Exploring the Essentials of Capital Raising: Types, Main Stages, Best Practices

According to Insider Inc., 29% of businesses fail because they run out of cash. Consequently, capital raising becomes a crucial endeavor for virtually every business aimed at facilitating growth. It’s a way for company owners to bring business to a new turn and for investors — to get a share in a growing business or have their debt payment repaid with interest.

Keep reading this guide to learn more about capital raising, its types, the important steps, and how to tell if your business needs it.

Key takeaways:

• Raising capital means getting money from outside resources to develop or expand your business in some way.
• The main types of capital raise are debt raise, equity raising, hybrid (convertible) raising, and SAFE raising.
• The top motives for raising capital are mergers and acquisitions, restructuring, debt financing, an increase of working capital, restructuring, purchase of fixed assets, and the launch of new projects.
• The main types of fundraising investors include accelerators and incubators, government funds and crowdfunding, angel investors and venture capitalists, and banks.
• For an effective fundraising round, it’s essential to define the purpose of fundraising clearly, present the company’s current and projected financials, and track the progress after getting an investment.

What does it mean to raise capital?

Capital raising is a process a company initiates and goes through to raise money from outside resources to develop, transform, or expand a business in some way.

In other words, companies raise capital to bring a business to the next level and “prolong its lifespan.”

Notably, the approach to capital raising varies significantly across companies due to their diverse financial needs. Some initiate their journey with personal savings, while others secure millions of dollars in loans or investments. The diversity in capital requirements stems from the distinct nature of businesses and their growth aspirations.

This infographic illustrates how much money various companies had to start a business:

Source: KeeVurds
*Note: The basics of capital raising for small businesses are perfectly described in the educational video series by the U.S. Securities and Exchange Commission.

Types of raising capital

Generally, there are four main types of capital raise: 

1. Debt capital raising 
2. Equity capital raising
3. Convertible/hybrid capital raising
4. SAFE capital raising

Let’s review each of the four types in more detail. 

1. Debt capital raising 

Best for: established businesses to fund short-term needs or to finance large capital expenditures.

Common types: loans, bonds, and lines of credit.

Debt raising refers to taking out loans from external sources to finance a business. It is a popular option among companies as it allows them to obtain large amounts of debt capital at relatively low-interest rates without loss of control or ownership of their business. The key characteristic of debt raising is that all the borrowed capital is expected to be paid back with interest.

The lenders have traditionally been public debt markets and banks, but now they also include a variety of financial institutions and private equity investors. A lender can include a variety of terms and conditions on the loan that is supposed to protect them in case a company is not able to pay the debt back.

Pros:  

• Businesses get quick access to cash.
• You remain the sole decision-maker in the business.
• Debt raise is a good option for all types and sized businesses: from small to larger companies.
• Once the debt is paid, your liabilities are over.
• The interest you pay is tax-deductible.

Cons:

• You must repay debt with interest, even if the business doesn’t perform well.
• Debt raising might negatively impact a borrower’s credit rating.
• Depending on the loan terms, it might be difficult to grow the business. 

2. Equity capital raising

Best for: startups and growing businesses seeking significant capital infusion.

Common types: crowdfunding, venture capitalists (or private equity investors), venture capital firms, angel investors, and any private investors.

Equity financing is the process of issuing shares to external sources on the stock market in exchange for funding. This type of capital raising is particularly beneficial for businesses as they do not need to make regular repayments, and the company keeps control over its operations.

The most common examples of equity funding are crowdfunding, venture capitalists (or private equity investors), venture capital firms, angel investors, and any private investors. 

Just like with debt raising, there are certain equity financing terms and agreements. When such terms and agreements have special conditions attached, it’s usually referred to as “preferred equity.”

Pros:  

• You don’t have to pay any debt off.
• You receive a chance to get mentorship, as angel investors and venture capitalists are interested in your business development.
• Equity raising is technically a less risky fundraising solution.

Cons:

• The investment dilutes business ownership.
• It might be obligatory to involve investors in the decision-making process.
• Equity raise might not be an option for startups since investors are only interested in promising business ideas.

3. Convertible/hybrid capital raising

Best for: startups and companies with potential for rapid growth.

Common types: convertible bonds and preferred shares.

Hybrid raising is the combination of both debt and equity. It is a popular option for companies as it combines the benefits of both debt and equity. This strategy allows the company to raise a larger amount of capital without needing to issue any additional shares or without taking on too much debt.

A hybrid capital-raising process presupposes a convertible debt. Simply put, it means you get the funding now, but don’t give a common stock or preferred shares in your business right away. The investment money helps your business grow, and when it’s “stronger”, and a pre-agreed event takes place (usually, it’s when you raise the next equity round), your company is evaluated. It’s at this time that investors get their returns in the form of shares in your business.

Pros:  

• It gives companies access to a broader range of potential investors.
• This is an especially beneficial option for startups.
• The arrangements can be more flexible for investors and company owners.
• It provides both parties with a lower risk proposition.

Cons:

• Raising capital in such a way is usually more favorable for investors than company owners.
• It can be more complex and costly than debt or equity raising alone. 

4. SAFE capital raising

Best for: startups that seek initial funding other than convertible notes.

This type of raising funds presupposes the use of a Simple Agreement for Future Equity, also known as a SAFE Note. 

The SAFE Note implies that the company owner takes on investment, and then it converts into equity in the future. On the surface, this type is similar to hybrid capital raising — the business receives investments now and pays off the debt in the form of shares later after the valuation. However, the principal difference is that a SAFE capital raise is much simpler and more flexible, as SAFE Notes are not recorded as debt instruments.   

Pros:  

• It’s simpler than using a convertible capital raise.
• It gives startups much more freedom because there are no repayment obligations at the start.
• There are no complex terms and agreements as in the convertible capital raise.

Cons:

• Such a raising capital type can typically be more favorable for investors than for company owners.

Capital raising process essentials

So, let’s assume that you’re a startup owner or a CEO of a large company who is considering capital raising as a possibility to grow your business. You’re probably wondering where to start the process, you want to know the essentials and what to do next. 

Here’s what you need to know about three primary capital raising stages — preparation, the capital raising process, and post-fundraising. During each stage, you need to find answers to a few specific questions — they’re arranged in the table below.

Now, let’s answer each of these questions.

1. Why raise capital?

Essentially, companies consider raising funds to grow. It might be the need to fund a new business venture, expand its current operations, purchase new equipment or inventory, or invest in new technology.

By investing the funds they raise, businesses can take advantage of new opportunities and increase their product offerings, customer base, and overall market share.

It’s essential to understand the reason you’re raising capital since it helps to properly prepare for the round properly. Here are some top motives for raising capital:

• Mergers and acquisitions. Companies may raise capital to acquire another company or merge with a competitor. It allows businesses to expand their customer base, increase their market share, and consolidate their operations.
• New projects or ventures. Businesses may need to raise capital to launch a new product line, invest in research and development, or open a new market. Raising capital allows businesses to take advantage of new opportunities and increase their growth potential.
• Debt financing. Raising capital can also be used to pay off existing debt, allowing businesses to improve their financial position and free up funds for reinvestment. By raising capital, businesses can take advantage of new opportunities, pay debts, and invest in their future. It’s an essential part of any business plan that can be used to increase profitability and growth potential.
• Purchase of fixed assets. Fixed assets such as equipment, inventory, or buildings may need to be purchased to expand a company’s operations. Raising capital can help cover the costs associated with these purchases.
• Working capital. The money businesses need to operate day-to-day, and it may be necessary to raise funds to increase working capital. It can help keep businesses running smoothly to ensure they have enough cash to meet short-term obligations.
• Restructuring. Capital-raising initiatives may also be necessary if a company needs to restructure its operations. It could involve reorganizing departments, consolidating debt, or introducing new operational processes.

2. When to raise capital?

Understanding the right time for fundraising is important because it helps to reduce possible drawbacks and benefit from all possible advantages.

Notably, in recent times, the venture capital landscape has exhibited some noteworthy trends. For instance, data from the first quarter of 2023 indicates a significant decline of 53% YOY in global venture funding.

Given these market shifts, it’s essential to consider these factors when deciding the timing of your capital raise:

Below are four signs that you need to raise capital:

• You’re unable to meet the demand for your product. When your product is popular and in demand but your business is having trouble meeting that demand, it’s an obvious sign you’re ready for expansion. Moreover, investors are attracted to product demand and sales growth, so chances are you will be able to raise funds quickly.
• You lack the professional staff to achieve business goals. If you have everything for the company’s development and understand how to do it, but it still doesn’t happen, maybe you need to review your staff and consider hiring new players. For example, you might need new professionals on the sales team.  
• You have a clear roadmap and business plan. Potential investors will more likely be interested in your business when they see you have a clear understanding of how to reach the objectives and make the investment work. 
• You have repeat and referral purchases. There’s no better sign of customers’ appreciation than their return business and referrals. When this happens, it might be a sign a fundraising round will only help you increase earnings and expand business operations. 

3. Who to raise from?

Below are the main options to raise capital from:

• Accelerators and incubators. It’s usually a great fundraising option for startups since they not only provide cash for development but also often act as mentors and help the business to grow.
• Government funds and crowdfunding. Government funds involve an investment from the government, while crowdfunding is basically a system of third-party donations. However, crowdfunding often puts startups at risk of intellectual property, as they have to disclose their unique business idea to get donations.
• Pre-seed funding. Pre-seed funding relates to the period when a startup is only first getting its operations off the ground. Pre-seed investors are usually family offices, close relatives, or friends.
• Angel investors and venture capital firms. These are commercial investors who are interested in investment returns and are usually hands-on with the business. Angel investors usually act as mentors, while venture capital firms are institutional investors that are capable of investing more money than angel investors.
• Bank loans. Banks provide companies with desired cash without being interested in taking part in business operations, which is a great advantage for business owners. However, banks are harder to raise capital from for startups since the latter doesn’t have enough credit history.

4. How to raise capital?

Here’s what you need to do before initiating the capital-raising process:

• Review and update your financials. You’ll need to prepare, at minimum, basic financial statements and, a cap table before fundraising. You need to have financial documentation to support your arguments and to present to potential investors.
• Calculate your needs. Define the target sum you want to raise to ensure that your business meets production.
• Make sure you know how to use the money. When getting ready to pitch potential investors, make sure you know how you’re to manage the cash you expect to receive from investors. 
• Focus on experts that bring value. It would be good to attract investors that have expertise in your business area because they can bring extra value by sharing their knowledge.
• Hire a strong legal team. Hiring professionals in fundraising or investment banking will help you navigate through all the legal agreements properly.
• Be ready to explain your long-term vision. You should clearly understand and be ready to explain how the company expects to repay its investors.

5. What is the capital raising timeline?

The timeline of the capital raising process is as follows: 

• Defining the purpose. This includes telling the story of your business and stating its mission. Potential investors or lenders want to know WHY they’re loaning you cash and WHAT they’re getting in return.
• Preparing the documents. Gather all the documentation prospective investors need to answer their questions to fund your business. Involve a legal team in this process.
• Planning. Work out a clear business plan to show investors you know where you’re at now and what objectives you want to achieve with a capital raise.
• Finding investors. The next step is to find investors that might be interested in investing in your business. Ideally, you would already have some networking results by this stage, so the investors’ search is easier.
• Pitching. When you’ve found interested investors, it’s time to pitch your business ideas, mission, what problems you want to solve, and why your company raises funds.
• Setting out the deal. Once an investor is interested in helping you finance your business with cash, it’s time to negotiate the terms and agreements of the deal. 
• Conducting due diligence. Once an investor and the company owner agree on the terms of the deal, the investor initiates the due diligence process to review the current state of the company and forecast its potential.
• Closing the deal. At this stage, a binding contractual agreement is needed. This document confirms the investor’s agreement to invest capital in the company.

6. What documents to prepare? 

The pack of documents that you’ll need to prepare before the fundraising round depends on such factors as the business’s size and the country of operations. However, below is the list of the most common documents you might need for a capital-raising process:

• Constitution. This document clarifies how the company is governed internally and discloses the relationship between the shareholders and directors.
• Pitch deck. This is a key document to present to the investors. It’s a trademark of your business that explains what you’re all about, what you want to achieve, and how fundraising can help you with it.
• Confidential information memorandum. This is your company’s large (usually a 40-100-page) marketing presentation. It should cover all the details about your company prospective investors might want to know.
• Financial model. This document projects the performance of your company in the targeted period, as well as contains core financial information about its current and historical operations.
• Shareholders agreement. This is a private and confidential document that outlines the rights and obligations of shareholders and the company’s management.
• Term sheet. This document specifies the agreements between an investor and a company.
• Subscription agreement. This document is needed when a company is issuing shares to an investor. It states the terms and amounts of the investment as well as the details on the type and number of shares to be issued.
• Vesting agreements. This document defines the relationships between the founder and the company, and outlines the terms of what will happen with the founder’s shares if they leave within a specified time.

7. What are some post-fundraising tips?

Unfortunately, a successful capital-raising process doesn’t always mean actual growth for the business. However, the way a company operates after funding is important. Notably, 7.5 out of 10 venture-backed startups fail. 

So here are a few tips on how to avoid becoming a part of failed statistics:

• Make sure your future milestones are clear to everyone on the team and that you are on the same page. Understanding the objectives will keep everyone committed to the company’s goals and accountable for the results.
• Track your progress and be able to show where the capital is spent. Make sure the post-fundraising results align with the plan you set out while pitching investors before the capital raise.
• Allocate funds only to those departments or areas of your business that can bring value to your company and accelerate its growth. 

The risks of raising capital

Here are the most common risks associated with capital raising and their solutions:

1. Raising capital might take longer than expected, leading to neglect of the business and reduced sales.
   Solution: Maintain a balanced focus on both fund-raising and business operations and have a contingency plan to sustain the business during the waiting period.
2. Choosing the wrong capital provider can lead to misaligned expectations and failed funding attempts.
   Solution: Thoroughly research potential investors and lenders to identify those who align with the business’s financial needs.
3. Not repaying loans can result in losing the business, particularly when using personal assets as collateral.
   Solution: Develop a clear repayment plan before taking on loans, considering different scenarios and ensuring the business’s ability to meet financial obligations.
4. Raising too much equity capital can lead to loss of majority ownership and even removal from the company.
   Solution: Carefully consider the amount of equity to be offered and the implications on ownership before securing funding.
5. Sharing sensitive information with potential investors can lead to unintentional leaks, damaging the company’s reputation.
   Solution: Implement strict confidentiality measures and consider utilizing virtual data room software to control access to sensitive documents.

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