HOW TO FUND A RAPIDLY GROWING VENTURE (1)
Make no mistake about it, raising growth capital is a time consuming and costly process. For this reason, many entrepreneurs choose to grow slowly instead, depending exclusively on internal cash flows to fund growth. They have a basic fear of debt and of giving up, to investors, and control of or equity in the company. Unfortunately, they may act so conservatively that they may actually stifle growth.
Raising Money Takes Time
It is important that entrepreneurs understand the nature of raining money so that their expectations will not be unreasonable. The first thing to understand about raising growth capital (or any capital, for that matter) is that it will invariably take at least twice as long as expected before the money is actually in the company’s bank account.
Consider the task of raising a substantial amount of money – several millions of dollars, for instance. It can take up to several months to find the financing, several more months for the potential investor or lender to do “due diligence” and say yes, and then up to six more months to receive the money. In other words, if an entrepreneur does not look for funding until it is needed, it will be too late. Moreover, because this search for capital takes the entrepreneur away from the business just when he or she is needed most, it is helpful to use financial advisers who have experience in raising money, and it is vital to have a good management team in place.
The second thing to understand about raising growth capital is that the chosen financial source may not complete the deal, even after months of courting and negotiations. It is essential, therefore, to continue to look for backup investors incase the original investor backs out.
Another point about second-round investors is that they often request to buy out the first-round funding sources, who could be friends or family because they feel the first–round investors have nothing more to contribute to the business ad they no longer want to deal with them. This can be a very awkward situation because the second-round funder has nothing to lose by demanding the buyout and can easily walk away from the deal; there are thousands more out there.
It Takes Money to Make Money
It truly does take money to make money. The costs incurred before an investor or bank money is received must be paid by the entrepreneur, whereas the costs of maintaining the capital (accounting and legal expenses) can often be paid from the proceeds of the loan or (in the case of investment capital) from the proceeds of a sale or internally generated cash flow.
If the business plan and financial statements have been kept up-to-date since the start of the business, a lot of money can be saved during the search for growth capital.
When large amounts of capital are sought, however, growth capital funding sources prefer that financials have the approval of a financial consultant or investment banker, someone who regularly works with investors. This person is an expert in preparing loan and investment packages that are attractive to potential funding sources. A CPA will prepare the business’s financial statements and work closely with the financial consultant.
All these activities result in costs to the entrepreneur. In addition, when equity capital is sought, a prospectus or offering document will be required and preparing it calls for legal expertise and often has significant printing costs. Then there are the expenses of marketing the offering. Such things as advertising, travel, and brochures can become quite costly.
In addition to the up-front costs of seeking growth capital, there are “back-end” costs when the entrepreneur seeks capital by selling securities (shares of stock in the corporation). These costs can include investment banking fees, legal fees, marketing cost, brokerage fees, and various other fees charged by state and federal authorities.
The cost of raising equity capital can go as high as 25 per cent of the total amount of money sought. Add that to the interest or return on investment paid to the funding source(s), and it is easy to see why it costs money to raise money.
The Venture Capital Market
Private venture capital companies have been the bedrock of many high–growth ventures, particularly in the computer, software, biotechnology, and telecommunications industries. Because venture capitalists rarely invest in startup ventures outside the high-tech arena, the growth stage of a new venture is where most entrepreneurs consider approaching them.
Waiting until this state is advantageous to the entrepreneur because using venture capital in the start-up phase can mean giving up significant control.
Venture capital is, quite simply, a pool of money managed by professionals. These professionals usually assume the role of a general partner and are paid a management fee plus a percentage from the gain from any investments. The venture capital firm takes an equity position through ownership of stock in the company. It also normally requires a seat on the board of directors and brings its professional management skills to the new venture in an advisory capacity.
The ability of an entrepreneur to secure a classic venture capital funding depends not only on what the entrepreneur brings to the tale but also on the status of the venture capital industry.