THE NEED FOR CAPITAL * START-UP OR VENTURE CAPITAL * WORKING CAPITAL * INVESTMENT CAPITAL
START-UP CAPITAL – “Seed money” which is simply the money needed to begin one’s business, to pay your first rent, licensing fees and all costs associated with starting a business. VENTURE CAPITAL – Started by wealthy individuals who have surplus cash but do not have time to run a company. These venture capitalists will buy shares for an average of 4-5 years and then sell them back to the entrepreneur at a profit.
ADVANTAGES OF START-UP OR VENTURE CAPITAL * Raises much needed capital without losing control for very long * Can have access to management advice from the venture capitalist * Do not have to register on the stock exchange * Less legal constraints DISADVANTAGES OF START-UP OR VENTURE CAPITAL * Although temporary, some control is lost * Shared profits until the venture capitalist is repayed * May have to repay high amounts to the venture capitalist
WORKING CAPITAL – The funds available to run the day to day operations of the business. Working capital is used to meet short term obligations of the business, such as purchasing goods, office supplies, paying rent and wages. It is calculated by using the equation: Working Capital = Current Assets – Current Liabilities
CURRENT ASSETS – resources that the business expects to get rid of (convert into cash) within one year or the businesses operating cycle, whichever is longer. Eg. Stock, cash, bank, accounts receivable Current Liabilities – obligation that the business expects to pay within one year or the businesses operating cycle, whichever is longer. Eg. Accounts payable, overdraft, short term loans
INVESTMENT CAPITAL – Money put back into the business to foster growth and productive capacity. It may include investment in better machinery or a bigger plant (factory) for example.
SOURCES OF FINANCE * Debt Financing – When companies Borrow from lending institutions, they take on loans (which are a form of debt), which they repay over time with added interest. Trade Credit is also a form of debt financing where businesses are allowed to buy supplies and stock on credit, to be repaid at a later date often within the short term. * Equity Financing – refers to funds that are raised by a business in exchange for ownership in the company. Often raised by issuing shares in the company. Unlike debt financing which must be repaid over time, equity financing does not have to be repaid. Equity also comes in the form of direct capital investment.
DEBT VS EQUITY DEBTEQUITY Must be repaid with interest on a schedule whether or not the business makes money. Risk may be high Does not have to be repaid The original owner can retain control. Lending institutions are not interested in taking a share of the business Investors/shareholders can influence management decisions as they share ownership in the company Once the debt is repaid, the lender has no further interaction or claim on the business Risk is kept low. It is often difficult for small businesses and new ventures to obtain debt financing Dividends are paid out
FORMS OF EQUITY * Capital – The profit retained in the company by the directors for investment purposes. This profit still belongs to the shareholders since they are the owners but it will not be paid to them unless the business is liquidated. * Shares – The sale of shares raises finance ofr a company in exchange for part ownership in the company. Dividends are part of the profits that are paid to shareholders as a return on their investment.
FORMS OF DEBT * Debentures – long term debt which is unsecured, meaning that there is no collateral put up in the event that the debt is not repaid to the borrower. The two parties sign an agreement called an indenture * Bonds – issued for a period of a year or more and are a means of raising capital. There is a written agreement to repay and the debt is secured against assets of the company. Governments, corporations and other institutions issue bonds. Some bonds do not pay interest but even if this is the case, the principal amount is repaid. * Short term debts – to be repaid within one year or the businesses operating cycle whichever is longer.
SOURCES OF SHORT TERM FINANCE * Bank overdraft and short term bank loans * Trade credit * Debt factoring
SOURCES OF MEDIUM TERM FINANCE * Hire Purchase * Leasing * Medium Term Bank Loan
SOURCES OF LONG TERM FINANCE * Commercial banks * Development banks eg ADB, BDC * Venture capital * Small business associations * Development funds * Family