Why raise investment and what are the top three options?

We mostly write about and discuss the world of crowdfunding. But in this article, I’m going to take a step back to consider why a business would want to raise investment in the first place. I’ll also touch on some potential downsides.

Note that the main focus here is ‘raising investment’, as opposed to the broader term of ‘raising funds’. Generally speaking, the former is a subset of the latter. Other ways businesses raise funds include rewards-based crowdfunding (which we discuss here), debt finance i.e. a loan which has to be repaid and usually attracts interest, through to things like selling inventory and assets owned by the business. Common to all these ways of raising funds is the primary objective, which is to inject money into the business. 

Why do you need money?

The main reasons businesses raise capital are: 

1. to enable them to do or build something that they can’t do without additional capital (cash in the bank) and or; 
2. to execute their overall strategy faster and/or bigger. 

In the absence of such investment, a business may find it difficult to do any of those things within an acceptable timeframe, or even at all. And in a worst-case scenario, that could impair the longer-term viability of a business. 

This article doesn’t discuss ‘distress funding’ i.e. money required to prevent business failure. That’s a whole different matter and very rare, if not entirely non-existent, for equity crowdfunding.

Top Three Ways To Raise Money

I’ve been asked the question many times, ‘what’s the best way to get money in the bank for my business’. My answer might surprise you because in an ideal world, it’s not equity investment. In fact, that approach is a rung or two down the ladder. 

Aside from things like grant funding and suspensory loans - which aren’t really that common in the grand scheme of things - the best way to fund your business strategy is from revenue or, more accurately, profit. If you’re able to sell your products/services at a profit and from those profits set aside provisions for things like developing new products and expanding into new markets you’re probably in the best position. But as you might expect, this is easier said than done.

Setting aside variations such as additional founder funding and sweat equity, the second position goes to debt finance i.e. a loan of some sort. The rationale is if you’re able to borrow the money you need and pay it back including interest, you might ultimately be better off than if you had sold shares in your business. Of course, this approach is likely to introduce other considerations such as security and guarantee requirements from lenders. 

Note that the best time to fund your business growth and development via debt finance is when interest rates are low and affordable. When inflation is on the rise, interest rates usually follow which is great for savers, but not so much for borrowers. And one of the quickest ways for a business to find itself in administration is to fail to repay its debts; not a good look. So increasing company debt in an inflationary economic environment isn’t recommended unless you’re really sure of yourself. 

Therefore this puts equity investment in third position, well sort of. The downside of equity investment is that by selling shares you reduce the level of stakeholding you have in your own company. And if there are already other investors, for example, one or more co-founders, then selling equity shares reduces their stake in the business in the same way. 

But…is that a bad thing? Not at all, the benefits of equity investment are manifest, we write and talk about them all the time. For example, you might find yourself with a ‘smart investor’ i.e. someone who brings value to your business over and above their money. Commonly you might discover a whole new group of customers. And in practical terms, it’s not unusual for raising equity investment to be less hard - as opposed to easier - than the other two main approaches discussed above; have you ever tried asking your bank manager for a six-figure business loan? 

Takeout

So when you’re considering raising equity in order to pursue your ambitions of being the next Google, but are worried about diluting your own business stake, here’s the question to ask yourself. “Do I want to own 100% of a business worth £1M, or 40% of a business worth £100M, or 5% of a business worth one unicorn?"

Author: Richard Mojel, Commercial Director, ISQ.