Definition of Capital Financing

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Businesses run on money. Capital financing refers to the methods you use to raise money to launch your business and set up cash reserves in case the revenue stream dries up for a while. The two primary forms of capital finance are selling ownership in your company and taking on debt.

TL;DR (Too Long; Didn't Read)

Capital financing is defined as the methods businesses use to raise money, such as debt financing and equity financing. In debt financing, you borrow money to pay for business operations. With equity financing, you sell an ownership stake in the company — by issuing stock, for example.

Examples of Capital

Capital is more than just money. Your business can have several types of capital, including financial, human and natural.

  • Financial capital comes primarily from equity and debt when you start your business. Over time, revenues give you more capital to work with.

  • Human capital refers to you and your team and the abilities you have: social networking skills, intellectual abilities, experience, talents and training.

  • Natural capital covers any natural resources you're able to tap. Resources could include a silver mine, a forest of high-quality timber, or the use of wind or solar power to generate energy. 

While many businesses do fine without natural capital, few of them can function without human and financial capital.

Uses of Capital

Financial capital keeps your business running. It makes it possible for you to buy goods and services such as office equipment, factory equipment, vehicles, web design services and liability insurance. If you have employees, you pay their wages with capital.

After you start earning a profit, some of your capital comes from your revenues. When you start your business, you'll probably need an outside source. Even established businesses often need additional capital financing.

Capital Finance: Equity

Capital financing consists of the methods your business can take to raise money. If you're starting small or you have deep pockets, you may be able to survive with only your own resources. However, most small businesses rely on raising capital either by debt or equity financing.

With equity financing, you sell off an ownership stake in your business in return for capital. Public stock offerings are one way to raise money, but you can also issue stock privately to venture capital firms or individual investors. Unlike debt financing, you don't pay interest and don't have to make installment payments every month; investors make their money from dividends or from selling the stock when the price rises.

The drawbacks? When you're not the sole owner, you lose some of your control. Offering stock to thousands of investors may be less of a challenge to your authority than selling it privately to a high-powered venture-capital firm. However, a public stock offering is expensive due to federal regulations and necessary paperwork.

Capital Finance: Debt

The alternative to selling equity in your business is to take on debt. The most common form of debt financing is borrowed money. Loans can be short-term or long-term, backed by cosigners or by collateral, and high-interest or low.

The advantage of borrowing money using any of these types of capital financing is that you don't give up any control over your company. However, you have to make regular payments on the loan, including interest, which can drain your capital down the road. If you can't make payments, you lose your assets or enter bankruptcy.

Most companies that rely on capital finance try to balance the two forms. Don't take on so much debt that the payments wipe out your profits. Don't sell so much equity that it's no longer your company.

References

About the Author

Fraser Sherman has written about every aspect of business: how to start one, how to keep one in the black, the best business structure, the details of financial statements. He's also run a couple of small businesses of his own. He lives in Durham NC with his awesome wife and two wonderful dogs. His website is frasersherman.com

Photo Credits

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