As with anything in life, it is easy for the capital raising process to devolve into an inescapable labyrinth of our own perceptions about the strength of our business model, investors and markets, regardless of whether or not those perceptions match reality. At all times on the capital raising path, we must be on guard against misperceptions and, when they arise, cut through them with the sharp swords of reasoned analysis and common sense.
One phenomenon that greatly complicates the search for capital, particularly for people who are raising capital for the first time, is myths that exist about capital raising that distort reality, take them down roads to nowhere and, perhaps most damaging of all, do not allow them to seize real opportunities or defend themselves against real threats when they actually come along.
Bright Side Myths
Capital raising myths can be divided into two categories: “bright side” myths and “dark side” myths. Bright side myths are those that greatly downplay the difficulties associated with capital raising and dark side myths are those that greatly exaggerate the potential roadblocks.
Two types of myths that complicate the search for capital are “bright side” myths and “dark side” myths.
Bright Side Myth #1
Capital Raising is Easy
This myth is based on the assumption that, because capital markets are massive and capital is raised all the time throughout the world, capital raising is easy. It is very easy to fall into the trap of this myth because many financing transactions and stories of successful searches for funding are publicized and the far greater number of aborted or failed capital raising efforts are generally not, creating a very distorted view of capital raising probabilities.
The hard reality is that particularly for entrepreneurs who are raising capital for the first time and businesses that are seeking capital for an initiative outside of their tried and true business model, raising capital is extremely difficult. Even for excellent projects with bright commercial prospects and strong teams, a high number of efforts to raise capital fail.
Bright Side Myth #2
Capital Raising is Quick
This myth is based on the assumption that because there is so much money in the financial system and there are so many investors with a wide range of risk and return requirements, capital can be raised very quickly.
The reality is that for many types of investments, particularly those that are highly risky, it can easily take months or sometimes even years to raise capital. This is due to the fact that many investors subject investment proposals to extensive internal vetting and due diligence and at times require multiple layers of internal approval before money is actually invested. Negotiating and preparing documents to reflect deal terms can also significantly extend transaction timetables.
Bright Side Myth #3
Investors Are All-Seeing
This myth is based on the assumption that investors, because they are steeped in business deals and financial markets, will immediately grasp the intricacies of ideas and business models presented to them, clearly understand their potential and unerringly map out a path for realizing that potential. The reality is that investors have the same inability to see into the future as everyone else and they must make important decisions based on limited information and in the face of significant uncertainty about how business plans will actually be executed and how market events will unfold.
Uncertainties often cause investors not to invest or, at a minimum, increase the return they expect for making an investment. Further, investors, like everyone else, will often consider business ideas based on their own particular set of experiences and perceptions, which can create a significant disconnect between perceived and real business model opportunities and risks.
Bright Side Myth #4
Investment Terms are Fair
This myth is based on the assumption that when capital is raised it will be on terms that are fair for the company and that investors without being asked to do so will immediately reward less risky business propositions with low interest rates or high entry valuations. While there are some exceptions, the reality for the vast majority of the professional investor universe is that providing capital is a business and profits in that business come from, within reason and market realities, maximizing the price that is charged for capital.
Many investors invest with other people’s money and those people have their own return expectations. Those expectations are based on money they are required to return to their own investors and so on and so forth up the lengthy interconnected capital chain. If investors do not obtain a high enough return to pay their own funding providers back, they will lose money, which will hurt their reputation and make it more difficult for them to raise capital in the future.
Further, for some types of investors, the return they expect on capital is not based on a reasonable assessment of the risks in connection with a project but their own target investment return, which may be significantly higher than the risks associated with a project warrant. Particularly for investors that invest in highly speculative industries where many investments fail, investing is often an exercise in recovering sunk investment costs in previously unsuccessful investments and the spread between real risk and return expectation can be very wide.
Bright Side Myth #5
Raising Capital is a Single Event Process
This myth is based on the assumption that the search for capital is a discrete process and once it is finished businesses will be able to leave capital concerns behind them and dedicate their time and energy to more exciting value-building commercial pursuits. The reality is that, rather than constituting a one-off event, for most businesses once the fund raising process is completed the search for capital becomes part of a broader and constant effort to optimize a firm’s capital structure, source capital for different types of investment and operating uses and reduce capital costs.
Capital Raising Dark Side Myths
While many people underestimate the challenges of capital raising, there are also people that equally as damaging to the formation and execution of capital raising strategy exaggerate the difficulties and take themselves off of the funding search path before even setting out.
Dark Side Myth #1
Raising Capital is Almost Impossible
This myth is based on the assumption that since many sophisticated businesses cannot raise capital, you will not be able to raise capital either.
The reality is that, while raising capital is certainly challenging, when all is said and done investors are in the business of investing, which means they must put their money somewhere. The investing business consists of seeking business models that have a good probability of meeting a target return and a good possibility of being implemented given the team and the market conditions that are expected over the proposed investment period.
These conditions are not necessarily dependent on and in many occasions have nothing to do with a company’s size, level of experience and contacts. While large and experienced companies may have certain types of advantages in the search for capital, they can have important disadvantages, such as:
● business models that are becoming outdated and are hard to change;
● limited growth prospects;
● high cost structures;
● large amounts of debt;
● negative publicity; and
● legacy performance problems.
On the other hand, new businesses may have numerous advantages over more established ones, such as innovative business models with the possibility of rapid and exponential growth, high levels of agility which allow them to adapt more quickly to market conditions or consumer preferences and lower fixed cost structures.
Capital raising success or failure is not necessarily driven by a fixed set of factors that traditionally have been viewed as defining business strength, such as the size of a company or the number of years that it has been in business. Ultimately what drives capital raising probability is the ability to convince an investor that the investor’s target investment return will be met.
Dark Side Myth #2
There is No Capital Available for My Project
This myth is based on the assumption that investors will not be interested in a project because the project is novel, is in a new business area or targets a niche consumer base.
The reality is that there is an extremely wide range of investors looking for almost every conceivable type of project and every conceivable level of risk. Some investors prefer to take as little risk as possible while others search for higher risk opportunities that also present the possibility of higher investment returns. There are very few business ideas, regardless of how successful they have proved to be, that at one point were not deemed to be unrealizable. These success stories often involved investors who grasped the potential of new ideas before others could see it.
Dark Side Myth #3
Investors Just Don’t “Get It”
This myth is based on the assumption that investors will not invest in a project because they lack real street-level business experience and cannot understand the real potential of a business proposition.
The reality is that many investors have a great deal of business experience, often are extremely sophisticated and, because they have seen many types of business models over and over, can often spot potential risks and roadblocks very quickly that can save entrepreneurs and businesses a great deal of time and money. Next to successful funding, getting quick and well-informed feedback on an investment proposal is one of the most valuable treasures that can be found on the capital raising path.
Additionally, many investors can provide support to businesses as they go forward in many ways other than just providing capital, such as offering strategic advice and contacts and even simply serving as a knowledgeable sounding board for ideas and offering alternative perspectives on proposed courses of action.
Many investors are highly sophisticated and because they have seen some types of business models over and over or are highly familiar with market conditions where a project will be implemented they can very quickly point out business plan weaknesses and offer suggestions regarding how to correct them.
Dark Side Myth #4
Investors Are Just Out For Themselves
This myth is based on the assumption that the capital search process is a zero-sum game where one party to the investment process wins and the other one loses.
The reality is that in any investment marriage where the investor and a business will have an ongoing and financially or even operationally symbiotic relationship for many years, there are natural organizational and economic pressures to put in place terms that are economically sensible for both parties, because if a Faustian arrangement is struck and hastily agreed to deal terms are unworkable from the start it will often cause the relationship between the parties to break down at one point in the deal negotiation process or during the parties’ commercial relationship. This can prevent a good deal from closing or negatively affect the business initiative once it is implemented, which will harm the financial return for both parties.
Dark Side Myth #5
Capital Raising Will Swallow My Business
This myth is based on the assumption that raising capital is such a difficult and time consuming exercise that it will divert scarce time away from real business activities and prevent a business from concentrating on what it needs to focus on in order to grow.
The reality is that capital is not only a means in and of itself but the financial fuel that can allow a business to move faster, cover additional business ground and obtain many types of new resources that are vital to a business, such as new partners, new employees and new technology. As a business obtains these resources it can help the business accelerate its growth.
Further, as the business grows, it can employ additional people and segregate organizational functions, which can allow, for example, financing experts to concentrate on financial matters and other people in the company to focus on other business activities. These organizational divisions can often create operating efficiencies that lead to substantial business value creation beyond the specific initiative for which capital was initially raised.
This article is excerpted from my book “The Path to Fundraising Success: Capital Value Mountain.” https://www.amazon.com/Path-Fundraising-Success-Capital-Mountain-ebook/dp/B07863M6VR
The photo for this article was taken from Unsplash. The photographer is Sharon McCutcheon.