Hitting the mark: How to know exactly when to raise capital
Published on July 22, 2021
At some point, almost all businesses need to raise capital. Most startup founders and business owners don’t have the cash on hand to fund their operations without third-party funding. And there’s a reason why raising capital is so important.
Half of all businesses in the United States fail within the first five years of starting. However, according to research conducted by the U.S. Bank, a whopping 82% of those businesses fail because of poor cash flow management and failure to understand cash flow. Even more, 72% fail because they didn’t start with enough money.
A lack of a well-developed business plan is the third-largest contributing factor to failed businesses. Before you even consider approaching investors, you should have a detailed business plan. (You can download a free business plan that caters to your industry and tailor the content to suit your company.)
As you can see, raising money can make or break your business. But no business should start their fundraising ventures for the sake of having more cash. The decision to start fundraising involves detailed planning, meticulous research, and careful consideration. There are several factors that a business needs to consider before making the final decision.
Armed with a business plan, you’ll have a much clearer idea of where your company stands and where it’s projected to go. Now it’s time to consider the pros and cons of raising money.
Pros and cons of raising capital
While the pros and cons differ depending on the source of funds (such as a private bank loan or venture capital), here are a few general pros and cons of fundraising that you should keep in mind:
Pro: accelerates your business growth
Armed with additional funds, you can grow your business quicker and meet game-changing milestones with greater ease. Whether you need an investment to bring your product to market or to fulfill existing orders, a solid investment allows you to take that next step towards your goals.
Con: you lose equity and control
If you’re raising capital through investors, you’ll have to give up a portion of your company. As a result, you’ll have to answer to your investors and keep them involved in key decision-making. Ultimately, you’ll be giving up a bit of coveted creative control.
On the other hand, if you are raising capital through bank loans, you will have to pay interest. This might limit your cash flow, which can lead to further problems.
Pro: build your network
Often, investors mentor young entrepreneurs and help them explore new and potentially lucrative opportunities. This can be a great learning experience for entrepreneurs and can increase your chances of success.
For example, an investor might have connections to a manufacturing company that could significantly lower your production costs. Or they might know how to get your product into big retailers.
Ultimately, you’ll have access to a larger network of relevant people and companies that you may not have otherwise.
Con: time consuming
Many entrepreneurs agree that raising capital is like a full-time job. It requires an investment of time and resources. You’ll need to start researching potential investors, putting together a business plan and pitch deck, crunching your numbers, and contacting your shortlisted investors.
If investing your time and resources into fundraising negatively impacts the company’s current trajectory, consider this a sign you aren’t ready.
Signs you should start raising capital
If you raise at the right time, you’re more likely to reap the pro benefits and mitigate the cons. Here are a few signs you should start raising capital:
1. You're unable to meet demand
If you can’t meet the demand for your product, this is a good sign that raising capital is right for you. Reputable investors are attracted to sales growth, and if one of your biggest obstacles is the inability to fulfill purchase orders or meet demand, it represents a clear situation where money could help you solve a serious problem.
2. You lack additional staff to reach next milestones
If you're unable to achieve the goals for your business with the current staff, it's a sign you need more people in your team. However, there should be a clear and demonstrable need for additional staff. This means you should be able to tell investors why a lack of staff is preventing you from maximizing.
Ask yourself, “will a full-time front stack developer or CMO make a significant difference to my bottom line, or do I just think a bigger team will help the company grow?” How, exactly, will your new staff help your business grow sales?
3. You have a clear roadmap for the future
Your vision and roadmap should be clear and calculated. You should know exactly what you’re going to do with the raised capital, from how much you’ll dedicate to your marketing budget to the cost of hiring new talent.
Your roadmap and allocation of investment funds should be well-documented with data to support it. Track your progress and make relevant adjustments where applicable.
4. Your business is generating repeat and referral purchases
If your customers are happy with their product or service, they are likely to refer it to their friends and family. Repeat and referral purchases offer market validation and are a great sign that what you’re doing is working.
Raising capital would allow you to go beyond organic referrals and expand your reach.
Signs it's too soon to raise capital
If you rush to raise, your plan can backfire. Unfortunately, some businesses raise capital a little too soon.
1. You can't commit to the process of finding investors
Raising capital is a tiring and time-consuming process. From building a financial plan and business model to preparing your pitches, fundraising can quickly become overwhelming, especially in a startup culture where continuous integration and development are a core part of operations.
When you raise money, you’ll likely need to take a step back from focusing on the business. Weigh the tradeoffs and see what's the best way for you to go.
2. Financial forecasts don't support the growth of your market
You should always do your homework before raising capital. Analyze the future of your current market. If you don't see positive forecasts, it might not be a good option to raise capital. Investors want to know that your business has verifiable growth potential.
You have to prove that the market is on your side, and if you don’t have the means to do this right now (which could be the case for innovative or groundbreaking products), you may have to wait until the data leans in your favor.
3. You want to grow rapidly or don't need additional funding
If your goal is to grow rapidly, you might not want to opt for fundraising, especially if you have the resources. Committing to fundraising means investing time and energy that you could otherwise invest in your business.
When a startup is in its growth stage, a lot of focus and dedication is required to overlook the marketing and operations side of the business. Hence, you shouldn't raise capital if you have it already. It will only slow down the growth process.
4. You don't want to negatively impact acquisition opportunities with sky-high valuations
Raising funds can have a negative impact on your acquisition opportunities. When you raise money, your valuation increases. Depending on your circumstances, this could end up hurting your strategy. For example, if you have a clear exit strategy in mind, raising money could negatively impact those goals.
Once you have successfully raised funds, it's time for you to get to work and put the money to good use. Unfortunately, as previously mentioned, many failed startups tanked because they didn’t use their investments wisely.
Katerra, a startup unicorn that was valued at $3 billion in 2018 filed for Chapter 11 Bankruptcy in June 2021. The livestreaming app Periscope, which was purchased by Twitter in 2015 for $100 million, was phased out by the company due to declining usage.
There are hundreds of similar stories of startups who raised money, burned through cash, didn’t meet market expectations, and more. In fact, according to CB Insights, who published an analysis of startups post-mortem, the primary reasons startups failed after fundraising was because there was no market need; the second biggest failure factor was running out of cash.
These should be warning signs for startups raising funds. If you manage to acquire an investment, here are some tips to avoid becoming a failed startup statistic:
Have a solid plan before you start investing the money.
Make sure you and your team are on the same page.
Your future milestones should be clear to everyone. Transparency isn’t just good for company culture; it keeps everyone accountable towards their goals.
Track your progress. How are you spending your money? How do your results align with the fundraising plan you set forth? Analyze your post-fundraising progress to mitigate potential risks.
Allocate funds only to those departments/areas in the business that will add value to the firm.
Start the hiring process in parallel with fundraising. Although it can be a risky and fine line to walk, you’ll be ahead of your strategy if you’re able to choose the best candidates as soon as the deal is closed.
Spend wisely on advertising. Many startups falsely assume if they throw a ton of money at advertising that customers will come. Advertising is just a piece of the puzzle; focus on creating a great product, a great service, and building a brand, too.
According to Entrepreneur, only 0.05% of startups raise venture funding. This low number is surprising to many people because the media disproportionately covers startups who successfully raise funds; no one talks about the thousands of startups that never landed an investor meeting or failed to impress a lender with their business plan.
Preparation, research, a strong commitment to quality product, and a thorough understanding of your market are all essential pieces of the fundraising pie.