This piece was originally published April 4, 2017.
You’ve done it, against the odds. You set out to build a company, and you’ve launched your first product in the marketplace. Perhaps you’ve even started to receive an influx of cash into your business from sales of your first product, and you and your team are psyched at these early indicators of success for your company.
It’s a Friday afternoon, and you’re grabbing celebratory beers with a few other founders. Perhaps you’re swapping “war stories” of the times when something went horribly wrong—when your team had to band together after a customer service nightmare or re-code an entire web application to enhance security after a threat. You share that you’re in the final phases of your initial product launch and that your team has been asking how the company will scale to capitalize on your initial success.
“Have you considered raising capital?” says an entrepreneur across the table. Of course you have. You’ve read industry news. You’ve followed companies that raised millions of dollars. You’ve attended events and heard from entrepreneurs in the middle of raising capital. And yet, you’re not sure where to begin.
Asking for money for your business is hard. The stakes are high, and taking on debt or yielding ownership of your company through an equity investment can be scary. But if you’ve got a product in the market and a strong team, you might be a great candidate to raise money to scale your business.
Building on our prior advice about how to land a business loan and how to develop solid banking relationships, we figured entrepreneurs in this scenario could use some actionable tips to raise capital the right way, so they can get back to building the company of their dreams.
We spoke with Philip Cave, wealth advisor for Wells Fargo, and Susan Jessup, senior private banker for Wells Fargo, about how entrepreneurs can leverage capital to help their businesses grow.
Understand capital market structure
It may seem obvious, yet entrepreneurs need to understand the full range of options available to them, says Jessup. Each comes with certain trade-offs. But fundraising starts with understanding the capital market structure—the proportion of debt and/or equity in the capital configuration of a company.
Though a technical term, says Cave, it’s critical to understand capitalization structures because this knowledge can help an entrepreneur decide whether to pursue a loan to finance growth or sell equity in the business.
If an entrepreneur trades equity in the business for investment, “this will dilute their ownership,” says Cave. Entrepreneurs will always need to be balancing maintaining control of their company with bringing on additional sources of capital.
Raising a round through friends and family investment or through angel funding will attract investors that tend to be more focused on earning returns from the company over time, says Cave.
“For most entrepreneurs, ownership and control are the most important aspects of their business,” says Cave, which is why debt financing might be more attractive to some entrepreneurs.
Create relationships (early)
For entrepreneurs who don’t want to yield equity (ownership) in their company to investors, debt investment can be a viable option. This would traditionally involve a banking institution, though there are some angel investors who might consider a loan rather than an equity investment.
Securing a bank loan to scale your company isn’t as simple as walking into a bank with a business plan and your most recent financial statement. “I’m not describing a transaction,” says Jessup, “I am talking about a relationship.”
A good relationships, says Jessup, is always based on an appropriate level of give-and-take. Bankers enjoy helping entrepreneurs and small business owners think about how to modestly or aggressively scale their business. It’s important to build relationships with financial professionals, says Jessup, because then “you’ll grow together in the relationship, rather than having a one-and-done conversation.”
And, advises Jessup, know that it takes time. Entrepreneurs will know their business, product, service and market better than almost anyone out there, and far better than a banker will ever know.
“You need to start early, to educate your bank, to educate your banker and to allow your banker to educate you on the steps you need to take in order to continue on your path to finance your business,” Jessup says.
Treat bankers (and others) as trusted advisors
We all know the “Golden Rule”: to treat others as we want to be treated. This applies in building a banking relationship. Just as you want others to see you as an expert in your field and as an expert in your business, treat bankers as experts in theirs.
This is advice that is relevant far beyond the fundraising process, says Cave. However, it is critically important that entrepreneurs find financial professionals like bankers and CPAs that can grow into trusted advisors.
“You want to think about your relationships with people as opportunities to work with thought-leaders,” says Cave. “Think of your relationship with a banker as a trusted advisor, and not as a transactional conversation.”
As you build a relationship with a banker, be open to his or her advice, says Jessup. If entrepreneurs aren’t open to receiving feedback and learning from the conversations with the banker, they’re not prepared or ready to consider all of the options and tools available to them when it is time to scale their company through financing options.
“You must be willing to see things differently than you’ve seen them in the past,” says Jessup.
Spend time revamping business model
Banks don’t invest in the products or services that a company provides. They invest in the business model—the assurance that a company will make more money than it spends.
A bank wants to finance companies that will be successful and able to repay debt on a set repayment schedule. So entrepreneurs that can demonstrate sufficient financial acumen and prove a business model that can meet that schedule are far better prepared to qualify for debt investment.
Though it’s critical to also build your product as you’re building relationships, Cave says, the most important way to prepare for attracting capital is to build a strong business around the product.
“They also need to refine and update their business model,” says Cave.
A company’s business model needs to be dynamic and not static, says Cave, and it needs to be presented often to bankers.
“We will see opportunities as business models, not as business ideas,” he says.
In your business model, and in your pitch to bankers, include the mission of your company, advises Jessup. It’s okay if it shifts and changes over time.
However, understand that you’ll need to present the quantitative aspects of your business model alongside the qualitative. Demonstrating your knowledge of the market, the obstacles, the competition and how the market may change over time will go a long way toward convincing a bank to fund your expansion, says Jessup.
Get your finances in order
A no-brainer, right? Of course it will be important to demonstrate sound financial knowledge when you’re fundraising. This prepares you for the necessary work of reporting back to investors should you elect to take on investment in your business through either equity or debt financing.
This may be the most critical lesson for entrepreneurs. Financial information must be good, says Jessup: “It can not be a back-of-the-envelope calculation, it can’t be something put together in a hurry before a meeting.”
Entrepreneurs need to have a great CPA, or at least someone with that skill set, so that when presenting to a bank or an investor, the financial information is accurate, valid and supported by real data.
For example, if you are asking for money or for investment and say you want to grow your company by 20 percent within a specific timeline, be sure to include the facts on which you’re basing your growth plan. Similarly, with any investor or bank, be up front about what the risks are going to be.
“There are two sources of failure for entrepreneurs,” says Cave, “Growing too quickly, or taking a focus off of the financial numbers.”
Which calls to mind an example from Jessup’s work.
“Years ago, I had an entrepreneur come to me and tell me that they were growing their company, year over year, with great sales data,” says Jessup. “But when we looked at their numbers, the entrepreneur was only looking at the top-line information. We looked at their bottom line.”
Just because you are increasing sales does not mean that you are making money, advises Jessup. So get to know your financial information, or hire someone that will.
There’s no shame in learning how to better manage, interpret and present financial information. This isn’t some innate talent or skill that some people possess and others do not. It’s a learned ability, and you can learn it too.
An entrepreneur can acquire additional knowledge in a variety of methods—reading books, publications or case studies, or seeking help from mentors. But one of the best sources of knowledge will be those that work in the industry every day: your banker.
Entrepreneurs that adopt a mentality of constant “advice-seeking” are often the most successful, Cave says. They’re open to receiving advice, to learning new information and incorporating it, when relevant, into their business models.
By working with trusted advisors, entrepreneurs can better position themselves to choose and select the right option for raising capital to scale, says Cave.
If they don’t, they may not have a choice of how to raise capital to expand, which could lead to yielding ownership and also control of the company to investors.
While the route of equity financing is not inherently bad of course, entrepreneurs deserve to have as many options available to them so that they can select the funding mechanism that will make the most sense for their business, in the short-term and in the long-term.