It costs money to make money and starting a business or maintaining one can cost a pretty penny and that is why having the funds to not only cover these expenses but give your business the ability to thrive off of them is important. Whether you are a start-up, a small business, or an established business owner, knowing how to raise capital is the difference between success and failure.
Raising capital is a crucial activity that takes place through all growth stages of a business that helps a business on the path to opportunities for development, continued relevance, and long-term stability. What exactly is capital though? While capital might seem like cash or profit, it is actually different. Capital can be stronger than cash value because you use it to generate revenue and income (such as investments) and since you can use capital to make money, it is considered an asset or something that adds value to your business.
Let’s dive into the four types of capital first: Debt, Equity, Working, and Trading.
A business can acquire capital by borrowing and debt capital refers to the money that the business borrowed in order to fund its operations. Debt capital can be mistaken as a personal loan but they are a corporate loan obtained through private or government sources that can be repaid at a later date. For smaller businesses debt capital can include other sources including friends and family, online lenders, credit card companies, or federal loan programs.
Debt is a heavy word and when individuals hear it, it can be scary but for businesses, it can be an opportunity. Well-managed debt capital is a way for businesses to obtain a large sum of money to pay for major investments or expansions. Early on, it is easier to manage debt capital because you usually have fewer creditors. As your business grows, you may have multiple creditors and your operations are growing more complex. Mismanaging debt credit can not only jeopardize a business’ access to future capital but lead to business failure. To help manage it effectively have the in-house expertise or at least have a central system record and clear plans about how to manage it.
Equity Capital refers to the capital collected from a business from its owners in exchange for a portion of ownership in the business. The biggest benefit of this is that a business is not liable to repay the funds raised and allows a business to raise capital without going into major debt. There are a few different entities of equity capital:
- Sole Proprietorships: unincorporated business run typically by one owner and equity financing is limited to the owner’s assets
- General Partnerships: requires at least two owners who agree to share responsibilities including assets, profits, and financial and legal liabilities
- Limited Partnerships: requires at least two owners where one general owner runs and oversees the business while the other partner(s) does not manage the business day-to-day
- Corporations: a group of individuals who act as a separate legal entity
- LLC/LLP: a hybrid business structure that protects its owners from personal responsibility for its business’ debts or liabilities
Working capital, also referred to as net working capital, is the difference between a business’ current assets and its current liabilities. Working capital measures a business’ short-term liquidity and represents its ability to cover its debts, accounts payable, and other obligations that are due. Businesses typically use this capital to pay for day-to-day operations and convert cash into other investments.
The working capital formula is pretty simple once you determine your current assets and liabilities:
Working Capital = Current Assets – Current Liabilities
Negative working capital is when a business’ current liabilities exceed its current assets. Businesses can face temporary negative working capital when making a large purchase, investing in more stocks, adding new products, or investing in new equipment. Positive working capital indicates that a business is ready to fund its current operations while having the ability to invest in its growth but be mindful of high working capital – while positive, high working capital can indicate a business has too much inventory, is not investing its excess cash or not capitalizing on low-expensive debt opportunities.
If you are ready to begin investing or have already begun investing, you need to consider trading capital. Trading capital is the amount of money a business has available to them so that they can buy or sell different securities on the financial market such as stocks and bonds. It is important to remember that each securities market has a legal minimum of trading capital you need to even begin trading, which is to ensure you have enough funds to handle losses.
Keeping all of this in mind, while trading capital is a common type of way to raise capital in business – small businesses do not necessarily need to do it. Small business owners are already focused on day-to-day operations, have limited staff, and probably do not have time to focus on the market. So do not feel pressured to begin trading just yet, wait until your business can take the time to focus and afford to do so.
Raising Capital Strategies
So we know what capital is and how it is important to the overall health of a business. It’s time to use available avenues to raise it. As a small business, you might find yourself limited on options that a more established business would have access to but you are never left with nothing. There are several different strategies for raising capital as a small business.
Finding The Right Loans
One of the most common options, when able, for small businesses is commercial loans. There is a variety to choose from and you should always take the time to find which one works for your business:
- Loan Program through the U.S Small Business Administration (SBA): SBA loans are not funded directly through SBA but they guarantee the loan through your local lender who participates in the service you can choose between:
a. SBA 7(a) Loans: The most common loan program that can be used for a variety of business expenses including real estate, short or long-term working capital, refinancing business date, or supplies.
b. SBA 504 Loans: These loans are for businesses purchasing major fixed assets that help promote overall business growth such as a new office building.
c. Microloans: these loans only have a maximum size of $50,000 and are designed to help small businesses expand and can be used towards working capital, inventory, supplies, furniture, machinery, and equipment.
d. Lender Match: this program works by having you establish your business needs, get matched with lenders who can meet these needs, and be able to compare rates and eventually apply for a loan that works best for your business.
- Term Loans: these loans come with fixed monthly payments. Once you determine how much your business needs to meet its goals and how long you’ll need to pay it off, the bank will then determine the interest rate and the total monthly payments.
- Short-Term Loans: these loans will run for smaller sums of money and are to be repaid typically within 18 months. They also have a faster approval rate than standard term loans.
- Equipment Financing Loans: these loans are specifically available to purchase high-priced equipment or other assets for your business. Most of the time the equipment itself can be used as collateral.
- Commercial Real Estate Loans: this loan is used to purchase commercial real estate as a business space or to buy properties as an investment.
- Business Line of Credit: this type of commercial loan has several characteristics of a credit card. Your lender will approve a maximum borrowing amount and you can use funds from your line of credit when needed.
Angel Investors can be made up of an individual or group of people who are known for helping provide seed funding for a new business or helping an existing small business grow. Typically, angel investors are high-wealth, accredited investors who provide funding for an equity stake, which sometimes can be up to 50% of the business but take on mentor/advisor roles in the business, helping ensure success. There are also less-wealthy but still accredited investors who will use equity-crowdfunding platforms such as Fundable or SeedInvest.
When approaching an angel investor, be sure the investor shares in the views and objectives of your business and is someone you feel comfortable having a working business partnership with. Also, make sure your investor knows the industry and you take the time to cultivate a solid working relationship with them since they will be involved in ensuring the overall success and growth of the business.
You could also consider looking for a Venture Capitalist, but they typically prefer to invest in slightly more mature companies than angel investors, require a high stake in the business, and want more say in the day-to-day operations instead of acting in an advisor role. Depending on your business and its needs, take the time to research both to see which would be more beneficial to the future of your business.
A Different Path to Capital
Now some businesses might not have access to loans or angel investors but that does not mean you have no way to raise or fund anything. There are several ways to continually raise capital even without government assistance, bank loans or investors including:
- Funding it Yourself: while not ideal for everyone, a lot of smaller businesses have needed to dip into personal savings to create funds. Now funding it yourself can get really expensive but the positives of it are that you have full control of your business and you have no debt or obligations to a third party.
- Crowdfunding: a newer capital raising strategy, crowdfunding is the pooling of money from individuals through either an organization or most commonly, a website. This can help support the costs of small businesses and help fund specific products or projects. Contributions can take on the forms of donations or trading equity. Examples of contributions are:
a. Donation-based: contribution without anything in return
b. Rewards-based: contribution of a certain amount will receive some type of tangible reward in return (coupon, free merch, social media shout out, etc)
c. Debt-based: contribution with guaranteed payback
d. Equity-based: contribution in return for partial business ownership
- Family and Friends: while also not ideal for everyone, donations from your family and friends are essentially like crowdfunding your inner circle for capital in the form of debt without giving up equity or control in your business.
It is important to remember that taking these routes to raise capital does not offer stability long-term but can be great for supporting specific goals, projects, or small expansions for a small business. These options are also not ideal for everyone, be sure to evaluate the funds your business is currently needing and what these options can realistically bring to your business.