Capital financing refers to the methods that businesses use to raise money. There are two primary forms of capital financing: debt and equity. Equity capital is a business’s working capital from its investors and shareholders. Interest payments or monthly repayments do not accompany this form of capital financing.
Equity
Equity financing involves selling ownership stakes in a company to investors. Typical investors include angels, venture capitalists, and private equity firms. Investors usually expect a higher rate of return than lenders, as they bear more risk in funding new businesses. This type of financing is ideal for established companies with stable cash flow, a good credit rating, and assets (collateral) on their balance sheet. Start-ups that do not qualify for debt financing or have erratic revenues, net profits, and insufficient collateral use equity financing.
In this form of capital financing, you do not have to make regular loan payments and can keep more money in your business. However, you will sacrifice some control of the company and must give up future profits in exchange for the investment. Most companies rely on capital financial services, and many run extensive analyses of their costs to find the optimal capital structure. These analyses typically compare the benefits of each option against a formula called the weighted average cost of capital, or WACC.
Assets
Asset financing is a common way to secure funding for business growth. It involves pledging assets as security for debt. It can include hard items such as plants, machinery, and vehicles, and soft assets such as software, CCTV, or tills. This finance method can benefit small businesses and start-ups that may still need to qualify for long-term loans. It also allows a company to spread the purchase cost and free up vital working capital. This form of funding can also be used to fund day-to-day expenses, such as payroll or rent. However, balancing this type of funding with other states is important, as debt and equity issuance can drain your business’ cash flow. Moreover, you will have to make regular payments and interest on your loan, which can be difficult if your company is not profitable. Therefore, it is best to run an extensive analysis of your options.
Loans
Loan financing is a form of capital funding whereby a company borrows money from banks or other lenders and must repay the funds with interest. Companies often use this type of financing to finance fixed assets or working capital. When a business borrows funds from lenders, they must typically pledge collateral to secure the loans. Lenders will usually charge a rate of interest that varies depending on the borrower’s credit standing and the loan amount. These rates can be fixed, revolving, or a combination of both, and the loan terms will be outlined in detail by the lender.
Another way that companies raise capital is by issuing additional shares in the market. It will dilute existing shareholders’ holdings and give new investors a larger proportion of the company and voting rights. However, this type of capital financing will often come with higher interest rates than debt financing.
Debt
A business’s capital financing can come from both debt and equity. Debt financing involves borrowed funds that must be repaid with interest. Entities like banks or financial institutions usually give these funds. They can also be acquired through alternative sources like invoice factoring, which involves an entity offering businesses short-term loans in exchange for a percentage of a company’s recurring revenue minus a fee.
Another way to raise debt financing is by selling corporate bonds to individuals and through institutions. These investors get paid back through coupon payments twice a year until the bond matures. Other debt instruments include debentures and mortgages. A more flexible type of debt financing is a line of credit, which allows companies to borrow against their assets or accounts receivable for specific purposes, such as expansion and renovation projects. Other types of debt financing include commercial real estate loans and equipment financing. These types of financing require fixed repayment schedules and typically involve higher interest rates.
