All businesses require capital. Whether it is to start a company, pay salaries, innovate, or spend on marketing, your business won’t be able to grow without any funding. There are many ways to raise capital. It is important to understand the advantages and disadvantages of different types of fundraising and to make sure you use the right documents when raising finance.
How to do it
Step 1: Raise money through debt capital
Debt financing refers to borrowing money from an outside source, such as a bank, with the promise of paying back the borrowed amount plus any agreed-upon interest at a later date. Taking out a loan from a bank typically requires your company to have collateral.
Some legal instruments by which you can take out loans include:
Convertible Note: A debt instrument that converts into equity under predefined conditions.
Factoring Agreement: An increasingly popular mode of financing for companies that have been in operation for at least two years.
An advantage of debt financing is that it gives the company instant liquidity without diluting your ownership interest. However, note that unlike equity, debt must be repaid at some point. Even during difficult financial periods, your company still has an obligation to pay the interest rates or you would default on your loan. There are typically also restrictions that come with debt financing, such as the requirement that you seek the lender’s permission should you wish to pursue further fundraising activities. This may curtail your ability to raise capital.
Step 2: Raise money through equity capital
Equity financing is essentially raising capital by selling shares in your company to investors. There are two main kinds of shares that companies can issue: ordinary shares and preference shares. By default, all issued shares are ordinary shares. Ordinary shares entitle the shareholder to a claim over the income and assets of the company in the event of winding up or liquidation. In some cases, you may want to issue preference shares to your shareholders, which would give the shareholder additional rights and benefits, such as additional voting rights or a fixed rate of return to create certainty on your shareholder’s return on investment (ROI).
Preference shares may be cumulative or noncumulative:
Cumulative preference shares: If the fixed dividend entitlement of any financial year is unpaid, the dividend amount that is owed accrues and must be paid in the future. All accumulated dividends must be paid to the preference shareholders before distribution of dividends to ordinary shareholders;
Noncumulative preference shares: If a dividend is not paid in any financial year, it will be deemed “forfeited”.
The benefit of raising capital through preference shares is that unlike a loan, you don’t have to pay a fixed interest rate.
Client case study
Stella Pe from Pacifictrust Holdings uses Zegal to raise money through loan that legally protects both – payer and payee.