In the business world alone, capital has several meanings. In a broad economic sense, capital refers to any of a company’s assets that hold monetary value, including funds, property, plant and equipment, and inventory. In this sense, capital is generally used as a measure of wealth or a tool to generate wealth (i.e., via direct investment).
In the narrower context of business finance, capital refers to funds or liquid assets held in reserve or for expenditure in day-to-day operations and investment in future growth.
The importance and use of capital
If you have ever attended a finance or accounting class at university, you may recall the phrase: “cash is king”. As it turns out, this is true, and cash, or capital in general, is indeed one of the most important factors in deciding whether a business succeeds or fails.
First, consider the concept of credit sales. For many businesses, revenue will be larger than funds received from customers at the end of a given financial period. This is because businesses often accept credit sales. The collection period for these receipts can vary between a few days to a few months. However, over the collection period, a business will still need to pay operating expenses like wages, utilities, and the cost of sales. Therefore, a business needs to manage its capital to have enough money to continue operations throughout its’ usual working capital cycle and ultimately avoid insolvency.
Capital is equally critical for expanding a business’s operations. Expanding operations requires additional inventory, machinery, employees, property, and office equipment for some businesses. For other businesses, expanding operations requires an effective marketing campaign.
Capital is critical for obtaining the necessary tools required to grow a business. Sometimes the window of opportunity available to expand a business is small. Therefore, it is imperative that a business is well-capitalised and can take advantage of a great business idea or opportunity.
Sources of capital
Capital can be generated from several sources, depending on the size of the company and the stage of the business life cycle a company is in.
Start-ups and small businesses typically rely on personal savings, a personal loan from friends or family, an angel investment, or an investment from a venture capital firm. Large unlisted private companies can generate capital from an initial public offering. Established businesses can generate capital from local, state, or federal government grants, private business loans from a bank, and public market debt (including debt securities from the bond or money market).
Capital is generally generated from three main sources: debt, equity, or business operations (operating cash flow).
Most existing businesses generate capital from business operations (i.e., from selling goods and services). Businesses often retain earnings (instead of paying out dividends to existing shareholders) to fund future operations and growth. Some businesses generate capital by borrowing money from financial institutions or public markets. Alternatively, businesses can raise more money from current shareholders and new investors through capital raising.
What is a capital raise?
Capital raising is where a business asks shareholders or lenders for additional funding. These shareholders can be both current or prospective institutional investors or retail investors.
Types of capital raise
Capital raising can take the form of debt, equity or an instrument combining debt and equity.
Debt raising is where a company borrows money from financial institutions, private investors or public markets. Debt must be repaid at a later date.
Equity financing involves raising money by issuing common stock to retail and professional investors. Whilst equity does not need to be repaid, an investor receives an ownership stake in a firm due to purchasing stock. Investors can then potentially receive a return on investment when the firm issues dividends or sells its share at a higher price to other investors.
Methods of raising capital
In public markets, businesses can raise equity through an initial public offering, share placements and purchase plans.
An initial public offering (IPO) is where a business offers investors the opportunity to purchase a share in the firm. The shares can then be traded on a public stock exchange like the ASX. This is typically a long process involving a roadshow (where the business is marketed to prospective investors) and publishing a prospectus (a document that outlines the company’s performance and what the raise will be used for etc.). The IPO process is typically aided by an investment bank. Upon floating, the firm must then frequently publish reports and abide by the regulations set by the public market’s governing body.
Share placements are where shares are offered to sophisticated (experienced high net worth investors) or institutional investors. This process is beneficial as it can be conducted quickly. However, a firm’s restricted by the amount that can be raised through this method.
On the other hand, a share purchase plan is an opportunity for existing retail investors to purchase more shares at a (typically) discounted price.
In private markets, businesses frequently approach venture capitalists, private equity firms and other capital partners to raise funds. These firms pool funds from institutional investors
What simple steps can you take to help raise capital for your business?
Improve your financial statements
Cleaning up your financial statements is a simple way to capture the attention of lenders and investors. This may involve paying down outstanding debt to improve your balance sheet. Cashflow can be improved by negotiating shorter receivables periods with your debtors. You can also improve your profit and loss statement by reducing certain operating expenses.
Develop a solid business plan
Well-crafted business plans outline a company’s goals, target market, competition, and financial projections. A plan should also include a clear strategy for generating revenue and achieving growth.
Focus on your unique value proposition
What sets your business apart from the competition? Communicate your unique value proposition to potential investors and explain why your business is poised for success.
Investors want to see that your business has gained momentum through customer acquisition, revenue growth, or other key indicators. By demonstrating traction, you can show investors that your business has the potential for future success.
Greenwich Capital Partners
At Greenwich, we work closely with small to medium-sized enterprise owners and management teams to assist with the continued growth of their businesses.
As a capital partner, we provide the following services:
- Operational and process improvement
- Restructuring and repositioning
- Governance, leadership, talent and culture
- Mergers and acquisitions
- Capital structure optimisation
- Sourcing debt and equity capital
Frequently Asked Questions
Why would you want to raise capital?
Companies typically conduct capital raising to fund growth. The funds can be used for acquisition. This is a common practice among venture capital and private equity firms. The funds can also enable a business to expand by entering new markets or create value for customers by creating new products. Raisings can also be utilised to enable businesses to improve their balance sheets or improve daily operations.
Sometimes, businesses raise capital to rebalance the company’s capital structure. For example, a highly leveraged company can lower its debt-to-equity ratio by issuing shares to rebalance its capital structure. This practice is common amongst public companies, where capital structure influences various valuation methods.
Is raising capital good?
Determining whether a capital raising is beneficial depends on the allocation of the raising. If a firm’s management team can effectively allocate and invest funds, a raising can enable a company to grow faster and further than possible without the raising. It also depends on the type of raising and the current capital structure of the business. For example, if the firm’s structure is heavily debt-weighted, a debt raising can be detrimental to the firm’s value when interest rates rise.
What are three sources of capital?
The three most common sources of capital are:
- Debt capital, where a company borrows money;
- Equity capital, where a company sells an ownership stake in the business;
- Retained earnings generated from profitable operations.
How do small businesses get capital?
Small enterprises can obtain a small business loan through a bank. Alternatively, they can approach venture capital or private equity firms specialising in fostering small businesses.