In a recent episode of The Transaction Abstract, Joe Hellman sat down with Thomas DeMinico, Director of the Middle Market M&A Advisory Group with Bank of Montreal (BMO). Tom has more than 12 years of experience advising clients on M&A and capital raise transactions. He joined Joe to provide his insights on capital raising–the best way to do it and potential roadblocks to watch out for. Listen to the episode below.
Tom referred to raising capital as an art, “the art of bringing third-party financial resources to your business.” In most cases, capital is raised to support a specific operational or strategic endeavor (e.g., growth-, operational-, or shareholder-related motives). Tom identified three “buckets” most capital raising activity falls into:
In the simplest terms, raising capital means infusing cash into the business – but doing so for a specific purpose intended to benefit the business and its shareholders. As with any transaction, the expectation of investor ROI must be built into the company’s strategy for using the funds.
There are a number of different ways to raise capital, but all will fall into two categories: debt capital and equity capital. The most common approach to raising capital in either form is “private placement” – that is, raising capital from private investors.
Early-stage companies are more closely associated with raising money from individual angel investors.
Large, established companies have the option of raising capital through an IPO (initial public offering). If a company is already publicly traded, it may be possible to increase capital opportunities via a follow-on or secondary offering. A Special Purpose Acquisition Company (SPAC) can complete an IPO in some cases. A SPAC can be preferable because its execution time is a fraction of the time needed to finish a standard IPO. SPACs are being looked at by regulators which may result in changes to the process and timelines.
Last, crowdfunding has become a popular way for some small businesses to secure funds.
Most listeners of The Transaction Abstract are probably familiar with the popular reality show Shark Tank and the outsized personalities it features as its investors. While this is somewhat dramatized, it provides a sense of the way pitches are carefully constructed, and complex negotiations take place.
Your timeline will vary based on the avenue you choose for raising capital. The differences reflect not only the process of negotiation but the various processes, procedures, and regulations that different investors follow. All investors will evaluate an opportunity in detail before making capital available.
The typical time period for an individual transaction is 3-10 months, but outcomes are highly variable.
Optimizing timeframes is especially important for early-stage entrepreneurs, who often find themselves in a cycle of “Always Be Raising (Capital).” Early-stage businesses may see a longer or shorter process depending on lifecycle stage, technology offering, disruptiveness, and growth potential. Investors can be induced to move faster on a transaction if there is a clear incentive to optimize growth by doing so.
Not All Businesses Have an Appetite for Investor Capital – But Most Have the Potential
A business does not necessarily have to be in a “hot” industry with short-term high growth to attract investor capital. However, many businesses do not actively seek these opportunities. Whether a first-time or serial entrepreneur, it is important to ask the following questions about a transaction:
All of these add up to a single concern: “Can I afford and am I willing to take what is necessary to get to the end of that plan?” Although the calculus can be complex, business owners have access to a variety of capital raise types they can use in combination to reach their desired exit.
One critical concept to understand in capital raising is dilution, which most often relates to equity capital. Dilution represents the level of ownership stake outside investors receive as a result of their investment. Other forms of dilution exist, including options for the senior management team.
In general, entrepreneurs seek agreements that minimize dilution. A better valuation provides for less dilution overall. If there are clear reasons to believe valuation will soon increase, it may make a strong argument to delay your capital raising activities.
There are pitfalls business owners can encounter when they raise capital, especially for the first time. Tom highlighted two specific issues they can prepare for in advance:
For independent entrepreneurs and family-owned businesses, strategic transactions can be complex and time-consuming. They also require challenging “game-time” decisions. Early-stage businesses are often called on to give more during transactions than their established counterparts would.
In addition to equity stake, this can take the form of consent rights, dividends, liquidation preference, and more. Optimizing these terms often demands the expertise of an outside M&A advisor, especially among small businesses with lean internal teams.
General legal and financial experts have a place in any transaction, but a dedicated M&A advisor makes a key strategic difference. Raising capital functions as a full-time job on top of running the business; it is best overseen by a specialist with complete visibility into the process.
An M&A advisor not only supports all the necessary transaction preparation but can also help business owners access the right investors. Since the advisor is knowledgeable both about investor criteria and your exit requirements, they ensure you do not waste time reaching out to the wrong audience.
The advisor’s role also includes day-to-day outreach activities, which may free business owners from many hours of work. A broad perspective enables the advisor to make the connection with investors who buy into the business’s story and goals and will function as long-term, supportive partners.