Startups know all too well how closely growth can be tied to rounds of capital funding. Established companies face their own questions on the matter. Not just how to find external sources of capital, but when to consider such a move.
Every company has an idea or twelve as to how it would use an injection of cash. Some of them may be good enough on their own merits, but none in and of itself is a good reason to seek external sources of capital.
Raising capital at the right time can help a company fulfil important strategic goals. Raising it at the wrong time can tie it to increasingly onerous debt-servicing requirements, or muddy the leadership waters when times get tough. Here are two crucial factors to bear in mind when you consider raising capital for your business.
When your company’s strategic plan calls for it
Capital investment should feed your strategic plan. Specifically, it should support phases of your strategic plan that specifically depend on significant capital investment.
Not all phases meet that standard. For example, if sales are steady and growing quickly enough to outpace production, you will need to take action. That does not necessarily imply the kinds of capital investment successful companies secure from external sources. Some responses require no capital investment at all. You might, for instance, look at your pricing structure as a way to moderate sales volume while increasing revenue.
Other responses to success do require some investment: increasing production and warehouse capacity will require some outlay. But those expenses should be readily offset by continued increases in sales revenue. The wiser move in a case like this may be to draw against current cash flow to pay for the new investments, borrowing only the minimum amount necessary to make up the difference.
Some phases of your strategic plan, though, all but call for you to raise capital. When you enter a new market altogether, you will need more than a one-time loan to fund a new production line. The new employees, new facilities, and new customers that come with such a move will change your company. Issuing a bit of debt or tweaking your company’s ownership structure by offering some equity may be entirely appropriate.
This goes double for companies expanding into new geographic markets. Such moves often incur unforeseen expenses and early inefficiencies. It may be wiser to treat those costs as part of the broader capital expense of expansion than to draw entirely on cash reserves and anticipated cash flows. If you raise capital through equity, you may find a partner who is both willing and motivated to lend an expert eye to your new operation.
When your company is on sound financial footing
This might seem counterintuitive, but the best time to consider raising capital is when your cash flow is steady and your finances are stable. There are two good reasons for this.
First, raising capital from “external” sources always involves an exchange of some sort. You will surrender equity or issue debt. Neither is a healthy trade simply to improve cash flow for current operations.
If you raise capital by offering equity in your company, you dilute your own share of the company’s profits. You also restrict your company’s flexibility when addressing challenges or exploiting opportunities in the future. The same goes for issuing debt, though you may preserve some operational flexibility while incurring greater risk.
In either case, raising external capital only makes good business sense if your business is stable and growing. Otherwise, it amounts to raising money against unfavorable terms just to right the ship. The better approach is to perform some triage if necessary and focus on optimizing your operations.
Second, external investors will naturally want to hedge their bets if your company appears to have significant financial weaknesses. If your debt profile and cash flow aren’t what they could be, investors will likely see this as well.
The good ones—the ones you’ll want to partner with—might avoid your company altogether, or ask for terms that are better for them. That leaves a relatively large pool of less-desirable investors offering more onerous terms. Again, it’s better to improve your bottom line through internal action than to make your company beholden to an investor who doesn’t share your vision. Grasping this logic though, doesn’t entirely clarify the decision to take on an external partner when you’re performing well.
Understanding your financing options
Raising capital of any type can lead to undesirable situations for your company. To mitigate this risk, ensure that you are familiar with the different types of financing available to you, as well as their impact on your business. If you do not have sufficient expertise in-house, seeking help from a firm that specializes in this area can go a long way. At Cap Expand Partners, we assist companies and independent sponsors through a network of associate partners with cross-border expertise, using modern methodologies to raise capital in a structured and reliable manner.
In business, timing is everything. That extends to the timing of your capital-raising efforts. Knowing your financing options prepares you to make the right moves at the right time.
This was also published by Coruzant on Nov 12, 2021