BUSINESS FINANCING AND THE CAPITAL STRUCTURE
BUSINESS FINANCING AND THE CAPITAL STRUCTURE
Raisinga business capital is a crucial step on every entrepreneur who aims at starting a business. They should conduct extensive research on various funding options which will suit their specifications. They should also consider the prevailing market competition to help them chose a method that would give their businesses an upper hand in the competing market.
There are two ways in which the entrepreneurs can acquire a startup capital. One is through equity financing, and the other one is through debt financing.
Equity financing is private- investors’ money that the entrepreneur gets in exchange for a share of ownership in the business. In general the capital is provided by a venture capitalist or angel investors. On the other hand, debt financing is financing one's business using a long-term loan acquired from a bank or any other money-lending institutions.
Advantages and disadvantages of equity and debt financing
Equity advantages
The equity financer does not have to be repaid as part the agreement states that payment is made on the profit made. Not worrying about the repayments helps the entrepreneur to shift their focus on making the products more profitable. Maintaining a low debt-to-equity ratio also puts the entrepreneur in a better position to apply for a loan in the future.
Equity disadvantages
An entrepreneur loses partially or complete autonomy over the business to the investor. In most cases, the investors always want a larger share of the business as well as say in every decision making process. Over time, one realizes that the shared amount normally exceeds the loan amount.
Debt advantages
This method equips the entrepreneur with funds needed to buy new buildings, equipment and any other fixed or current assets before earning the necessary funds. It best suits those who want to pursue a growth strategy with low interest rates. The entrepreneur also experiences the benefits of repaying the loan in installments. He or she does not suffer the consequences that equity financing brings to the business, like sharing the business ownership.
Debt disadvantages
The most observable drawback in this method is that the loan is repaid plus and added interest, failure to do so the entrepreneur risks repossession of the goods by the bank. The profit earned by the business is spent repaying the loan rather than expanding the business. Overusing of debt financing also leads to stifle growth and severely limits future cash flow.
Selecting a proper investment banker
There are five points that an entrepreneur should consider while hiring an investment banker. One is the experience that the investment banking has in this field. Raising a business capital is one of the most complex processes that only an experienced investment banker will execute the plans well enough. It should also have a strong, professional support team that properly creates a dynamic marketing program that maximizes the value of the entrepreneur business. The investment banker should be at a position of creating some chemistry between the two parties involved. The investment banker should also be trustworthy as the entrepreneur places his or her life’s work in the investor banker’s hands. The tenacity level of the investment banker should also be credible.
Historical relationships between risk and return for common stocks versus corporate bonds
The risk and returns that are commonly associated with corporate bonds largely depends on the monetary steadiness and performance of the company issuing the bonds. This is because, if the company happens to go bankrupt it may not be at any possible position to repay the loan or any return on investments. On the other hand, the risk of owning common stock includes any loss on a projected portfolio and the money paid for the shares, only if the share price drops below the original price.
How diversification helps reduce risk in a portfolio
Diversification is a technique that minimizes various risks by distributing and allocating investments among various financial institutions, industries and other related categories. It also aims at maximizing profits or returns by investing in diverse areas that would each react differently to the same event.
Reference
Mayo, H. (2010). Investments: An Introduction. New York, USA: Cengage Learning.
