Capital funding is the money that lenders and investors give to a business to care for its needs. A company’s capital includes both loans (debt) and stock (equity).
Debt and equity are very different types of capital funding. Lenders may provide money for needed infrastructure and growth projects, but expect the loan and interest to be paid off in a timely manner.
In contrast, investors buy shares of the company and expect that those shares will increase in value. Both strategies provide the opportunity for new businesses and established businesses alike to obtain working capital in order to meet key objectives. However, equity will take a piece of ownership away from founders and management while debt will not.
What is capital funding used for?
Businesses use capital funding for a wide variety of projects and investments. These may include:
- Company expansion — the purchase of real estate, staffing increases, etc.
- Acquisitions — including buyouts and mergers
- Market penetration — the development of new product/service offerings, or entry into a new geographic region
Ultimately, the business that receives the capital funding hopes to convert that cash into more valuable assets and increased revenue. Within that framework, capital funding can be used for countless initiatives.
Types of Funding
There are three basic types of capital funding: equity, debtl, and venture capital. These forms of capital financing each have their unique benefits and disadvantages. Let’s discuss them in more detail.
Equity capital is working capital that a business receives from its owners and shareholders. This type of capital doesn’t have to be paid back. Equity capital represents the value of a company’s assets minus its liabilities.
The main advantage of equity capital is freedom from debt. While shareholders do claim an ownership stake in the company, there are no deadlines to pay off a loan or risk penalties. On the other hand, a business founded solely on equity capital may struggle to grow when cash is limited. Moreover, the cost of issuing stock may be higher than taking out a loan.
Debt capital is a form of capital provided by lenders. The owner of the capital typically agrees to regular payments to the lender (including a predetermined interest rate) in exchange for using the lender’s money.
In terms of raising capital, debt capital may be easier to obtain than equity financing – and there may be more available. This type of working capital can result in strong short-term growth and increased profitability. On the other hand, a company is contractually obligated to pay off the loan by a specific deadline. If the business suffers unexpected setbacks before paying it off, then debt capital could become a severe challenge to the company’s financial viability.
Venture capital funding is a form of financing provided to early-stage companies. Venture capitalists typically invest in startups with high upside and high risk. The ultimate objective of venture capitalists is to turn a profit from a diversified portfolio — which means, if the company is successful, selling their shares (or even the company) at some point in the future.
Venture capital is an excellent way to send company growth into “overdrive.” Besides a steady stream of cash, venture capital firms often have the technical expertise to streamline and optimize a startup’s business processes, and provide the infrastructure it needs. On the other hand, venture capitalists may also expect a certain measure of control in company oversight. Most importantly, entrepreneurs that accept venture capital are committing to an eventual exit: either by selling the company, or going public.
Making capital funding work for you
Capital funding is an important means of obtaining cash, and even infrastructure, with the objective of generating increased revenue from company projects and investments. Many companies use equity, debt and venture capital to achieve their short-term goals and position themselves for sustainable success.
It’s important to understand the basics of each type of working capital. If you do, you’ll be able to make sound business decisions as you look for ways to expand your presence and grow your brand.