Sources of Financing
Retained Earnings (RE)
Most primitive source of funding for any company
After profits are generated - company decides what to do with they earned capital and how to allocate it efficiently.
RE- can be distributed to shareholders as dividends, or the company can reduce the number of shares outstanding by initiating a stock repurchase campaign.
Company can invest the money into a new project, (building a new factory, partnering with other companies to cerate a joint venture.
Debt Capital
Companies obtain debt financing, / debt capital, privately through bank loans.
Also raise capital by issuing debt to the public.
The issuer (borrower) issues debt securities, such as corporate bonds / promissory notes. Debt issues also include debentures, leases, + mortgages.
Companies who initiate debt issues are borrowers because they exchange securities for cash needed to perform certain activities.
These companies will then be repaying the debt (principal + interest) according to the specified debt repayment schedule + contracts underlying the issued debt securities.
Drawback of borrowing money through debt is that borrowers need to make interest payments, as well as principal repayments, on time.
Failure of above may lead the borrower to default or bankruptcy.
Equity Capital
Refers to funds a company raises by offering ownership stakes, either publicly / privately, in exchange for investment
Compared to debt capital funding, companies with equity capital do not need to amke debt + interest payments.
Company profits are shred with investors instead.
Stock Market
Companies can raise funds from the public by offering ownership stakes in the form of stock (An IPO).
Ownership stakes are represented by shares issued to a wide range of institutional + individual investors.
When investors purchase these shares of stock, they become shareholders.
However, 1 disadvantage of capital funding is sharing profits among all shareholders in the long term.
More importantly, shareholders dilute a company’s ownership control as long as it sells more shares.
Private Market
Private equity capital is secured from private investors, such as venture capitalists / private equity firms. Companies raise funds from private investors in exchange for significant ownership stakes, often with a hands-on role in the company’s strategic direction.
Private equity + venture capital are common sources of equity capital for companies that are not yet publicly traded / are in the early stages of development.
Other Funding Sources
Include crowdfunding, donations or grants, and subsidies that may not have a direct requirement for return on investment (ROI).
What is Crowdfunding?
Represents a process of raising funds to fulfill a certain project / undertake a venture by obtaining small amounts of money from large number of individuals.
The crowdfunding process usually takes place online and is a common source of finance for startup businesses.
Donations
Common way for nonprofits + social enterprises to raise the funding they need to carry out their mission without the pressure of generating profits.
Donors who give money to nonprofits or social enterprises are motivated by the cause rather than financial returns.
Government Grants + Subsidies
Example of financing provided by government agencies to support specific projects, initiatives, or sectors that align with public policy goals.
Grants commonly provide funding for research, education, environmental protection, or community development.
Subsidies are financial assistance programs designed to lower the cost of goods or services, making them more accessible / promoting particular industries.
Agriculture is an example of an industry that frequently receives government subsidies.
What Factors Affect the Need for Sources of Funding
Businesses, most relevant factors influencing the need for funding typically include:
Growth Plans
Operational needs
Capital structure, i.e., mix of debt + equity
Research & Development (R&D)
Asset acquisitions
Stage of business development
Economic conditions / unexpected events, (natural disasters)
Bottom Line on Business Financing
Business aiming to grow, innovate / simply maintain stability in a competitive market should understand the various sources of funding.
All sources have their benefits and drawbacks.
They need to carefully evaluate their financial situation, growth plans, + overall strategic goals to choose the right mix of financing options.
Additionally, exploring alternative funding sources like (other sources) can provide valuable support without the obligations of traditional financing.
Ultimately, key to successful financing lies in balancing immediate needs with long-term objectives, ensuring that the chosen funding sources align with the company’s vision + capacity for growth.
Reference CFI - Sources of Finance