Most companies that need capital try to raise it as quickly as possible. This strategy is often based on the view that capital raising is expensive, uses scarce firm resources and diverts the company’s attention away from other important business activities. While this approach may sound reasonable, it often does not lead to the best capital raising results. This article suggests that, rather than taking a spot market view of raising capital, the cornerstone of company capital raising strategy should be building long-term relationships with potential investors that rest not only sound financial logic but also trust. Taking a long-term approach significantly increases the likelihood that capital will be raised on terms and with investors that are most likely to create lasting shareholder value.

Spot Market vs. Long-Term Capital Raising Strategies

Almost all companies raise capital from outside investors at one point or another. Companies raise funds for many different purposes, including funding company start-up costs, operating expenses, specific projects or flexible, long-term growth strategies. While many companies share the view that raising capital from time to time is necessary or useful, there are different views regarding the best way to actually raise that capital. These views are often based on divergent and at times conflicting ideas about the nature of capital, the role of capital raising in a firm and the value of the capital raising process itself.

Although there are many capital raising strategies, one broad way to classify fundraising approaches is to divide them into spot market and long-term approaches.

Capital raising strategies can be broadly classified into spot market and long-term capital raising approaches.

Spot Market Capital Raising Approach. A spot market capital raising approach is based on the view that there is a clear demarcation between the company and capital markets and if a company needs capital it should enter the capital market, raise capital as quickly as possible and then exit the market. Many companies that take this approach do so because they believe that capital is essentially a commodity and it should only be raised when it is absolutely necessary, such as when companies are facing imminent cash shortfalls or they need to make time-sensitive payments.

A spot market capital raising approach is based on the view that there is a clear demarcation between the company and capital markets and if a company needs capital it should enter the market, raise capital as quickly as possible and then exit the market.

Companies that use a spot market capital raising approach tend to focus on the amount of capital to be raised rather than how the terms of the capital raise or the relationship with the investor following the capital raise will impact long-term shareholder value. Firms that utilize spot market capital raising strategies often view the capital raising process as generating high transaction and opportunity costs that cannot be recovered and a suboptimal use of scarce firm resources.

Long-Term Capital Raising Approach. Another type of capital raising approach is a long-term capital raising approach. In this approach, there is no clear demarcation between the company and capital markets. Capital raising is viewed not as a spot transaction but rather a continuous, long-term process whose primary objective is not to meet short-term capital demands but rather to build shareholder value. Shareholder value is not necessarily created when capital is raised but rather when the cost of the capital is less than the value that can be created with the capital. With a long-term capital raising approach, the objective is not only to raise capital on favorable terms but rather to create relationships with groups that share the company’s values and vision and can potentially become financial or business allies in executing the company’s long-term growth strategy.

Capital Raising Strategy Overview

Capital Raising Strategy	Spot Market	Long-Term
View of Capital	Commodity that is intrinsically economically neutral	Means of exchange with highly variable value
Company and Capital Market Relationship	Separate	Integrated and continuous
Capital Raising Timing	As quickly as possible	Flexible
Purpose of Raising Capital	Meet short-term capital objectives	Build shareholder value through favorable economic terms and positive investor relationships
Value of Capital Raising Process	Value-destructive because it generates high transaction costs and uses scare company resources	Value-creating because it constitutes an investment in potential shareholder value growth

While some companies consistently use only one of these strategies, many firms use a mix of short and long-term capital raising approaches depending on the circumstances. Regardless of capital raising strategy preference, almost every company will adopt a spot market capital raising approach if it is facing a major cash shortfall. Even if the terms of the capital raise do not create shareholder value, the negative financial value is offset by the greater good of allowing the company to meet its financial obligations and remain in business.

Similarly, companies that are highly committed to spot capital market approaches may consider longer-term strategies if it is natural consequence of relationships with existing outside investors or if they are confident that these strategies can be implemented in a way that does not overly deplete company resources.

Three Investor Types

Both spot and long-term capital raising strategies should be considered against the realities of private capital market investor search dynamics. While there are a great many types of investors, the investor universe can be broadly divided into three types of investors. Let’s call these investors Type A, Type B and Type C investors.

Type A Investors. The key attribute of Type A investors is that they are often willing to do deals very quickly but on terms that are one-sided in their favor. This is the investor that wants to pay $50 for something that is very clearly worth $100. The reason that they are only willing to pay a small fraction of what the asset is worth is because they are seeking opportunities where a company does not have the time to seek out another investor who is willing to pay the asset’s fair market price.

Doing a deal with this type of investor, while providing needed capital, will very likely lead to the destruction of shareholder value and, at least from an economic perspective, should only be considered if the cost of not raising capital is greater than the difference between the price paid for an asset and what the asset is actually worth.

Type C Investors. Now let’s take a Type C investor. A Type C investor is the opposite of a Type A investor – they are willing to do a deal very quickly but on terms that appear to be very one-sided in the company’s favor. They are prepared to pay $150 for something that is worth $100. The reason for this is that investor believes that the asset’s market price does not reflect its true value.

For example, assume that a piece of land is worth $100. If an investor knows (or believes) that an airport will soon be built near the land and this will dramatically increase its value, the investor may be willing to pay $150 for the land.

Type B Investors. While Type A and Type C investors certainly exist, they tend to be a small percentage of the overall investor universe and the chances of running into Type C investors are very low. Far and away the most common type of investor that a company seeking capital is likely to encounter is a Type B investor – an investor that is interested in doing a deal on terms that are fair for both parties. For this type of investor, they make investment decisions not very quickly or only based on an analysis of the financial terms but after becoming familiar with the company on many levels. Depending on the investor, the market and the relationship with the company, this can take months or sometimes years.

Investor Dynamics and Capital Raising Strategy

While it is true that a spot market capital raising strategy is often unavoidable at certain times, particularly for firms that have volatile cash flows, from an economic perspective the probability is that spot capital raising strategies will not lead to investments from investors who are most likely to generate shareholder value for companies they invest in.

Because of this, a better approach is to try to create a capital raising strategy that is weighted toward building longer- term relationships with potential investors. This requires holistic investor engagement that involves:

• continuously conducting research to identify investors that are a good fit for the company’s growth strategy in light of market changes and shifts in investor investment strategy
• rather than concentrate on investment marketing approaches that are narrowly focused on presenting specific investment opportunities on a take it or leave it basis, build a program of continuous investor interface so that investors can more broadly see up close how the company implements its business plan, how the company reacts to different market opportunities and risks, whether the company meets its business projections and what deals could be put together from existing or potential synergies
• considering opportunities to involve investors in company activities or even advisory roles, such as through membership on company advisory boards
• staying aware of investor strategy and portfolio company performance and continue to reevaluate potential synergies and investment options.

Conclusion

There are different types of capital raising strategies. While some companies must resort to spot market capital raising strategies because of cash shortfalls, given the prevalence of different investor types spot market strategies are not likely to generate shareholder value for a company. A long-term approach has greater probability of generating shareholder value. This requires rethinking the interface with potential investors and viewing capital raising process not only as a sale but rather a step in the construction of a long-term relationship that will be advantageous for both parties.