Raising Capital for Your Business

Time To Raise Capital? How Much Should You Raise

The prospect of fundraising is understandably exciting to business owners. An injection of equity capital can mean explosive growth and the ability to break into new markets, among other things. As a business owner, you have probably imagined a best-case scenario where you had enough capital to make any strategic decisions you wanted. Raising capital with investors is a primary way to make that a reality.

But, like any other business decision, the choice to start fundraising needs to be carefully considered. Fundraising is a complex process that involves much more than pitching an exciting idea and receiving funds. Owners will need to decide how much capital their businesses need to raise. Owners will also want to be aware of how that capital will impact their business (and cap table) moving forward.

In this article, we will briefly outline how fundraising rounds work. We’ll then discuss in more detail how to determine the right amount of capital for your business to raise. Lastly, we’ll discuss the longer-term impacts of capital raising on a small business. 

How Capital Raising Works

Fundraising doesn’t typically happen as one distinct event but rather takes place over a series of rounds. Companies enter different fundraising rounds based on several factors. These factors may include how large each round is or how quickly they are growing as well as the industry they are in.

Fundraising rounds are a topic of their own, and we won’t discuss them in detail here. For the purposes of this article, we just need to understand that business owners shouldn’t aim to determine a single, unchanging amount of equity capital to raise. Rather, they should be reevaluating their capital needs based on data and real-time feedback.

Considerations for capital amounts

So, what should business owners consider when deciding how much capital to raise? Each business is different, and the optimal amount of capital to raise is a fairly individualized thing. However, potential investors will want to know how you came up to your amount. There are a few general guidelines that any business owner can follow, though.

Equity Capital vs. Debt Capital

If you are reading this article, you might already be set on looking at venture capital, identifying an angel investor, or equity crowdfunding. But a small business owner or entrepreneur, you should understand a few fundamental differences between debt and equity financing.

At a basic level, equity financing involves giving away a part of your ownership interest in return for capital. Often, there is no guarantee of return of this capital for the investor. Alternatively, debt financing involves getting capital in return for a promise to repay it at a later date.

Both types of financing have advantages. Debt financing is more readily available and allows you to keep all of the ownership interests in your business. However, for smaller business owners it often can mean personally guaranteeing the debt and the future payments will have an impact on cash flow.

Equity financing can help an entrepreneur by bringing capital into the business that won’t impact cash flow. This funding can also bring in valuable resources in the way of advice from investors that have helped others build companies. However, the cost of this capital is having to share future earnings.

Both financing methods have a place for small business owners. An accounting services professional, such as a virtual CFO, can help you decide for yourself which is the best option.

When Should You Be Raising Capital

Having a business idea is not enough for raising capital. While this might satisfy friends and family, it will be lacking for professional investors. Investment rounds are normally time to help businesses achieve a certain level of scale. For example, a typical first round of investment is called a seed round. A seed round usually funds your move from the time your concept is proven to initial sales.

Series A rounds help you scale your sales growth until you reach your next milestone. With so many options today for investors, if you try to shortcut this path, you’ll find raising capital hard.

You must be strategic with the timing of your fundraising strategy. Is not uncommon for businesses who raise funds too early to, without showing proof of concept or commercial traction, to part with 20 percent to 30 percent of your equity, for a very small check size. If the funds raised are not enough to reach your next milestone, this can create a cascading effect of raising equity at unattractive valuations.

Use Milestones to Determine Capital Raise Amount

Milestones are well-defined benchmarks that a business aims to reach. For instance a certain number of active customers or a specific amount of annual revenue earned. Milestones are a kind of first-line consideration when raising capital. This is because they make it easier to see how much capital a business might require to reach its goals. A business owner might set a milestone of acquiring 1,000 new customers, for instance, and then be able to determine the production and payroll costs that reaching that milestone would mean. 

As a business reaches milestones and sets new ones, owners will need to rethink how much capital they need to raise.

Base Raising Capital on Your Business’ Runway

A runway is just the amount of time a business can operate before running out of money. It’s easy to see how this is a reasonable consideration when deciding how much capital to raise. Business owner’s don’t want to have to shutter their doors.

Businesses should aim to raise enough capital to have a runway of 1 to 2 years. Using this strategy, they have time to reach milestones and prepare for a new round of capital raising. 

What kind of data should owners consider when determining their business’ runway, though? Apart from obvious operating costs like payroll and inventory, owner’s will need to consider several things. For instance, advertising budgets, additional personnel needs, and future equipment costs, among other things. Accurately determining your business’ runway will require an accurate budget or forecast. An accounting services professional like an outsourced CFO can be a helpful consideration during this process. 

Pay Attention to Industry Norms

Investors want to see that a business has carefully considered how much capital to raise and how to use that capital, and that means being familiar with fundraising standards in your business’ industry. If investors find that an owner is greatly overvaluing their business, or is asking for a wildly different amount of capital than its competitors, they may be turned off — and future investors, in turn, may be harder to find.

Raising Capital Costs a A lot

Entrepreneurs have to be aware that there is a lot of work involved in raising money from accredited investors, venture capital, and angel investors. In small businesses and startups, during the fund-raising cycle, the impact on founders’ time can be considerable. It is common to devote as much time and energy trying to get outside capital as it is to manage their company’s day-to-day operations. This can easily become overwhelming if not managed properly.

Even when the search for private money is successful, out-of-pocket costs can be surprisingly high. The costs of raising funds and paying lawyers, accountants, and printers among others can run 10% to 20% of a smaller offering and can go as high as 25% in some instances. Even with new crowdfunding platforms, fees can be extremely high.

Impacts of raising the incorrect amount of capital

Miscalculating the amount of capital to raise can have negative impacts on a business. First, if a business raises too much capital, it can cause its valuation to be artificially high. Future investors might expect the business to be growing more quickly than it actually is and be turned off in future rounds. Previous investors might find their investments diluted, damaging that business’ reputation.

On the other hand, if a business doesn’t raise enough capital, it may not be able to reach set milestones. This will be similarly off-putting to future investors. Potential investors want to see that the business is consistently meeting goals and reliably growing. 

Because of these potential impacts, business owners considering fundraising should seriously consider hiring an accounting services professional. The services of an outsourced CFO, for example, will benefit a business by organizing data and financial reports, developing a fundraising strategy, and helping with determining the correct amount of capital to raise. Financial professionals like virtual CFOs or controllers are trained to carefully prepare for important financial undertakings.

How To Prepare to Raise Capital

Kicking off the fundraising process can be a daunting thought. Below are some quick tips to get things kicked off the right way.  

Want to Read More About Raising Capital

How to Find Investors for Small Business

What is a Cap Table?

How Krieger Analytics Can Help

Krieger Analytics specializes in outsourcing accounting services for small businesses, from bookkeeping to virtual CFO consultations. Our background in entrapuernship and finance means we know what running a business entails. We want to meet your accounting needs without burdening you with the costs of a full-time accounting staff. We understand your position as a small business owner, because we have experience running businesses ourselves. 

Have questions about anything discussed in this article, or interested in what valuable insights a CFO have for your business? Conversations are free, so don’t hesitate to reach out at [email protected]. Let us explain how our accounting services could be the right fit for you.