Nouvelle L. Gonzalo, Esq. and
Anthony Foscolos, CFO
Businesses should seek the capital they need. The task of doing so, however, can sometimes seem daunting if a large raise is necessary, or if you are newer to the process. As such, it is important to be aware of the possible challenges of raising capital. You should also be prepared to invest the time and money to do thorough and careful research. You can increase your chances to raise funds by becoming well-educated about the process and understanding some of the common challenges. Some challenges include the following:
A. Knowing where to look for funds.
B. Finding investors that are the right fit for the company.
C. Not giving too much of the company to investors without receiving more in return.
D. Managing a denial by a bank due to little or no credit history.
E. Calculating the costs accurately or underestimating how much capital is needed.
F. Showing how and when the money will be repaid.
When you keep these potential challenges in mind, you can better anticipate what you will need for your company. Each business has a set of goals, pain points, and other challenges to navigate. However, you can raise capital despite these challenges, with a well-thought-out capital raise and investment strategy. To successfully raise capital, it is critically important to surround yourself with advisors who have the right expertise, experience, and commitment to understanding your funding needs and requirements.
In business, it is very helpful to start with a mindset of abundance and the positive view that there are more than enough opportunities available for each company. The world is a big place and there truly are many opportunities for everyone. Businesses should investigate those opportunities because they are only helpful when you utilize them. The following white paper provides insights from financial and legal counsel on the Top Considerations to Keep in Mind When Raising Capital.
- Establish a Strong Team of Advisors.
Apple co-founder Steve Jobs once said: “Great things in business are never done by one single person; they are done by a team of people.” In order to expand, a team of talented and dedicated individuals needs to be assembled and work together. This includes the chief executive officer (CEO), the chief financial officer (CFO), certified public accountants (CPAs), bankers, and corporate and securities lawyers, all of whom are the “leadership team.”
These key professionals can help a company increase its cash position. The CEO will explain the needs of the company. The CFO will develop a financial strategy to raise capital specific to the needs of the company. Legal counsel will ensure the company has the right protections and documentation in place to protect that strategy. The investment bankers will explore the options available to implement the strategy, and the CPA will look at ways to limit tax exposure of that strategy. Mid-size businesses can now accomplish creating this type of team by using fractional professional services. These include fractional legal and CFO services as an affordable alternative to the cost of hiring full time staff members
In addition to these leadership team members, entities that are raising funds to go public can seek the assistance of a placement agent. The placement agent is an intermediary who helps raise capital for the company by introducing the company to potential investors. Placement agents can provide value-added services, such as helping to prepare marketing material, formulating a targeted strategy, and negotiating on behalf of the company. Placement agents are especially helpful for marketing a company in places where the company has limited contacts. This is helpful because an introduction from a good placement agent enhances the credibility of the company.
2. Be Clear Why You Want to Raise Capital.
Raising capital is a key element in growing a business. This is true whether the business is a start-up, an existing business with a proven track record facing a challenge, or an existing business that needs capital to continue its growth. As a result, you must consider why raising capital is necessary in your organization. What do you want to do with those funds? Some reasons to raise capital include that it can serve as a much-needed cash infusion to start or expand operations, to continue much needed R&D, to hire professionals needed to drive revenue, to invest in necessary technology, to fund a merger or acquisition, to meet cash flow needs in between payments, or to deploy as an emergency line of defense. Being clear on why you need the capital is true in both service and product-based businesses. The additional revenue raised should contribute to the ability to drive additional revenue and increase long-term profit generation for the company. In short, raising capital not just access to it, is essential for healthy growing businesses.
3. Prepare Your Company for the Infusion of Cash.
“Money doesn’t change who you are, rather it magnifies who you really are.” – Businessman, Farrah Gray.
The same is true for companies as it is for people, which is why it is important to ensure that your organization is ready to receive and responsibly deploy any new capital it raises. If the company is very new and not well-organized, does not track financials efficiently, does not close projects efficiently to receive payment, or has structural challenges in processing its financials, then raising capital will only magnify those inefficiencies.
As a result, this means it is important for a company to have financial clarity, an effective organizational structure, and processes in place to ensure the capital raised is administered efficiently. If not, then the capital raise could lead to squandered resources and put the company back in the same cash-strapped position it was in prior to the raise. The company need not have everything perfect within its operations, yet it should have a solid foundation, make effective use of its funds, have reasonable cash flow management. It should take the advice of its financial counsel when it comes to managing the funds.
4. Calculate the Cost.
Next, you will want to calculate—as accurately as possible—the cost of what your company needs in terms of the amount of funding. You will have worked with your team to ensure the business is operating effectively, and now you want to review the expenses and revenues. Then you look at the best ways to achieve this. This thought process seems obvious, correct? You may say, “Of course I know how much I want to raise. That’s how I know I needed to raise capital, because I calculated the cost.” The question then arises: How did you calculate that cost?
For example, if you are a company that sells a pharmaceutical product, you may calculate the need for an additional $1 million USD for one part of the business. To keep the numbers simple, the calculation is broken down as follows:
200k for R&D
400k for Manufacturing
100k for Regulatory Compliance
300k for Distribution & Marketing
$1 Million USD Total
This makes sense and is logical. You then focus on the goal to raise $1 Million USD. However, do you see an issue here?
These calculations do not include any unanticipated or hidden costs that can arise and it does not take into account the timing of when you will use the money. Rather, these calculations exist as if in a perfect world and do not leave too much room for margin of error. Perfect worlds don’t exist and much less in business. How will costs be figured in if there are logistics issues such as supply chain delays, product shortages, or import detention delays at the port of entry? What if your product is quarantined at a port of entry for 30 days and cannot enter the country? Or what happens if product is returned to its point of origin because it does not comply with regulations or has spoilage? What if, in a service-based industry, you lose a key employee and your ability to drive revenue is reduced? What if a part or product must be recalled? What happens if you develop the product and it still does not work as intended? What if an existing product needs unanticipated additional development and redesign to work properly? What happens if you are a service-based business that miscalculated the demand for your services, or you have overspent in research or advertising, only to determine that additional funds are needed to correct course and refocus efforts. These are common challenges that should be considered in your calculations depending on the specific facts of your company. As such, you should discuss potential unanticipated costs with your leadership team and determine how much margin should be built in to account for them. Calculate the costs and evaluate if you have under or over-estimated the amount of capital you need. You may find you actually need less or more money than you think.
5. Develop a Plan to Raise Capital
“If you fail to plan, you are planning to fail,” is another aphorism that applies to multiple situations, including business. No matter how brilliant, how experienced, or how sharp we are on our feet, we must have a plan. This is especially important when we want to raise capital. Your plan should include how you will raise the capital that you need. Will it be from one source, such as with investors, or a variety of sources? In addition, the type of business entity involved and how long it has been operational are key considerations when determining the best path to follow for raising capital.
Some sources of raising capital include, yet are not limited to the following:
i. A Standard Bank Loan
ii. A Small Business Administration (SBA Loan). An SBA bank loan comes directly from the SBA and is government backed.
iii. Investor Capital
– From a strategic main angel investor or strategic investors that are an excellent fit for your business.
– This includes family and friends, accredited investors, and the general public.
– This can also be seed round funding from multiple investors.
iv. Sale of assets in one part of the business to fund the other part of the business.
v. Partnership Buy into a business
vi. Venture Capital Funds
ix. Government Grants
Some additional creative ways to Raise Capital include the following:
x. Vendor Negotiation on Equipment Leases. Negotiate deals with vendors for a lower price on equipment leases if you agree to longer term leases, when possible, to increase revenues. You can also negotiate terms with the business landlord to pay rent in advance at a lower rate. If your company plans to buy the location, then it can negotiate for options such as rent to own the space or a sale-leaseback of the property.
xi. Review Staff is Working Efficiently. Ensure staff is working as effectively as possible and that roles are not duplicated. Streamlining work or removing staff whose role is redundant will increase cash into the business.
xii. Negotiate Customer Rate for Prepayment. Negotiate with customers to have them prepay for product at a slightly lower rate in exchange for pre-payment.
xiii. SBA Employee Loan. Employees of a company can work with the company owner and SBA so the employee can obtain funding to buy the business of its employer.
xiv. Insurance Policies (e.g. Directors and Officers Insurance, Representation and Warranty Insurance, Food Recall Insurance, Litigation Insurance, and others as may be needed by the industry) Insurance policies provide additional sources of cash if the reason to raise capital is to cover legal expenses for trial, a breach of contract, or covered loss under a policy.
6. Execute the Capital Raise Plan as a Disciplined Business Person.
You have worked with your leadership team to formulate a plan, prepare the company to receive funds, and select the resources to raise funds. Now you must execute. When we talk about executing the plan as a disciplined business person, this largely means staying the course to use the capital as originally planned, budgeted, and strategized for the company. Even though unexpected changes can arise, you should continue to seek the wise counsel of your leadership team. Identify how you want the funds used. Be sure the funds are used consistently with the guidelines required for that source of capital. For example, if you have an SBA Loan, are you clear about the SBA guidelines for those funds? This is important to note because as capital is raised, there may be a temptation to spend the raised capital on additional projects or higher risk endeavors not originally contemplated.
7. Understand the Federal SEC Regulations to Raise Capital from the Public.
While growth is what most business owners strive for, they must also be aware of federal and state regulations when seeking outside capital. The business should work with legal counsel to understand these state and federal rules, which can sometimes contradict one another.
Although state considerations must be consulted, federal law predominantly governs what a business must and can do in its pursuits to raise capital. The Securities Act of 1933 (the “Act”) requires all companies offering their own securities for sale to the public to register with the Securities and Exchange Commission (the “SEC”), unless the securities they sell are exempt, such as under Section 4(a)(2) or Regulation D “safe harbors”. The Act requires disclosure of important financial information, which enables investors from the public to make informed judgments about whether to purchase a given company’s equity securities, while simultaneously prohibiting deceit, misrepresentations, and other fraud that may arise during the sale of securities. As a further safeguard, investors who purchase securities and can prove losses suffered were due to incomplete or inaccurate disclosure of important information during the registration process, have several recovery rights.
Those who violate the Act can face penalties for doing so. Willful violators can face fines up to $10,000, a prison term of up to five years, or both. Furthermore, anyone injured by false declarations in registration statements, prospectuses, or oral communications concerning the security sale—as well as anyone injured by the unlawful failure to register—may file a civil suit to recover the net consideration paid for the security or for damages if the security has been sold. Although these civil penalty provisions apply only to false statements in connection with registration, prospectus, or oral communication, the Supreme Court has held there is an “implied private right of action” for damages resulting from a violation of SEC rules under the Act.
8. Understand if You Have Private Transaction with Accredited and Sophisticated Investors that Are Exempt from SEC Registration.
Accredited investors are allowed to invest in unregistered securities. They are deemed financially sophisticated and have a reduced need for the protection provided by regulatory disclosure filings that come with SEC registration. Accredited investors include high net worth individuals, banks, insurance companies, brokers, and trusts. There are several ways to become an accredited investor, such as having an individual annual income exceeding $200,000 USD for the previous two years with the expectation of earning the same or a higher income in the current year, having a net worth exceeding $1 million USD, or being a private business development company/organization with assets exceeding $5 million USD. A non-accredited investor is any investor who does not meet the income or net worth requirements mentioned above, meaning everyone holding less than $1 million USD in assets, aside from the value they may have in their house, and those earning under $200,000 USD. The SEC regulates what non-accredited investors can invest in and what their investments need to provide in terms of documentation and transparency.
As for exemptions, Section 4(a)(2) exempts from SEC registration transactions by an issuer company that do not involve an offering to the public. To qualify for this exemption, the purchasers of the securities must: (1) either have enough knowledge and experience in finance and business matters to be deemed “sophisticated investors” (someone able to evaluate the risks and merits of their investment), or be able to bear the investment’s economic risk; (2) have access to the type of information normally provided in a prospectus for a registered securities offering; and (3) agree not to resell or distribute the securities to the public. In general, public advertising of the offering and general solicitation of investors are incompatible with exemption.
Ultimately, if a company offers securities to even one person who does not meet the necessary conditions, the entire offering may be in violation of the Act.
Additional exemptions can be found in Regulation D of the Act, which contains three safe harbor rules: Rule 504, Rule 506(b) and Rule 506(c). Rule 504 permits an exemption from registration when securities are offered with an aggregate price of up to $5,000,000 USD during a 12-month period. However, 506(b) and 506(c) do not place restrictions on how many securities can be offered and allow issuers to raise an unlimited amount of capital through the offering of securities. On the other hand, 506(b) and 506(c) place limitations on the sophistication of the investor that may purchase the securities being offered, whereas 504 does not include such limitations. In particular, 506(b) and 506(c) require that the issuer have a reasonable belief that the investor is accredited and, under 506(c), the issuer must take reasonable steps to verify the investor’s accreditation.
9. Understand the State Regulations to Raise Capital from the Public.
Aside from complying with federal laws to raise capital, issuers of securities must comply also with state laws. Each state has its own securities regulations, known as the state’s “blue sky laws.” These laws regulate the offer and sale of securities as well as the registration and reporting requirements for broker-dealers and individual stockbrokers doing business (directly and indirectly) in the state. Blue sky laws also regulate investment advisers seeking to offer their investment advisory services in the state. These state laws all share certain features to prevent sales agents from promising unrealistic returns and misinforming investors about the investment risks. The state laws provide for oversight of the sales process and create liability for fraudulent sales. You should work closely with your securities counsel to review these items.
10. Consider Key Legal Documents to Protect the Raise of Capital.
When it comes to raising funds, there are different paths a business can pursue. Some common paths are through a Promissory Note, a Safe Note, Phantom Equity, and a Convertible Note. In addition, another option is to provide potential investors with pro forma financial statements, which are financial reports issued by an entity that use assumptions or hypothetical conditions about events that may have occurred in the past or which may occur in the future. These statements present a view of corporate results to outsiders, perhaps as part of an investment or lending proposal. A budget may also be considered a variation on a pro forma financial statement because it presents the projected results of an organization during a future period, based on certain assumptions.
In conclusion, businesses have several options when it comes to raising capital. Do your research and build your team. You will do well! For additional information, contact the authors.
About the Authors
Nouvelle L. Gonzalo, Esq. is a magna cum laude graduate of New York University, an honors graduate of the Ohio State University College of Law, and was a visiting scholar at Oxford University in Oxford, England. Atty. Gonzalo is a U.S. and international corporate lawyer who works with companies across the globe. She is the managing attorney of Gonzalo Law, a U.S. and international corporate law firm with offices in Florida and Ohio. In addition to the active practice of law, she served as adjunct faculty of international corporate law at the University of Florida, Levin College of Law for three years. She is recognized with the top 2.5% of Florida lawyers as a rising star by the national organization, Super Lawyers from 2019- 2022. Her practice areas include: U.S. corporate contracts and acquisitions, international corporate law, and intellectual property law. Atty. Gonzalo can be reached at [email protected] or via phone at 877-613-9553.
Anthony Foscolos is the Managing Principal in the South Florida office of the largest CFO provider in the state, NPerspective CFO Services. Mr. Foscolos offers clients extensive financial leadership support. Over his 25-year career, he has served as CFO, COO, and CEO, giving him both a unique perspective in analyzing financial information and the ability to work with leadership teams to synergize meaningful action plans.
Mr. Foscolos contributed significantly to the growth of several businesses in his C-Suite positions. The results have been impressive and consistent, with year over year growth of +30 % over periods in excess of 10 years. In one case, he increased revenues in seven years from zero to $30 million. As a professional public accountant and a compliance auditor, Mr. Foscolos is well rounded in several industries, including retail, professional services, health services, manufacturing, production, engineering and construction. He also developed technology and research-based businesses within these sectors. Mr. Foscolos can be reached directly at [email protected] or at +14074882042.
Mr. Alexis Sverdlik
Mr. Svederlik is a magna cum laude graduate of Brandeis University and a second-year juris doctorate candidate at the University of Florida, Levin College of Law (Class of 2023). He also serves on the Florida Law Review, is a Deans List Scholar, and was a Legal Research and Property Cali Award Recipient. Mr. Svederlik served as a Summer Associate with Gonzalo Law and provided excellent research and writing assistance to prepare this article.
 See generally Matthew Cain et al, Intermediation in Private Equity: The Role of Placement Agents, HARVARD LAW SCHOOL FORUM ON CORPORATE GOVERNANCE, (April 13. 2015), https://corpgov.law.harvard.edu/2015/04/13/intermediation-in-private-equity-the-role-of-placement-agents/, (last visited Jan. 4, 2022).
 The Laws that Govern Securities Industry, U.S. Securities and Exchange Commission – Investor.gov., https://www.investor.gov/introduction-investing/investing-basics/role-sec/laws-govern-securities-industry, (last visited Dec. 28, 2021).
 15 U.S.C. § 80a–24.
 15 U.S.C. § 80a–11, 12.
 Case v. Borak, 377 U.S. 426, 431 (1964).
 Accredited Investor – Updated Investor Bulletin, U.S. Securities and Exchange Commission – Investor.gov, (April 14, 2021), https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins/updated-3, (last visited Jan. 2, 2022).
 Private placements – Rule 506(b), U.S. Securities and Exchange Commission, (Mar. 15, 2021), https://www.sec. gov/smallbusiness/exemptofferings/rule506b, (last visited Dec. 28, 2021).
 17 C.F.R. §§ 230.506(b)-(c).
 Deepa Sarkar, Blue Sky Law, Cornell Law School Legal Information Institute, https://www.law.cornell.edu/wex /blue_sky_law, (last visited Dec. 28, 2021).
 See generally Kelsey Miller, What Are Pro Forma Financial Statements?, (Oct. 28, 2021), Harvard business school online, https://online.hbs.edu/blog/post/pro-forma-financial-statements (last visited Jan. 4, 2022).