- WHY IS CAPITAL NEEDED FOR A BUSINESS?
Capital/Fundings helps business initiate their journey by hiring a team, buying equipment, marketing and also promoting their brand. Companies always seek sources of funding to grow their business. Funding, also called financing, represents an act of contributing resources to finance a program, project, or need. Funding can be initiated for either short-term or long-term purposes. An entrepreneur can perform a lot of business model development without funding; but when it comes to building the company, funding is necessary.
Types of Capital for a Business:
Add retained Earnings as that is the best source of capital and a short para for it.
- MEZZANINE CAPITAL:
Mezzanine financing is a hybrid of debt and equity financing that gives the lender the right to convert the debt to an equity interest in the company in case of default, generally, after venture capital companies and other senior lenders are paid. In terms of risk, it exists between senior debt and equity.
Companies will turn to mezzanine financing in order to fund specific growth projects or to help with acquisitions having short- to medium-term time horizons. There are various ways in which mezzanine debt can be structured, the most common being a legal right to convert to equity, in case the debt is not repaid on time or repaid in full. The percentage of interest can be structured differently, with some portion being fixed and some portion variable. In mezzanine financing, interest can also be paid by increasing the principal amount, instead of frequent cash pay-outs. The most common structure for mezzanine financing is unsecured subordinated debt.
- EQUITY CAPITAL:
Companies can raise funds from the public in exchange for a proportionate ownership stake in the company in the form of shares issued to investors who become shareholders after purchasing the shares. However, one disadvantage of equity 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.
From a valuation perspective, equity capital is considered to be the net amount of any funds that would be returned to investors if all assets were to be liquidated and all corporate liabilities settled. In some cases, this may be a negative figure, since the market value of company assets may be lower than the aggregate amount of liabilities.
- DEBT CAPITAL:
Debt capital is the capital that a business raises by taking out a loan. It is a loan made to a company, typically as growth capital, and is normally repaid at some future date. Debt capital differs from equity or share capital because subscribers to debt capital do not become part owners of the business, but are merely creditors, and the suppliers of debt capital usually receive a contractually fixed annual percentage return on their loan, and this is known as the coupon rate.
Debt capital ranks higher than equity capital for the repayment of annual returns. This means that legally the interest on debt capital must be repaid in full before any dividends are paid to any suppliers of equity. Common types of debt capital are: bank loans, personal loans.
An entrepreneur should choose one which meets the capital structure that best fits their business.