Depending on the balance-sheet, purpose and duration of capital, as well as the size, sector and stage of business, there are many ways businesses can raise money. It could be direct from the markets through equity, loans or convertible bonds.
While each method has its pros and cons, making the right decision mostly involves avoiding common pitfalls such as:
• Targeting correct type of capital - This depends on type of business. For instance, tech firms can raise money from informal channels or angel investors, while real estate and food businesses go for a mix of equity or debt.
• Raising excess capital - Firms often project overly optimistic numbers and raise capital based on those, ending up not using all of that. And possibly losing shareholder trust.
• Preparing distorted business plans - Unrealistic plans lead to raising capital through debt and hampering the working capital.
• Failing to prepare an exit strategy - While the type of exit strategy is not crucial, investors look to the management’s plan and commitment in building long-term value.
• Failing to network and channelize contacts - Business owners need to rely on experienced financial advisors to manage their funding portfolio.
• Pricey valuations - Demanding too much upfront may make the firm seem unrealistic or not fit for investors.
• Getting into complicated terms of agreement - Owners should be wary of complex contracts with complicated terms and hidden clauses.
• Having too many investors and lenders - Managing too many expectations of funding sources results in dire consequences from conflicting interests or demands from not so silent partners.
Specific mistakes in equity funding
Not factoring in lengthy processing times: In case of urgency, equity funding, which could easily take six months and more, might not be the right option.
Equity investors might have their own agenda: They expect higher rewards for the risk they carry, making it difficult for owners to run operations as per their vision and goals.
Raising equity capital in further rounds: Depending on the amount raised in the first round, it might be challenging to raise further capital as consensus from all equity holders is difficult because they will be looking for the final exit and liquidity.
Selling preferred stock: It might be complicated, time-consuming and expensive. Plus the company would need to be valued, which may lead to owners losing a say in the operations.
Pitfalls in funding through loans/debt
With a low credit rating, firms might have to pay a higher interest rate and further deteriorate their rating.
Firms need to check for hidden fees and type of interest rate, and if the loan can be terminated pre-term.
- Saikat Kumar is CEO of Skycap Investment Management.
