Sources of Capital and How to Evaluate Them

Capital is used to fund the day-to-day operations as well as the long-term growth of your company. You must obtain it and use it wisely to create a strong, healthy business.

In most companies, the capital structure is a combination of various sources of capital. It’s important you understand each source and how it will affect your business goals and long-term success. With this information, you will be making smarter decisions for your business.

Sources of Capital

Let’s take a closer look at several types of capital and how they work.

Debt Capital

Debt capital refers to any type of money that is borrowed and must be repaid.

There are a variety of ways you can secure debt capital including:

Credit cards
- Business credit cards function similarly to personal credit cards. You’re given a credit line and are expected to repay the credit within a given time period, if you do not repay in time, you will begin collecting interest.
- Credit cards will best serve your business if you need a smaller amount of financing or don’t qualify for loans.
Bank loans
- Borrowing money through a bank lender isn’t always easy for new businesses. Banks can be leery of lending to businesses lacking proof of financial stability. However, this is one of the more common ways to secure debt capital. Usually, interest rates are low and the money can be used on anything.
- Bank loans are good for short or long-term debt, depending on the size of the loan and how quickly you plan to pay it back.
Government loans
- The Small Business Association (and some other programs) offers loans and is the most popular way for entrepreneurs to acquire debt capital. However, you have to explain why you need the capital and show you are able to repay the loan.
- Again, depending on the size of the loan and how quickly you plan to pay it back, government loans may be a good option.

Like most forms of debt, debt capital requires an agreement to pay interest. This can be a drawback to using debt capital because if you aren’t careful, you could create a much bigger financial burden for your business. Additionally, in the unfortunate event your business fails, you are still responsible for paying what is owed.

On the other hand, leveraging debt capital comes with its advantage. Since your debt is finite you, or your lender, can calculate exactly how much is needed for repayment each month. As long as you don’t miss a payment, and once the debt and interest are fully paid, the burden is no longer on your plate.

Another advantage to using this type of capital is that it does not dilute the owner’s interest in the company like other forms, such as equity capital which will be discussed in the next section. The debt is yours, meaning you pay for it with your revenue. You don’t have to worry about paying out your revenue to equity owners. Your money stays within your business.

Equity Capital

Equity capital is money from invested shareholders. As mentioned in the previous section, using equity as a form of capital dilutes the owner’s interest in the business because each shareholder is considered part-owner, even if it is just a small fraction of the company.

Here are the two most common forms:

Common stock
- Common stock is typically sold to shareholders to raise capital. Shareholders with common get some say in certain business decisions and could potentially receive random dividends.
Preferred stock
- Preferred stock owners have no voting rights but businesses usually pay a fixed dividend to preferred shareholders before they pay common shareholders. However, businesses are not required to pay anything.

Unlike debt capital, equity capital does not need to be repaid, however, businesses will usually provide some return on the investment made by shareholders based on market performance. Equity is most useful when your company’s eyes are set on high levels of growth and you are looking to scale the company quickly.

Like any source of capital, leveraging equity comes with its advantages.

You and your business are not required to repay investors. Resulting in less risk because there isn’t a required payment due, even if your business fails.
Investors could end up being a significant benefit to your business, depending on the role they want to play.
- Types of investors:
  - Angel investors – Angel investors usually are closely connected to the business, offer less than $500,000 as an investment, and typically stay out of management decisions.
  - Venture capitalists – Venture capitalists are picky investors who generally want a say in business decisions.
  - Accelerators – Accelerators offer mentorships, investors, and other support to new businesses. They will play a heavy role in the management of your business.

While you may find benefits from equity capital, you may be put off by some of its disadvantages.

Leveraging equity requires a lot of your time.
- You’ll need to provide your shareholders with a detailed look into your business plan and continually update them on your progress.
There’s a chance you’ll lose control of your business.
- The more involved your shareholders are, the more say they will want in business decisions.

Crowdfunding

Crowdfunding is a newer, growing type of capital that is accessible to companies. It is the use of small amounts of funding from a large number of people to reach the desired goal. Instead of turning to one lender, the funds come from many individuals.

Social media has aided in the uprising of crowdfunding because large amounts of people are easily accessible. Investors can come from anywhere to support your business.

Crowdfunding comes with its benefits:

You won’t have to give up equity in your company.
- Multiple investors are giving your business money simply because they support the idea. They expect nothing in return.
You can test the market.
- Investors are quite literally buying into your business. A high level of support in crowdfunding can often mean a high level of support within your market.

However, a disadvantage to crowdfunding is that it can carry a negative reputation when it comes to public opinion because it is sometimes seen as a last resort to funding.

If your company does not have access to alternative forms of capital, crowdfunding may be an option.

Capital Grants

Capital grants are an award of money given to the company to achieve a specific goal or to incentivize performance. These are funds that do not have to be repaid but may come with some conditions.

A range of grant options are available and each is a bit different in terms of applying for and obtaining them. Most often, there is an application process for those that meet basic requirements. Companies must meet the specific eligibility conditions to apply. Usually, this means you are a part of a specific industry and your business has shown its ability to grow.

If you have a specific need, this type of funding may be your best option, considering you often have to prove how you are using the money to meet that need.

Grants create a strong influx of funding and are beneficial because there are – usually – no costs associated with them. However, it can be difficult to track the success of grants and there is always the potential to lose a grant, which could put your business at risk financially.

Need Help Determining Which Source of Capital is Right for You?

Selecting which source of capital is right for your business can be difficult. As we’ve discussed, there are plenty of factors at play, and turning to the wrong source could result in financial distress.

This is why we recommend working with a trusted accounting partner, like New Economy. We will learn the ins and outs of your finances and work with you to determine the best source of capital for your business, taking the work off your plate, and ensuring financial success.

New Economy is ready to answer your questions and help you implement best practices for using capital to help you reach your business goals.

Let us be the partner you need! Contact New Economy, to learn more! It