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Think your business is prepared to take the step and increase capital? In this episode of Raising Capital 101, we’re discussing reasons why you may want to raise capital or funds for your entity. There are many drivers – expansion, diversity, etc. but there are always cons to consider as well. Different projects may call for various sources of funding – have you thought through how those sources may affect your business?
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Episode Transcript:
Tom Voekler:
Welcome to Raising the Capital 101 podcast, presented by KVCF. I am Tom Voekler. I am with my colleagues, Rhys James, Mike Beville and John Watson. And we are trying to introduce the idea of capital raising, and the pitfalls, and the benefits, and the cons. And today we’re going to discuss why people would want to potentially raise capital. Why don’t we start with some of the pros we think on raising capital? Mike, you have any ideas on?
Mike Beville:
Yeah. I think that the biggest one, most obvious is it’s almost like leverage. You’re using other people’s money to acquire assets, grow business, whatever it may be, which may come at a cost. It may come at a cost upfront, may come a cost on the back end, whatever it may be. But you’re able to then leverage that money to grow and do things that you otherwise would not be able to do. I think it can open doors, it can expand what you’re able to do with your company. Of course, we deal primarily with real estate, and of course other companies. But with real estate, the easiest example is being able to go buy a larger asset maybe than you were otherwise thinking, and the returns may be better, the scale of the returns may be better. I think it can open more doors for you.
Tom Voekler:
Yeah, that’s an interesting concept. I hadn’t really thought about diversification. So, it allows you to do something you didn’t anticipate doing or couldn’t do on your own. Opens the pocketbook up to not necessarily… I mean, if you’re an entrepreneur, John, I guess you’ve got an idea, but you don’t have money.
John Watson:
And even if you do have money, you might not want to put your personal assets at risk, at least not completely. Maybe a little bit, and you can also raise capital as well. But if it’s risky, you don’t want to put all your money into it.
Rhys James:
John’s right, that it’s risk/reward is a large portion of the decision to raise capital. If you’re an entrepreneur, you’re balancing the need for capital, the desire or lack thereof to include all of your personal assets into a single business, versus the dilution of your interest in your baby, your idea that inevitably occurs if you raise capital from third parties. So, when you make that decision, that’s when you’ve decided to engage in the capital raising process.
Tom Voekler:
He’s getting into a little bit of the pro-con concept, like there’s always benefits, but there’s risks. And what Rhys was addressing was the risk of control, losing control. Again, go to an entrepreneur, John, as we were talking about. You have an idea, you control that idea until you raise capital.
John Watson:
Right. And then if you sell equity in your business, then you’re giving up some amount of control to your investors who will want a return on their investment. And if they don’t get that return, they might try to exercise more control over your business, which could hurt your returns as well.
Tom Voekler:
Mike, you talked about now you can get into bigger assets. Does that mean you can get in bigger trouble?
Mike Beville:
Yeah, yeah. I think bigger trouble. And it’s funny, we’re talking about control as the extreme. But man, there’s a lot of scale in between there too. I mean, just having to report to somebody else. Sometimes entrepreneurs who want not just control, but they don’t want to have to tell people what’s going on and have people scrutinize, ask questions. And people give you their money, the first thing they’re going to want is a lot more information, and they are going to scrutinize. And honestly, rightfully so. It’s a big relationship that you’ve now entered into with somebody and you’re responsible for managing their money, so to speak. So, I think that’s something that commonly folks who go out and raise money come back and say, “Man, do I really have to talk to this person or that person? Do I really have to provide this?” And sometimes you get out of the legal realm and more into just the facts of business. And the answer is typically yes.
Tom Voekler:
Yeah. And you are kind of alluding to something that’s always on my qualm list. My first talk to potential fundraisers is, “You have to understand this is going to occupy some or a lot of your time.” So, go to the entrepreneurial idea that we were talking about. That person no longer can solely focus on whatever that idea was. Or go back to real estate focus, if we’re talking about managing real estate or acquiring real estate, now you have to spend time not only raising the capital and talking to potential investors, but you have an ongoing, if you want a continuing relationship and a successful relationship, we’ll talk about it in further podcasts, what your obligations actually are. But you have an obligation of communication. And so, a lot of times people don’t realize that what they are great at on a day in and day out basis, they are being pulled away from to deal with capital raising.
Mike Beville:
Yeah. I think that’s a great point. I pull back to my analogy of relationships. And Rhys, I know that you’ve talked to a lot of people about that and the trials and tribulations of dealing with people who are demanding your time.
Rhys James:
Absolutely. And it’s not just time. As you grow, and particularly if you are on the side of a business that is going to raise capital or intends to raise capital serially, it becomes not just a time commitment, but a financial commitment as well, as you have to dedicate resources to reporting on folks’ investments, perhaps even hiring dedicated investor relations staff. And so, you’re going to have both time and material expenses that you don’t have if you don’t raise capital.
Tom Voekler:
I guess, going back to some of the pros, we had talked about the ability to do things that you maybe would not be able to do on your own. You may not be able to get a lender involved due to credit worthiness or if the asset is ready to be funded, so there is the ease of capital from that perspective. We’re talking about control. Those controls be different than what a lender is looking for, which may be very rigid. The payments to a lender may be very rigid. You may be able to work something out that’s more on a success based with investors. And so, the actual cost of capital may be less. If you add all the things we’ve been talking about between pros and cons, you have to make that analysis of “What is that cost?” It’s not just dollars and cents, it’s time. But what do you think the differences, Mike, are, if you need a little bit of capital versus a lot of capital?
Mike Beville:
Well, the most important thing would be then also how many people are you raising capital from, I think, and the character of the capital that you’re raising. Obviously, the more money you’re raising, the more liability you could be potentially facing from different facets, which we hope to get into more in future podcasts. But in a general sense, you take more money, you take in more investors, you take in investors that are truly passive, maybe you’ve taken ones that are more active. I think it becomes much more of a disclosure issue, becomes much more of a access issue for investors. And again, not to keep repeating it, but how much as an entrepreneur, as a real estate developer sponsor, how much do you want to get into that and how much of that is worth it to you? Because it’s cost the time, it’s everything under the sun that you’ll have now start paying attention to.
Tom Voekler:
Well, I guess that’s size right into some of the things we talked about with control, losing control or having less control of your idea, your project, whatever it is. If you’re looking for a larger amount of money, you’re going to be going either to a larger, sophisticated investor who’s going to ask for a lot more control, oversight, communication, versus more diverse, a large pool of investors that are each putting in a smaller amount, but at the end. Larger than if you just go to your dad and say, “Hey, I need some money.” So, I guess from that perspective, it ties back to some of the cons. John, do you have any ideas on if it’s shorter term, that you need this money, or longer term investment? Does that play at all, you think, in kind of the capital raising?
John Watson:
That might determine what the type of capital you want to raise, debt or equity. A short term need might be satisfied by debt if your cash flows can cover the interest, and the lender is willing to lend to you. Long term, if you may have an equity investment, then you won’t have to pay it back. You can use that capital for longer projects.
Tom Voekler:
That’s a great idea. And I guess we keep coming back to why would you want to raise capital? And I think we covered that pretty well on here. I think we talked about it could be a less regulated as far as banks, credit requirements, things like that. Quite frankly, it may be quicker depending on who you know, what you’re raising it for, the excitement behind it. It may be a quicker way to get some capital into a project, and it may be the only way for you to be able to undertake something that you don’t have the wherewithal to do on your own, or to grow. So, I think everybody needs to think about those pros and cons. And we will go into greater detail on some of the liabilities. We’ll be going into how you raise funds, how you can do it successfully, a little bit about the cost of some of these things in future funds on why you’d raise capital.
John Watson:
One idea that I had is that the process of raising capital, you’ll be scrutinized by either the lender or the equity investor. So, you have to take a hard look and they’ll be taking a hard look at your business model. If there are weaknesses in your business model, they might tend to notice that and allow you to refocus on your core business.
Tom Voekler:
It lets you really line up what you’re doing. That’s a good point, getting you ready for potentially a larger market, getting you ready for growth if you have a successful product. I think we’ve all been there with a client that has grown over time, and John has a good point. The requirements of those larger invest become more and more strict. And so, if you get into good governance early on, and good business plans, and good communication, it could be a very good way of being ready to ramp up. Rhys, any last words of wisdom?
Rhys James:
I think that as they were saying, you go through a little bit of expense up front on getting your house in order, and you’ll prepare yourself for avoiding a lot of expense down the line relative to your growth plane. And as we get into more of the legal side of things, I think the point here is that as an entrepreneur, as a real estate sponsor or developer, it is important to weigh the business cost of capital, which as we’ve discussed, is not just the 8% you’re paying on the loan or the 20% of the company you’re giving up in dilution, but also the time and expense related to dealing with that investor, dealing with that bank or the dilution of your control of the business, having to listen to another voice, speak to your idea, which may be a benefit, but a lot of folks sometimes don’t see it that way initially.
Weighing all those things, versus what do you need that capital to do? What are you growing into? What are you diversifying into and from? How are you, as Mike said very early on, leveraging your idea and your capital, using the capital of third parties in order to really further your business aims? It’s a decision on the business front before you get into some of the more legal minutia that we’ll start pointing towards.
Tom Voekler:
Yeah, that’s great. I think we’ve successfully raised some of the issues that we’re going to be talking about in the future, whether that’s legal or quite frankly, ethical and market concepts. And we look forward to continued podcasts, Raising Capital 101 by KVCF. Thank you.
This podcast is provided by KVCF, PLC for informational purposes only and should not be considered legal or investment advice. The transmission of the information in the podcast is not intended to establish, and the receipt of such information does not establish or constitute an attorney-client relationship. The listener should not act on information contained in any of the materials on this podcast without first consulting legal counsel. The podcast should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.
