In the capital raising process, it is essential to identify different sources of capital and select the type that best aligns with the company’s objectives. Capital options can generally be divided into three main categories: equity, debt, and grant-based capital. Each type of capital has its own characteristics and implications for the company’s risk profile and valuation. This blog post examines the features and uses of these three types of capital or funds to consider when entering fundraising.
See also this blog series' previous article on the materials for capital raising here.
1. Equity Capital
Equity capital involves raising funds in exchange for shares in the company. This form of capital brings both benefits and challenges, which are essential to consider in the decision-making process.
- Shares in Exchange for Capital: Equity capital means that investors receive shares in the company, giving them ownership and voting rights.
- Priority in Bankruptcy: In the event of bankruptcy, equity investors are often last in line for any remaining assets, which places them in the lowest priority.
- Return from Share Appreciation and Dividends: Investors’ returns come from the appreciation of shares and potential dividends that the company may distribute.
- Types of Investors: Equity investors can often be categorized as financial investors (e.g., funds), strategic investors (e.g., industrial operators in the same sector), or a combination of both depending on whether the investment is entirely independent of the investor’s other operations such as industrial activities.
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- Financial Investors: For financial investors, it is essential to ensure that the investment aligns with their operational boundaries. For example, funds may limit their investments to specific types of companies, and choosing not to invest may indicate that the project does not meet their criteria, such as company size, industry, or stage in its life cycle.
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- Strategic Investors: For strategic investors, it is crucial to assess the added value or synergies that collaboration between the investor and the target company might bring. For example, the investment target could be valuable as a distribution channel or as a unique service package marketed with exclusivity, adding value to the strategic investor.
2. Debt Capital
Debt capital involves raising funds through loans, where the capital is exchanged for collateral, and the return comes in the form of interest and principal repayments. The position and terms of debt capital can vary significantly depending on the company’s needs and stage of development.
- Collateral in Exchange for Capital: Debt capital is typically secured with collateral, which reduces the lender’s risk.
- Priority in Bankruptcy: Debt investors are often in a more favorablefavourable position in the event of bankruptcy, adding security to their investment.
- Returns: Debt investors earn returns through interest and principal repayments.
- Cash Flows and Debt Repayment Capacity: Assessing future cash flows is a key focus for lenders, as cash flow determines the company’s ability to repay loans on schedule. Cash flow analysis helps lenders evaluate whether the company can reliably meet loan terms and repayment obligations. Stable and predictable cash flows are often crucial factors in lending decisions.
- Debt Options: Depending on the company’s life cycle and funding needs, debt capital options can vary widely. Examples include government development loans, venture debt, growth loans from funds, bank loans, leasing, receivables-based financing structures, export credits, and publicly traded bonds.
- Diverse Loan Terms: Loan structures can vary significantly, with as many combinations of loan terms and individual practices as there are lenders. This diversity allows companies to tailor financing to their specific needs.
3. Grant-based Capital
Grant-based capital, often referred to as "free money," is typically provided by public institutions and is often used to finance high-risk projects.
- Free Money and Competition: Grants are highly competitive since they do not need to be repaid.
- Public Funding: Grants usually come from public institutions and are aimed at specific projects that support economic development or innovation.
- Private Capital Required: Grants often require private capital alongside them, complementing public and private funds.
- High-Risk Projects: Grants are often directed toward high-risk projects, such as product development, technology demonstration, or production investments in a new industry.
- Types of Grants: Grants can take various forms, such as direct subsidies paid as a lump sum or tariff-based grants, where support is provided based on the quantity of the produced good.
Conclusion
Identifying sources of capital and understanding their characteristics is essential for a successful fundraising process. Equity investors can bring long-term growth support to the company, debt lenders provide more secure funding with repayment, and grants can enable high-risk projects without the obligation of repayment. Each capital option requires careful consideration, and the right choice can help the company grow and achieve its goals.
Author of the blog:
Miikka Lievonen
Director, Grannenfelt Finance
miikka.lievonen@grannenfeltfinance.fi
+358 50 554 5844
LinkedIn-profile
The writer has 10 years of experience working in corporate finance and capital raising related projects. He has advised multiple growth companies in fundraising including Vastuu Group, Beely, P2X Solutions, and Varjo.
