2021 has been a record-breaking year for the mergers and acquisitions industry. This is mainly due to the relative ease of raising capital for business owners or prospective buyers. Interest rates are low and investors have committed capital to invest in growth companies.
Even with all this good news about getting access to funds, startups can struggle to raise cash. Startups often bootstrap using family and friends’ money until they have a history of success to attract venture capital or private equity funding. It may take even longer to attract a traditional bank to be interested in providing cash to your growing startup. We’ve provided more details on these methods below.
Bank Loans
Bank loans are the traditional way of raising capital for a business. They’re very reliable and relatively flexible means of raising money for several reasons. The first is that there are multiple options for types of loans including: long-term loans, short-term loans, lines of credit, etc. The second, is that they typically have lower interest rates than other funding options. Finally, you have a high degree of flexibility in how you can spend the funds compared to limitations an investor may impose on a company’s use of funds.
There are downsides to bank loans. The biggest one is that it’s hard for new companies to get traditional bank loans because they don’t have a financial history, they don’t have collateral to support a loan or they don’t have adequate revenue to pay the debt service. Banks are less willing to take on the risk of new entrepreneurs or business without a proven track-record of success. And unlike the cash you get from investors, you have to pay the loan back using precious cash that could be used to fund growth.
While some banks are looking for ways to help small businesses, often the reality is that lending to startups is too risky for most traditional lenders.
Angel Investors
Angel investors are typically high net worth people who fund startups or early-stage businesses. Most are accredited investors under SEC rules and have a minimum net worth of $1 million or at least $200,000 in annual income.
In most instances, the founders’ networking makes connections to angel investors. Angel investors can be friends, family, professionals in your network, or those who have a passion for the product or service offered by the company. They typically invest in startups in exchange for equity or convertible debt that will convert to equity at a later date. They want to invest in high-growth startups that will allow them to get a high multiple of their investment.
A disadvantage of taking investment early on is that a founder may have to give away significant equity to get cash when the company has an early and low valuation. Founders should balance the need for cash and contacts and expertise that an angel investor may bring to the table with giving away a lot of equity early in the startup stage.
Venture Capitalists/Private Equity Firms
While not exactly the same thing, both venture capitalists (VC) and private equity (PE) firms are groups of investors that are looking to invest in an enterprise that they believe can be bring a significant return with the help of the money they invest. Unlike banks and other traditional lenders, VC and PE firms are more willing to take on riskier projects, meaning it’s potentially much easier to get the funding you need. Furthermore, they also bring other benefits besides money such as industry expertise and industry or potential client connections.
The main downside to this source of funding comes from the pressure for an investment to pay off. VC and PE firms are taking on a fair amount of personal risk when they invest in a small business. Because of this, they often will expect high returns with a fairly tight deadline. They also will typically want a say in how the business is run, as well as equity in the company. This restricts the amount of flexibility that you can have with the funds you receive.
Crowdfunding
The newest form of raising capital, crowdfunding, can be a great option for raising money if other more traditional avenues aren’t available. The SEC authorizes companies to raise up to $5,000,000 in a twelve month period under its crowdfunding rules.
One of the biggest pros for this option, is that your company may attract investors that are excited about your idea or the social impact of the company’s product. This is a great way to build a loyal base of supporters early on. It’s also a simpler process than other financing methods because it’s as simple as setting up a campaign on a site like Kickstarter or IndieGoGo. Founders also have limitless potential on what can be raised and can exceed the initial amount asked for in the crowdfunding campaign..
There are some things to consider with this option. One of the big ones is that it can be very difficult to generate the hype and excitement required for people to donate. Typically, crowdfunding is done by people who are looking to put their money towards something they really care about. Since they aren’t generally professional investors, it can be hard to convince them to part with their money. Furthermore, you will generally have to provide some kind of reward to donors, which can lead to potential complications depending on the reward you choose to offer.
Conclusion
There is a broad range of ways to raise capital in 2021. The main tradeoff to consider is the ease of acquiring funds from an investment source versus the expectations of the investor. While banks can be difficult to get a loan from, there is a longer process of repayment with lower expectations for the business as opposed to VC or PE firms. Crowdfunding is a great option if you have a compelling product or giveaway. Having an advisor, such as Seck Advisor Group, can help you decide which source of funding is right for your situation. Next time, we will go into the essential things to know about the process of raising capital.
sources:
5 Ways to Raise Capital for Your New Business (startupnation.com)
8 Essential Things You need to Know When Looking to Raise Capital - Maximpact Blog
12 Unique and Creative Ways to Fund Your Small Business (intuit.com)