Raising capital is arguably the primary motivation for companies, especially startups and small businesses, to seek outside investment. Through injections of capital from investors like angel investors, venture capital firms or private equity firms, companies can fuel their growth and expansion in a manner not possible through internal cash flows alone. The capital raised provides the financial resources to develop and launch new products and services, build infrastructure, hire talent, enter new markets and acquire technologies or other assets. This allows companies to rapidly scale at a pace much faster than what could be achieved through organic growth. Furthermore, external capital provides a cushion against unexpected cash flow shortfalls or economic downturns. Having sufficient reserves is vital for avoiding disruptions to operations or even bankruptcy during periods of distress. Though profitability and returns are central investment considerations, the overriding importance of capital drives most companies to open their books and ownership stakes to investors. Simply put, capital enables strategic objectives and survival, making it arguably the primary motivation behind investment.
Startups and early-stage ventures rely on external capital to fund product development and market entry
For startups and early-stage companies that lack an established revenue stream, external investment is absolutely critical. These fledgling ventures need capital to take their innovative ideas and develop tangible products or services targeted to an identified market need. They require funds to build prototypes, conduct testing, obtain patents, refine designs, lease workspace and purchase equipment and software, all before having any paying customers. Early marketing and talent acquisition also necessitate major upfront outlays well before profits materialize. Angel investors and venture capital firms specialize in providing the capital needed to bridge companies through the pre-revenue phase into commercial launch and beyond. Their funding enables startups to achieve key milestones that make future venture capital and growth equity rounds possible.
Growth companies use capital to rapidly scale operations before accessing public equity markets
Once startups transition into the growth phase, their capital needs continue expanding to keep pace with their rapidly scaling operations. Growth stage companies may not yet have the operating history or consistent profitability to raise substantial capital through debt financing or an initial public offering (IPO). However, their promising business models and trajectory make them attractive investment targets for private equity firms that can provide larger scale growth equity financing. This expansion capital allows companies to quickly augment their talent pool, technology stack, production capacity, office locations and other operating infrastructure ahead of the revenue curve. Capital may also facilitate acquisitions of smaller competitors or complementary businesses that can accelerate market share gains. Eventually, growth capital helps enable companies to achieve the scale and financial metrics to pursue an IPO and access cheaper public equity financing.
Mature companies use capital to fund expansion projects and strategic acquisitions
Even mature companies that are consistently profitable and cash flow positive may still pursue external investment for major growth initiatives or acquisitions. Undertaking large expansions, entering new geographical markets or acquiring major assets requires substantial capital outlays that may strain internal cash reserves. Issuing additional debt can jeopardize credit ratings or breach loan covenants. Thus, selling minority stakes through private placements is an attractive means of raising funds for strategic projects that require sizable investments well above and beyond current cash flow levels. The capital can also strengthen balance sheets and allow companies to fund growth using less leverage. Furthermore, institutional investors may provide expertise and relationships that support market entry and integration of acquisitions. Thus, capital funding enables companies to pursue value-enhancing projects and opportunities that would otherwise be out of reach.
Companies use capital to build financial slack and resilience against downturns
Adequate capital reserves also provide critical protection for companies against unexpected challenges and downturns. Having liquidity buffers and spare debt capacity enables companies to weather short-term cash flow disruptions, finance temporary operating losses and ride out economic storms. Keeping powder dry on the balance sheet mitigates risks of distress during recessions or unforeseen catastrophes that devastate cash flows. For example, many businesses relied on emergency equity and debt infusions to survive the severe demand and revenue collapses experienced during the COVID-19 pandemic. Companies that entered the crisis with strong capital positions fared much better than overleveraged firms with minimal liquidity. Thus, maintaining access to capital provides an insurance policy for companies to withstand periodic shocks and volatility.
In summary, the overriding incentive for companies to open up ownership and seek outside investment is to obtain the capital necessary to start, grow and operate their businesses. Capital provides the financial fuel for product innovation, talent acquisition, capacity expansions, market entry and strategic acquisitions that enables competitive advantage and value creation. It also serves as a buffer and lifeline during unexpected crises. While investment returns matter, access to capital is the primary motive.