Traditional versus New Models of Capital Raising
Private capital raising has typically hinged on companies and funds being able to connect to a narrow base of large institutional investors. This historical focus on only tapping a select group of large investors is largely a byproduct of a regulatory and technological framework in which the costs—whether in time, money, or compliance risk—of accessing more investors outweighs the benefit of receiving more numerous smaller checks. New innovation and new regulation are changing this paradigm. [See ‘Fundraising Post JOBS Act‘ for more] As this space evolves, I believe the new “normal” in private capital raising will include substantial funds being raised by a larger pool of smaller investors that have been aggregated via low-cost and scalable technology solutions.
This original version of this article appeared in VC Experts, Private Equity and Venture Capital Articles. It was written by Christopher S. Connell of Stradley Ronon LLP. While the macroeconomic context has improved somewhat since it was penned, these deceptively simple tips remain extremely relevant in making sure your business can weather any financial storm. All small or medium sized business owners that are looking to access capital or ensure their business is on sound financial footing should take a quick look.
The financial crisis facing the United States is front-page news on a daily basis. Although the tone of the message has improved in recent weeks, we can’t escape the reminders of the financial pressures on all levels of our economy. Homeowners are experiencing decreased buying power due to the housing downturn, high unemployment and tightened credit standards. Local governments are dealing with budget cuts and lower tax revenues. Small-business owners, those who are most likely to stimulate the economy by growing their businesses and hiring more employees, are having difficulty obtaining the capital necessary to drive that growth.
But why is it that so many solid businesses can’t get their hands on the capital they so desperately need? And how should these businesses approach the current lending environment to enhance their chances of success? Let’s first take a look at some of the basic reasons the financial markets have tightened so much.
Traditional Capital Raising is Old School
Traditional capital raising is an old school process. This means that succeeding in raising funds has typically depended on two criteria—a strong track record of success and/or a dense network of connections. Real world connections, whether professional or personal, help create the right meetings, draw the right attention, and get funds committed.
While the capital raising environment is in a transformative state (see below) it’s not all “out with the old.” A history of success and a well-developed network will always remain important.
One of the biggest differences between investing in private companies versus public companies is the amount of information readily available. Publically traded equities have far more verified data available then private securities. The prevalence of this information together with the low-cost of obtaining it forms the very basis for the creation of efficient public markets because it facilitates comparing the risk/return profiles of different securities.
Agree or disagree with the market structure argument, few would dispute the micro-argument that without credible disclosure between company managers and prospective investors the efficient flow of capital would be impeded. After all, most investors do not invest in something without knowing something about the opportunity. But for various reasons information flows within the private markets are often constrained. The end result can include more expensive capital for companies and a severely tilted information playing field for investors relative to management (or even relative to one another).
In order for the private capital markets to continue to become more liquid and more efficient (and thereby benefiting all involved parties) a standard for minimum acceptable information disclosure should be fostered.
This article, which first appeared in the VC Experts ‘Buzz Feed, features Joe Bartlett explaining some basic terminology on the VC and angel industry.
Considering an angel investment?
Before you take the plunge, learn to talk shop like a professional VC.
Angel investing is an increasingly common practice among high-net-worth individuals. But many would-be angels lack a true insider’s vocabulary – and the savvy that goes with it. Do you know the difference between a “burn rate” and a “burn out”? The pros do, and so should you if you’re looking to invest in a start-up. For a summary of “types” of angels see this post.
What then, in plain English, are all these venture capitalists talking about?