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Running a business requires a great deal of capital. Capital can take different forms, from human and labor capital to economic capital. But when most people hear the term financial capital, the first thing that comes to mind is usually money. That's not necessarily untrue. Financial capital is represented by assets, securities , and yes, cash. Having access to cash can mean the difference between companies expanding or staying behind and being left in the lurch.
But how can companies raise the capital they need to keep them going and to fund their future projects? And what options do they have available? There are two types of capital that a company can use to fund operations: debt and equity.
Prudent corporate finance practice involves determining the mix of debt and equity that is most cost-effective. This article examines both kinds of capital. Debt capital is also referred to as debt financing. Funding by means of debt capital happens when a company borrows money and agrees to pay it back to the lender at a later date. The most common types of debt capital companies use are loans and bonds , which larger companies use to fuel their expansion plans or to fund new projects.
Smaller businesses may even use credit cards to raise their own capital. A company looking to raise capital through debt may need to approach a bank for a loan, where the bank becomes the lender and the company becomes the debtor.
In exchange for the loan, the bank charges interest, which the company will note, along with the loan, on its balance sheet. The other option is to issue corporate bonds. These bonds are sold to investors—also known as bondholders or lenders—and mature after a certain date. Before reaching maturity , the company is responsible for issuing interest payments on the bond to investors. Because corporate bonds generally come with a high amount of risk , they pay a much higher yield.
That's because the chances of default are higher than bonds issued by the government. The money raised from bond issuance can be used by the company for its expansion plans. While this is a great way to raise much-needed money, debt capital does come with a downside, notably the additional burden of interest. This expense, incurred just for the privilege of accessing funds, is referred to as the cost of debt capital. Interest payments must be made to lenders regardless of business performance.
In a low season or bad economy, a highly leveraged company may have debt payments that exceed its revenue.
Let's look at the loan scenario as an example. Of course, most loans are not repaid so quickly, so the actual amount of compounded interest on such a large loan can add up quickly. Sample 3. Capital Raise means the issuance by the Company of Common Stock or other Equity Securities of the Company in a private placement or similar transaction pursuant to which the Company raises additional capital.
Capital Raise means the dollar amount or equivalent amount in dollars of any capital raised by the Corporate Guarantor as evidenced in the Latest Accounts ;". An entrepreneur and one of his vice presidents held simultaneous negotiations with several venture capitalists, three or four strategic partners, and the source of a bridge capital loan. After about six months, the company was down to 60 days of cash, and the prospective backer most interested in the deal knew it.
The managers felt that while the deal was not cheap, it was less expensive than conventional venture capital, and they had few alternatives since none of the other negotiations had gotten that serious.
Yet the entrepreneurs were able to hide their bargaining weakness. Each time a round of negotiations was scheduled, the company founder made sure he scheduled another meeting that same afternoon several hours away. He created the effect of more intense discussion elsewhere than in fact existed. By saying that he had to get to Chicago to continue discussions with venture capitalist XYZ, the founder kept the investors wondering just how strong their position was.
The founder finally struck a deal with the one investor that was interested and on terms he was quite comfortable with. The company has since gone public and is a leader in its industry. The lead entrepreneur understood what many others do not: you must assume the deal will never close and keep looking for investors even when one is seriously interested.
While it is tempting to end the hard work of finding money, continuing the search not only saves time if the deal falls through but also strengthens your negotiating position. Why should you have to get involved in the minutiae of legal and accounting documents when you pay professionals big fees to handle them? Because you are the one who has to live with them. Deals are structured many different ways.
The legal documentation spells out the terms, covenants, conditions, responsibilities, and rights of the parties in the transaction. The money sources make deals every day, so naturally they are more comfortable with the process than the entrepreneur who is going through it for the first or second time. Covenants can deprive a company of the flexibility it needs to respond to unexpected situations, and lawyers, however competent and conscientious, cannot know for sure what conditions and terms the business is unable to withstand.
The clause was so open to interpretation that it gave the bank, which was already adversarial, a loaded gun. Any unexpected event could be used to call the loan, thereby throwing an already troubled company into such turmoil that it probably would have been forced into bankruptcy.
When the founders read the fine print, they knew instantly that the terms were unacceptable, and the agreement was then revised. An infusion of capital—be it debt or equity, from private or institutional sources—can drive a company to new heights, or at least carry it through a trying period.
Many financing alternatives exist for small enterprises, and entrepreneurs should not be afraid to use them. They should however, be prepared to invest the time and money to do a thorough and careful search for capital. The very process of raising money is costly and cumbersome. It cannot be done casually, nor can it be delegated.
And it has inherent risks. Since no deal is perfect and since even the most savvy entrepreneurs are at a disadvantage in negotiating with people who strike deals for a living, there is strong incentive for entrepreneurs to learn as much as they can about the process—including the very things they are probably least interested in knowing.
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Jeffry A. Timmons is the Frederic C. Dale A.
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