When access to funding is vital to a business’s growth and development the business owner must make a thoughtful evaluation of the available options. An emerging business can seek to obtain needed capital in a number of ways, and no one particular source of capital is always best for all circumstances. The business owner’s ultimate decision of which source (or combination of sources) to tap at any particular time will require a balancing of considerations, risks and costs, including an assessment of the advantages, disadvantages,requirements, and timing of each source.
Friends & Family The simplest and most direct source of capital for a business is funds from existing owners. Owner-funding occurs in virtually every emerging business and is a critical first step in the capital-raising process. The main benefits of using existing owners’ funds are the ease and speed with which money can be raised (with relatively little complication and expense) and the maintenance of control over the business by the existing ownership group. Using owner-funding also delays outside ownership (and, therefore, dilution of existing ownership, control, and other issues) until a later, hopefully higher, valuation level is reached. Financing through owner-funding also serves as a tangible demonstration of the owners’ or founders’ commitment to the business (a factor of significance to most venture capitalists and institutional investors). The most significant disadvantage of owner-funding is that this source of capital is usually quite limited and may not satisfy a growing business’s capital needs.
Most emerging businesses also seek and receive funding, particularly at the early stages, from family members and “friends” of the founders and existing owners. This friends and family funding offers the advantages of speed, simplicity, generally favorable valuation and terms, and expansion of stockholder ownership, on a limited basis, to known sources. On the other hand, raising capital from friends and family might give rise to personal conflicts and issues. Additionally, existing owners could be viewed as taking advantage of the relationship with friends and family or their lack of sophistication, experience, or insight into the funding process (including on matters such as valuation, terms and follow-in financings). Finally, uninitiated investors (thought to be friendly) may bring unrealistic expectations and difficult demands regarding having a say in the operating matters, the amount and timing of potential returns on investment, the need for and difficulty in raising subsequent rounds, and delays and extended timeframes in achieving business profitability or any real exit transaction.
The SME business community often is associated and supported by communities which often is done in a formalized manner. These communities build charitable trusts to encourage entrepreneurship and support businesses within the community.
SMEs seeking funding can look at such community funding as an option, however, community funding comes with a lot of prerequisites. Typically, they are:
Such funds usually are available without any equity participation from the community and at very low costs.
Angel and venture capital funding is, simply put, risk-equity investing by professionally managed investment funds, providing seed, start-up, early-stage, expansion-stage and later stage funding to high-growth-trajectory private companies (from small start-ups to larger, more mature businesses capital funding always involves a longer-term, illiquid equity In addition to providing critical funding angel and venture capital investments can bring an important strategic partner, resources, and discipline to the business—in such areas as talent recruitment, sales and marketing, strategy and budgeting, scale and growth, industry networking and best practices, and assistance with future capital raises and exits depending upon the investment in a company believed to have exceptional growth potential angel and venture investors’ objectives, background and experience, as well as chemistry and relationship fit”. Angel and venture capital investments are made by professionally managed venture capital funds and “angels” or “angel investors”.
Entrepreneurs seeking funding through VC firms can expect substantial due diligence, intensive business, strategic, and financial planning, and aggressive negotiation of valuation, deal structure, rights, founder obligations and restrictions, as well as other terms.
A strategic alliance, partnership, or joint venture with a more established operating company may also serve as a means to raise needed capital.
Typically, in such a case, the established company is interested in some aspect of—or the future opportunity presented by the capital-seeking business, such as its proprietary position, technology potential, research prowess, product/market channels, location in the manufacture/distribution chain, or potential as a customer and/or supplier. A strategic alliance usually serves to facilitate the achievement of goals other than raising capital, including access to research and development, new technology, manufacturing capabilities, distribution channels and markets, customers, and management personnel, as well as an enhanced ability to compete. Funding can also be provided through strategic arrangements and relationships with customers, vendors, suppliers, and others with whom the company does business or who are familiar with the company’s business, products, services, capabilities, and market. Capital-related advantages can also be obtained by acquiring or adding symbiotic or value-added businesses, services, or product lines, or by disposing of (or discontinuing) non-core or “drag” businesses, services, or product lines.
For the emerging business, an established strategic partner which is pursuing the arrangement to pursue and fulfill its own interests and goals—typically has far greater experience and resources, and those resources can be deployed if underperformance occurs or if a dispute or conflict arises. The alliance can and often does limit the fund-seeking business’s flexibility to pursue its natural business course, or to engage in future alliances, acquisitions, and capital transactions.
Furthermore, the emerging business may find itself controlled in many respects, or its future substantially affected or limited, by a much larger company focused on its own agenda and priorities, which may not include, as the highest priority or at the most critical time, the successful growth and development of the emerging business.
If an emerging business is pursuing a strategic alliance solely or even primarily to raise capital, it probably should not be considering the alliance at all. Successful alliances are often “bet-the-business” relationships, which require a common vision in a joint enterprise, as well as a substantial commitment from management and personnel and the devotion of time, attention, and resources.
One of the more traditional, tried-and-true methods of raising equity capital is the private offer and sale of shares to a limited number of investors. Depending upon the circumstances, a private placement can be a cost & effective means of raising capital, usually at expansion and later stages of development. Private sales of shares may be accomplished with or without engaging a professional placement agent.
Expect the private offering process to take significant time and resources, including to consider and engage a placement agent, prepare an offering memorandum (short or long-form), identify suitable investors, conduct a road show (management presentation) of sorts, circle investor interest, negotiate terms, prepare and finalize documentation, and sign the investment agreements and close the transaction. Also, the business will likely be subject to and thus management will need to prepare for a rather extensive due diligence investigation.
From a business perspective, private placements have some elements of both angel and venture capital transactions and initial public offerings. Compared to an initial public offering, the private placement typically requires less due diligence, preparation, and documentation and is subject to far less regulation.