Raising Capital for Your Business [PODCAST]

Raising Capital for Your Business [PODCAST]

by Redpath and Company

In a recent episode of The Transaction Abstract, Joe Hellman sat down with Thomas DeMinico, Director of the Middle Market M&A Advisory Group with Bank of Montreal (BMO). Tom has more than 12 years of experience advising clients on M&A and capital raise transactions. He joined Joe to provide his insights on capital raisingโ€“the best way to do it and potential roadblocks to watch out for. Listen to the episode below. 

Tom referred to raising capital as an art, โ€œthe art of bringing third-party financial resources to your business.โ€ In most cases, capital is raised to support a specific operational or strategic endeavor (e.g., growth-, operational-, or shareholder-related motives). Tom identified three โ€œbucketsโ€ most capital raising activity falls into:

  1. Operating Expenses and Working Capital
    Raised capital can be used to fund basic operating needs such as marketing, payroll, talent acquisition and retention, and new inventory purchases. These are examples of expenses that help maintain the companyโ€™s current performance.
  2. Property and Equipment
    Manufacturing firms, in particular, will often raise capital to perform necessary equipment maintenance. Highly equipment-oriented industries may also use third-party capital to expand production and fuel growth.
  3. Finance
    Capital may be used to lay the foundation for the successful exit of a business partner or other major shareholder who wishes to leave the business. This often involves performing debt recapitalization.

In the simplest terms, raising capital means infusing cash into the business โ€“ but doing so for a specific purpose intended to benefit the business and its shareholders. As with any transaction, the expectation of investor ROI must be built into the companyโ€™s strategy for using the funds.

Types of Capital You Can Raise

There are a number of different ways to raise capital, but all will fall into two categories: debt capital and equity capital. The most common approach to raising capital in either form is โ€œprivate placementโ€ โ€“ that is, raising capital from private investors. 

Early-stage companies are more closely associated with raising money from individual angel investors.

Large, established companies have the option of raising capital through an IPO (initial public offering). If a company is already publicly traded, it may be possible to increase capital opportunities via a follow-on or secondary offering. A Special Purpose Acquisition Company (SPAC) can complete an IPO in some cases. A SPAC can be preferable because its execution time is a fraction of the time needed to finish a standard IPO. SPACs are being looked at by regulators which may result in changes to the process and timelines. 

Last, crowdfunding has become a popular way for some small businesses to secure funds.

Whatโ€™s Behind the Scenes When Raising Capital

Most listeners of The Transaction Abstract are probably familiar with the popular reality show Shark Tank and the outsized personalities it features as its investors. While this is somewhat dramatized, it provides a sense of the way pitches are carefully constructed, and complex negotiations take place.

Your timeline will vary based on the avenue you choose for raising capital. The differences reflect not only the process of negotiation but the various processes, procedures, and regulations that different investors follow. All investors will evaluate an opportunity in detail before making capital available.

The typical time period for an individual transaction is 3-10 months, but outcomes are highly variable.

Optimizing timeframes is especially important for early-stage entrepreneurs, who often find themselves in a cycle of โ€œAlways Be Raising (Capital).โ€ Early-stage businesses may see a longer or shorter process depending on lifecycle stage, technology offering, disruptiveness, and growth potential. Investors can be induced to move faster on a transaction if there is a clear incentive to optimize growth by doing so.

Not All Businesses Have an Appetite for Investor Capital โ€“ But Most Have the Potential

A business does not necessarily have to be in a โ€œhotโ€ industry with short-term high growth to attract investor capital. However, many businesses do not actively seek these opportunities. Whether a first-time or serial entrepreneur, it is important to ask the following questions about a transaction:

  • Is the plan right?
  • How much capital will be raised?
  • In what time period will the capital be available?
  • How much will be dilution versus non-dilution?

All of these add up to a single concern: โ€œCan I afford and am I willing to take what is necessary to get to the end of that plan?โ€ Although the calculus can be complex, business owners have access to a variety of capital raise types they can use in combination to reach their desired exit.

One critical concept to understand in capital raising is dilution, which most often relates to equity capital. Dilution represents the level of ownership stake outside investors receive as a result of their investment. Other forms of dilution exist, including options for the senior management team.

In general, entrepreneurs seek agreements that minimize dilution. A better valuation provides for less dilution overall. If there are clear reasons to believe valuation will soon increase, it may make a strong argument to delay your capital raising activities.

Right and Wrong Ways to Go About Capital Raising

There are pitfalls business owners can encounter when they raise capital, especially for the first time. Tom highlighted two specific issues they can prepare for in advance:

  • Timing
    Timing is tricky since it is impossible to ever time anything โ€œperfectly.โ€ Yet, it is one of the most common questions business owners ask: โ€œWhen should I raise this capital?โ€ The answer is highly dependent on internal and external factors, including:
    • When do you actually need the funds to be available?
    • What is the trajectory of the business?
    • What emerging market factors may influence the rise?
  • Preparation
    Before raising capital, an organization must be equipped with the documentation and rationalization a sophisticated investor requires for due diligence. Financial documents, contracts, and legal documents must all be available. This smooths the process and can significantly improve the outcome. Conversely, failure to prepare often leads to substantial timeline and valuation impacts.

Raising Capital as an Early Stage Business

For independent entrepreneurs and family-owned businesses, strategic transactions can be complex and time-consuming. They also require challenging โ€œgame-timeโ€ decisions. Early-stage businesses are often called on to give more during transactions than their established counterparts would.

In addition to equity stake, this can take the form of consent rights, dividends, liquidation preference, and more. Optimizing these terms often demands the expertise of an outside M&A advisor, especially among small businesses with lean internal teams.

General legal and financial experts have a place in any transaction, but a dedicated M&A advisor makes a key strategic difference. Raising capital functions as a full-time job on top of running the business; it is best overseen by a specialist with complete visibility into the process.

An M&A advisor not only supports all the necessary transaction preparation but can also help business owners access the right investors. Since the advisor is knowledgeable both about investor criteria and your exit requirements, they ensure you do not waste time reaching out to the wrong audience. 

The advisorโ€™s role also includes day-to-day outreach activities, which may free business owners from many hours of work. A broad perspective enables the advisor to make the connection with investors who buy into the businessโ€™s story and goals and will function as long-term, supportive partners.

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Redpath and Company

Redpath and Company

Redpath and Company helps clients make more informed decisions that contribute to their financial well-being by providing proactive, innovative, and value-driven CPA and advisory services for closely-held businesses, private equity, government entities, and nonprofit organizations. Core commercial industries served include manufacturing and distribution; construction, real estate, and engineering; and technology. Areas of service expertise include audit and assurance; personal, business, and international tax; state and local tax; sales and use tax; and succession and estate planning. Redpath also guides clients throughout the entire business life cycle with performance optimization and process improvement; M&A advisory, including corporate and deal strategy, due diligence, financial modeling, and M&A integration; accounting and management outsourcing; and valuations. The firm was founded in 1971 and is employee owned (ESOP). With offices located in St. Paul and White Bear Lake, Minnesota, the firm ranks as one of the top CPA and advisory firms in Minnesota. Redpath is a member of HLB International, a global network of independent advisory and accounting firms. For more information, visit www.redpathcpas.com.