Grants can be excellent as not only are they ‘free’ money as they do not involve the business having to repay them or service any interest, but they also act as good third part endorsement that the granting body believes that your business is worthy of ‘investing’ in, and this often encourages potential investors and lenders.  Some businesses are much more likely to have access to sizeable grants than others and these would notably be innovative businesses or those conducting extensive R&D.

Debt has the downside that it has an immediate impact on cashflow as it needs to be serviced on a monthly basis and, in many instances, it is only available to those businesses that have been trading for some time.  But for a founder that is looking to scale their business, perhaps the most important downside is that the amounts available are very restricted in size.

As such, for any founder that is looking to scale their business, certainly in a fairly rapid way, then raising equity funding is the only real option.  But so often founders leap straight to what should be question number two: ‘how much do I need to raise?’  Question number one should always be, ‘do I need to raise finance?’ as many businesses do not.  If the answer is ‘yes’,  only then start to think about how much is needed.

In order to answer the ‘how much’ question it is necessary to consider what the monies will be spent on and how will this impact the business.  The most typical areas for spending newly raised equity on include marketing, hiring staff, product development, stock, and premises.  Detailed assumptions and financial forecasts need to be prepared to assess the actual impact that this larger spending is expected to have not only on sales, but also on gross and net profit.

Remember that raising outside equity finance entails creating new shares in your business and selling them which means that whilst you will still hold the same number of shares that you did before, your actual percentage holding will be diluted.  Put simply, this means that by raising new equity, the enlarged business must grow by a bigger percentage than the amount of fresh monies raised.

When raising equity there are a number of golden rules of thumb to help guide you:

·       6 months – this is the typical amount of time that you should expect fundraising to take.  Whilst you are doing this, remember that it is distracting you from running and growing the business.

·       12-18 months – this is the runway that you should have once you have raised finance as this means that you are not going to run out of cash or get distracted by having to do a further fundraising round too soon.

·       10-20% - this is how much you should expect to get diluted at each round as this should be sufficient to produce the required runway and ensures that should you need to raise equity a number of times that you are not diluted more than necessary.  

These points will help to ensure that the amount being raised and the valuation are aligned with each other.  More on valuations in a later article.

Raising equity can be the only way of raising sufficient funds early enough in the life of your business for you to be able to scale it quickly and, if done correctly, whilst your percentage shareholding will be diluted, the overall value of your shares should be enhanced.  It will also enable you to take your business to the next level.

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16th May 2023

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Read my original article for Startups Magazine at https://startupsmagazine.co.uk/article-why-raise-equity-funding

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