There’s no getting away from it, global economic factors are making capital raising harder than ever. But that doesn’t mean it’s impossible or that you should give up on your company’s capital-raising dreams before you start. So, in addition to unpacking what raising capital involves, we bring you insights into the latest capital-raising trends and how these are impacting businesses of every size and stage.
What capital raising is and isn’t
Capital raising is all about getting funding for your business from external sources. Essentially, there are three types of capital raising: equity funding, debt funding and hybrid funding.
Equity funding
Equity funding is a specific type of funding. It’s an investment from backers who believe in your ideas and your business; not a loan you repay. With equity funding, you exchange a share of your business for an injection of investor capital from a Venture Capital fund or a Business Angel. The idea is that the money you raise takes your innovation and your venture forward, fulfilling your goals. And, if all goes well, the process delivers a return on investment for you and your investor.
Debt funding
Debt funding, on the other hand, is non-dilutionary. It doesn’t involve giving up a stake in your company. It’s money such as a bank loan or an R&D advance that you borrow, and you repay later with interest.
Hybrid funding
Hybrid funding, for example, a convertible note, is a combination of debt and equity funding. Usually it starts as debt, but comes with the proviso that it can be converted into equity. It combines the best of both funding worlds and suits investors and businesses seeking flexible funding options.
There are other types of business capital that don’t fall under the umbrella of capital raising. These include income earned by your business through sales and bootstrapping, for example, a business founder’s savings. For more information, read our article How to build the best R&D capital stack for your business.
Raise or hold?
Whatever stage your business has reached, whether you’re an early-stage venture or scaling up exponentially, there’s a capital-raising option for you. However, just because your business can raise capital (debt or equity), doesn’t mean it should. Despite its glamorous image, raising capital from investors is hard graft. It’s time-consuming and has a relatively low chance of success.[1] To tip the odds in your favour, it’s worth pausing for thought before diving headlong into a funding round that could leave you empty-handed. Equally, finance can take time to arrange, and traditional lenders tend to give start-ups and small businesses a wide berth.
It may sound simple, but it’s important to pinpoint your underlying reasons for raising capital. What goals are you trying to achieve? Is now the right time for your business to attract investor funding or take out a loan? Do you know which investors or financiers to target? Are there any risks to your business by pursuing a funding round or taking on extra debt? Have you explored any potential alternatives thoroughly? To help you work out when it’s the right time to raise capital for your business, read our articles, Five essential questions to ask before raising capital and How to leverage debt financing at every business stage.
Matched funding
While it’s true in life (and with capital raising) that timing is everything, when it comes to the latter, the stage your venture has reached is equally important. There’s no point in reeling in a loan and investment that won’t enable you to take your business to the next level. Equally, there’s no point embarking on a wild goose chase for investors that are out of your league or applying for loans with no chance of approval. While there are always exceptions to every rule, here are the best equity and debt funding options by business stage.
Early-stage/pre-revenue start-ups
Early-stage start-ups include businesses that have recently launched, are still developing a minimum viable product (MVP) and either have no income or profits. If this describes your start-up, your main capital-raising options include:
Equity
- Seed funding is the earliest stage of equity funding for start-ups and is often used to set the business up. Many Angel Investors specialise in seed funding, purchasing stakes in start-ups when their value is lowest to maximise their return on their investment. However, seed funding can come from other sources such as family and friends.[2]
- Equity crowdfunding involves raising funds from the public in exchange for unlisted shares (equity) in the business. These unlisted shares aren’t available for resale on an official stock exchange.
Debt
- Peer-to-peer lending, also described as debt-based crowdfunding, connects borrowers with capital at a lower interest rate than a traditional bank loan.
- R&D finance provides early and easy access to your R&D tax refund if your business is eligible for the Federal Government R&D Tax Incentive (R&DTI) refund.
- Start-up incubators usually don’t offer any funding, but some do as loans.
Hybrid
- Convertible notes, also known as convertible bonds or convertible debt are simple, short-term loans. These can be converted into shares that don’t have controlling rights over the business.
Venture-funded and late-stage start-ups
Once start-ups move beyond the early stage, they are often known as venture-funded start-ups. Late-stage start-ups are poised to fulfil their potential with reliable funding and solid teams in place, along with founders and early investors moving towards an exit.
Equity
- Accelerator funding is available from start-up accelerators which select start-ups that have developed an MVP, have their business model and founding team in place and are showing potential for strong, short-term growth. Accelerators will often provide significant seed funding and support in exchange for a 5-10 % equity share in the start-ups. Some Accelerators also offer equity-free seeding funding.
- Series A and B funding: Series A is usually available to start-ups that have developed a product/market fit for their innovation. It’s preferred stock that is sold to investors, for example, Angel Investors or Venture Capitalists. Preferred equity doesn’t automatically come with voting rights. However, preferred equity is at the front of the queue for dividends, and creditor payouts if the business fails. Series B funding is often provided by Venture Capitalists or even Private Equity investors. If follows a Series A funding round where a business becomes a venture-funded start-up and is already tried and tested. Series B funding comes into play when that start-up needs more capital to firmly establish itself and begin to scale up.
Debt
- R&D finance is an option for companies that have an aggregated annual turnover of $20 million or less.
- Credit cards, bank loans and overdrafts: while there are exceptions, most credit cards, bank loans and overdrafts require a start-up to have been trading for at least 12 months or more. Many traditional lenders are hesitant to lend to non-revenue businesses or companies without a profitable and proven income stream. Depending on the product or service a start-up has, and the sector in which it operates, secured loans may be out of the question. The reason is that newer companies tend to have fewer assets to use as collateral. Hence the need for venture capital funding for growing start-ups.
Hybrid
- Mezzanine debt is an unsecured loan or subordinated debt that can be linked to the value of the business, potentially increasing the return for lenders, for example through bonus payments. If a start-up defaults on a mezzanine debt, the lender can convert the debt into a special type of equity that trumps all other shareholders. This makes the mezzanine lender the company’s controlling shareholder in the event of bankruptcy. It’s normally only available to businesses that can service higher levels of debt.[3]
Scale-ups
Scale-ups are start-ups that are growing exponentially. They may have founders or investors looking to exit.
Equity
- Series C and D funding: a Series C round is for successful, late-stage, established start-up businesses looking to scale and enter new markets. Series C may also be used by successful companies that require extra funding to tackle some short-term challenges. Series D funding rounds are rare. They involve larger sums of money and tend to be used to boost a scale-up’s value ahead of an Initial Public Offering (IPO). In Series C and D rounds, Venture Capitalists and Private Equity investors tend to team up with other investors, including hedge funds and investment banks.
- IPO is where a private company is floated on the stock market and its shares are publicly traded by individual investors. It’s often seen as the most desirable of all exit strategies for founders and their early investors, as it usually offers the most lucrative return on investment.
Debt
- R&D finance is still on the table for scale-ups with aggregated turnovers up to $20 million per year. Beyond that threshold, eligible scale-ups with eligible R&D may qualify for a non-refundable R&D tax offset.
- Credit cards, bank loans and overdrafts: Once your start-up is a scale-up and is more established with more assets, it becomes easier to access substantial overdrafts, business credit cards with large limits, and sizable, secured loans from traditional lenders.
Hybrid
- Mezzanine debt tends to work well for scale-ups.
Established businesses
For established businesses that have successfully scaled up, an array of equity, debt and hybrid funding options remain on the table. This is conditional on your business maintaining reliable revenue, turning a decent profit margin and staying solvent.
The current outlook for capital raising
The global economy has been flirting with recession for more than 12 months. And some economists predict Australia will be in a technical recession during the second half of 2023. However you slice and dice it, economies and businesses worldwide are currently grappling with extremely high levels of uncertainty. Capital raising against a backdrop of war in Europe, climate change, global social and political upheaval and creaking supply chains is challenging.
Early-stage start-ups seeking seed funding rounds have been hardest hit. And late-stage start-ups and scale-ups targeting Series B and C are facing more due diligence and are exchanging more equity for less funding than previously.[4] With interest rates in Australia and around the world spiralling upwards, debt is now pricier than it has been for decades. While the Reserve Bank of Australia has hit pause on further basis point rises, it’s not clear if interest rates have peaked.
Plan to succeed
The odds may be against you landing a successful funding round or accessing enough debt capital to keep your business goals on track. But don’t give up without trying – the money is still out there.
Check out our article Raise capital in a recession and get investors hooked. It’s packed with tips to help you succeed. From crunching the numbers, perfecting your pitch and going the extra mile to being flexible and realistic, it’s still possible to bag the investor capital you need. And don’t forget, despite the changing landscape for capital raising, Radium Capital hasn’t changed its eligibility criteria for the Radium Advance. If you qualify for the R&DTI refund, you can still apply for a Radium Advance. And as we’ve discussed in this article, it’s debt financing that’s available to all stages of start-ups and scale-ups, providing they’re claiming the R&DTI refund. So, in these challenging times, why not challenge your thinking? Give our expert team a call about whether a Radium Advance is the capital you need for your business stage.
[1] Fundera by nerdwallet, 2020: Raising Capital for Startups: 8 Statistics That Will Surprise You. [online] available at: https://www.fundera.com/resources/startup-funding-statistics
[2] Visible.vc. (2022). Seed Funding for Startups 101: A Complete Guide | Visible.vc. [online] Available at: https://visible.vc/blog/seed-funding/.
[3] Investopedia. (n.d.). Mezzanine Financing: What Mezzanine Debt Is and How It’s Used. [online] Available at: https://www.investopedia.com/terms/m/mezzaninefinancing.asp#toc-example-of-mezzanine-financing
[4] Kamps, H.J. (2023). 5 trends in VC funding for pre-seed startups. [online] TechCrunch. Available at: https://techcrunch.com/2023/08/24/vc-trends-h2-2023/