Capital Raising – An Overview
Capital raising is the process a business goes through in order to raise money, usually with the intent to transform the business in some way. Although capital can take on different forms, such as labour and political capital, the first thing that comes to mind is typically money or financial capital.
Financial capital can be represented by securities, cash, and assets. We all know how important access to cash can be for businesses; in most cases, it means the difference between having the ability to grow rather than being left behind whilst waiting for liquidity to catch up, and in the most extreme cases, capital can be a case of life or death for an organisation’s survival.
Equity Capital – Equity capital is created by selling shares of a business’s stock in return for capital; these are typically sold as common shares or preferred shares.
A common share grants shareholders voting rights, but aside from that, these shareholders are at the bottom of the ladder regarding power and ownership within the company. This means that owners of common shares are not prioritized as highly as other shareholders in the company, and if the organisation was to go into liquidation, other shareholders or creditors will have to be paid first.
Preferred shares on the other hand are different in that payment of a pre-determined dividend is ensured by the company prior to any payments being made to shareholders with common shares. In return for this preferential treatment, holders of preferred shares will have limited ownership rights and give up their voting rights.
Prior to 2012, equity capital raises were only available to accredited investors; however, this was changed with the passing of the JOBS Act. The goal of the JOBS Act legislation was to stimulate job creation and economic growth by allowing companies to raise money from the public through three exemptions, Regulation CF, Regulation A+ and Regulation D.
Regulation D: Regulation D (Reg D) came into effect in 2013, simply put, it allowed companies to advertise investment opportunities to an audience at large. This was the beginning of what we now call crowdfunding.
Regulation CF: Regulation Crowdfunding (Reg CF) aims to help small businesses to raise money online through retail and accredited investors. Originally there was a $1,000,000 limit on the amount that could be raised, but in 2021 this number was amended to raise the limit to $5,000,000.
Regulation A+: Regulation A+ (Reg A+) went into effect in 2015. It placed set limits on how much capital could be raised annually and allowed businesses to raise up to $75,000,000 through accredited and non-accredited investors.
The main advantage of raising equity capital is that the company is not required to repay the shareholder’s investment directly. Rather the cost refers to the amount of ROI (Return On Investment) shareholders expect to be paid in dividends, according to the performance of the market at large.
A distinct disadvantage of using equity capital is that every shareholder, common or preferred, will own a piece of the business; regardless of how small this piece may be it causes ownership of the business to be diluted. Additionally, the company owners become beholden to these shareholders and must ensure the company is profitable so that dividends can be paid out.
Investors should recognize and accept the risks associated with investing.
Certain investments may require you to keep your holding for periods of many years with limited or no ability to resell unless there is a strongly regulated secondary market.
You may also have limited access to periodic reporting, see your holdings decrease and increase in value, or even lose your entire investment.
Investors should decide for themselves whether to make any investment, basing this on their own independent evaluation after consulting with financial, tax and investment advisors.
Never rely solely on marketing materials, as they could potentially be exaggerated and place a disproportionate emphasis on ESG criteria. A more comprehensive picture of the investment can usually be found in the company’s SEC EDGAR filings.
Reading the fine print can help avoid situations where the marketing or promotional materials for an investment might not tell the whole story.
ESG funds my take more work for fund managers to construct and manage and, consequently, can cost more than a passive fund that tracks a broad-based market index. Research how much any investment you’re considering will cost you over time, paying attention to the annual expense ratio for an ESG fund.
If you are using an investment professional, ask about any fees associated with an investment, such as sales charges, ongoing fund expenses, how much it costs to buy or sell the security, or assets-under-management fees.