In the present day, most people wish to start their own business and be financially independent. However, a major stumbling block has always been inadequate capital. Below, we explore the two most common forms of raising capital: debt financing and equity financing.
Debt financing involves borrowing funds with a promise to pay back with interest in the future. Debt instruments include bonds, bills and loans. A bond is a fixed income instrument that specifies the interest rate and when the company will pay back the principal. When a business issues a bond, the investors that purchase it act as lenders. Loans accessed from banks, saccos and microfinance institutions can also finance businesses. If it is a start up, then the owner will most likely be required to guarantee the loan.
Debt financing makes funds quickly available and allows the business owner to maintain a controlling stake in the business and remain the sole decisionmaker. On the other hand, they can only be accessed if the owner has a good credit rating. On top of that, a business with huge debt may be seen as risky, deterring potential investors. Furthermore, this financing method requires strict discipline as far as repayments go.
Equity financing, on the other hand, raises capital through the sale of shares or a stake of ownership of the company. Examples of equity financing include angel investing, venture capital, private placement and stock market listings. Angel investors are wealthy individuals who invest in start-ups or companies that are still in the seed stage and have the potential for growth in exchange for a stake of the company’s equity.
Venture capital funding lets small businesses with a high growth prospect access long term funding in exchange for a share of its equity. The stock markets help businesses and companies to access capital for growth through selling of their shares on the bourse via IPOs (Initial Public Offerings).
Equity financing is suitable for companies with credit and cashflow problems since cash will not be taken out of the business frequently. It is also less risky compared to debt financing since there are no fixed monthly repayments to make. Additionally, this method allows for long-term planning because investors do not need a return on their return immediately. On the flip side, the business proprietor completely cedes control of the company. He or she may also contend with disagreements with other partners when making decisions and be forced to share profits.
Standard Investment Bank continues to play an important role in helping companies raise capital through both debt and equity financing. We have been involved in capital-raising transactions of up to Kshs 239 billion since 2005, which include IPOs, rights issues, private placements and issuing of bonds.
For public and private companies looking to raise capital, email us at advisory@sib.co.ke
Sharon Sifa is a Corporate Finance Associate at Standard Investment Bank.
Great information