Startups know all too well how closely growth can be tied to equity financing rounds. Established companies face their own questions in this regard. Not just how to find external sources of capital, but when to do it.
Raising capital at the right time can help a company meet important strategic goals. Raising it at the wrong time can tie it to onerous debt service commitments, or muddy the waters of leadership when times get tough. Here are two crucial factors to keep in mind when considering raising capital for your business.
1. When your company's strategic plan requires it
Capital investment should feed into your strategic plan. Specifically, you must support the phases of your strategic plan that are specifically dependent on significant capital investment.
Not all phases meet that standard. For example, if sales are steady and growing fast enough to outstrip production, you'll need to take action. That doesn't necessarily imply the types of capital investment that successful companies get from outside sources. Some responses do not require any capital investment. For example, you can view your pricing structure as a way to temper sales volume and increase revenue.
Other responses to success require some investment: increasing production and storage capacity will require some outlay. But those expenses should be easily offset by continued increases in sales revenue. The smartest move in a case like this may be to use current cash flow to pay for new investments, borrowing only the minimum amount needed to make up the difference.
However, some phases of your strategic plan almost require you to raise capital. When you enter a completely new market, you will need more than a single loan to finance a new production line. The new employees, new facilities, and new clients that come with such a move will change your company. Issuing a bit of debt or adjusting your company's ownership structure by offering some equity may be entirely appropriate.
This is even more relevant for companies expanding into new geographic markets. Such moves often incur unforeseen expenses and early inefficiencies. It may be more prudent to treat those costs as part of the broader capital expenditure of the expansion than to draw entirely on cash reserves and anticipated cash flows. If you raise capital through equity, you can find a partner who is willing and motivated to take an expert look at your new venture.
2. When your company has a solid financial foundation
This may sound counterintuitive, but the best time to consider raising capital is when your cash flow is steady and your finances are stable. There are two good reasons for this.
First of all, obtaining capital from “external” sources always involves some type of exchange. It will deliver shares or issue debt. Neither option is healthy if the goal is simply to improve cash flow from current operations.
If you raise capital by offering shares in your company, you dilute your own share of the company's profits and may restrict your company's flexibility in addressing challenges or exploiting opportunities in the future. The same goes for the issuance of debt or new loans, although you can preserve some operational flexibility while incurring greater risk.
In any case, raising outside capital only makes business sense if your business is stable and growing. Otherwise it amounts to raising money on bad terms just to right the ship and in this case the best approach is to do some reshuffling if necessary and focus on optimizing your operations.
On the other hand, outside investors will naturally want to hedge their bets if your company appears to have significant financial weaknesses. If your debt and cash flow profile aren't what they could be, investors are likely to see that too. Good investors or funders, who you'll want to partner with, may avoid your company altogether or ask for terms that are better for them. That leaves a relatively large pool of less desirable investors offering more onerous terms. Again, it's better to improve your bottom line through internal action than to make your company beholden to an investor who doesn't share your vision. However, understanding this logic does not fully clarify the decision to hire an external partner when it is performing well.
Understand your financing options
Raising capital of any kind can lead to undesirable situations for your company. To mitigate this risk, make sure you are familiar with the different types of financing available to you, as well as their impact on your business. If you don't have enough in-house expertise, seeking help from a company that specializes in this area can be of great help. At Heritage Financial Advisors we help companies in their process of obtaining capital in a structured and reliable way, guaranteeing that the result is favorable in the long term for all those involved.