startup venture or small company that seeks to expand but cannot access equities markets. Note that the size of the equity position matches the amount of risk assumed by the venture capitalist.

The Process of Raising Capital

While the process can be daunting, people should not shy away from seeking the cash needed. And there are overarching steps for doing so, including:

Identifying Potential Lenders

The borrower here must have a clear view of how much money is required, what the funds will be used for, and how the loan will be repaid. If dealing with a bank, the borrower will want to know their credit score and have collateral ready to be offered as security. The search for lenders can start with banks or credit unions with which the borrower has a relationship. Otherwise, peer-to-peer lending platforms could be viable options. 

Preparing a Business Plan Plus Pitching

Funding to start, grow, or acquire a business will require a tight business plan. That does not mean the borrower does not need assets and a good credit history and the like – they do. But lenders also want to be certain that the company or business idea is viable and sustainable.

When seeking funds, the entrepreneur or investor must be ready to tell each potential source what management’s capabilities are and where it falls short, how much of the business they own, how they earn their compensation, and what their marketing strategies are. They will also have to show their personal and business financial statements. 

Due Diligence and Negotiations

One there is a list of potential lenders, and a business plan, in place, it is time for negotiations. Note that the lender wishes to lend the borrower money, so the borrower does have some control, in terms of terms and the amount, particularly since the credit is there and collateral is involved. If the lender is not amenable, another one likely will be. 

Challenges and Considerations

Every fundraising approach and funds source implies various kinds of commitments and out-of-pocket expenses. It is stressful and could take months. Founders will often spend up to half their time attempting to raise capital, and it is true: raising money costs money. 

For example, even when the search for capital works, out-of-pocket costs of going public could be lofty. Fees to regulators, printers, accountants, underwriters, and lawyers can run as high as 35% of a smaller offering. There also will likely be increased administrative costs and legal fees that go up commensurate with increased SEC reporting compliance. There may also be increased liability insurance premiums and directors’ fees. 

Then there is equity dilution — the drop in equity ownership for shareholders that happens when a company first issues shares. Usually, a founder owns 100% of their company when they first start out, but that ownership stake decreases each time capital is raised or shares are issued. 

Further, audits and independent reviews may follow bank loans of more than $1 million, which the funds recipient pays for. 

Unless such drains on time and money have been thought through and planned for in advance, the outcome could be less than desired.

Raising Capital for Alternative Investments

Capital can also be used for “alternative” investments – basically any asset class other than stocks and bonds – which are increasingly popular as investors seek relief from an inherently volatile stock market.

Following the 2008 financial crisis, and the crash of public markets, investors who depended solely on the stock market lost out and began searching in earnest for non-traditional assets. Such investments could provide a hedge of protection against inflation and possibly enhanced returns.

Enter the leading alternative investment platform Yieldstreet, which offers highly vetted opportunities in asset classes such as private equity, real estate, and venture capital. After all, compared to traditional portfolios of stocks and bonds, which has generated annualized returns of 6.5% since 2015, private market investments over the same period have produced a 9.7% net annualized return.

Investments outside of public markets also serve the important role of diversifying holdings, which mitigates overall risk exposure across investments. Diversification – crafting a portfolio with a mix of investments with disparate expected risks and returns – is key to long-term successful investing.

Portfolio Diversification and Alternative Investments 

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary

Business owners, private equity and venture capital investors, and real estate developers often need to raise funds to either get started or to optimize returns. Planning for and understanding the process, including challenges and considerations, can be crucial to success.