What is Capital Funding? Ways to Funding and Beyond

Key Takeaways

• There are two chief avenues a company can take to gain capital funding: raising capital through the issuance of stocks and through debt.

• Capital funding is money a business gets from equity holders and lenders for day-to-day operations or long-term needs.

• If a company’s return on invested capital is greater than the weighted average cost of capital, the company will usually proceed with its capital funding plan.

Capital funding can be used to fund investments and other efforts aimed at producing even more income over time. But what exactly is capital funding and how can one participate in venture capital? Here is that and more.

What is Capital Funding? 

Capital funding is money a business gets from equity holders and lenders for day-to-day operations and long-term needs. The funding generally comes from stocks and bonds, the holders of which expect a return on their investment via dividends, interest, and stock appreciation.

How is Capital Different from Money?

Rather than plain money, capital funding consists of stocks (equity) as well as bonds (debt). It is true that, at its essence, capital is money. However, capital is used in relationship to current operations and future investments and typically comes with a cost.

What is Capital Funding Used For?

Companies use capital for any of a number of reasons, with the ultimate goal of conversion of cash into more valuable assets and increased revenue. Such reasons usually include:

• Company expansion. As companies grow, they usually must raise funds to acquire properties, land, machinery and more.
• Mergers and acquisitions. Companies need to secure capital to fund a merger or buyout.
• Entry into new markets. Companies generally must raise capital to breach whole new markets for their business.
• Development of new products and services. The process of developing new products and services takes capital.
• Working capital. This is capital that is used for a company’s everyday operations.

Routes to Raising Capital

There are two chief avenues a company can take to gain capital funding: raise capital through debt or issue stocks.

1. Issuing stocks. Common stock can be issued through an initial public offering or by issuing additional shares into capital markets. In either case, investors who buy the shares usually get dividends or ultimately benefit from increased share values. Note that the issuance of more funds in public markets dilutes existing shareholders’ holdings, since it will reduce their proportional ownership as well as their voting influence.
2. Issuing debt. Issuing corporate bonds to institutional and retail investors can also be used to acquire capital funding. Investors are compensated with coupon payments semi-annually until the bond matures. Further, bonds may be able to be bought at discount and the bond’s face value will be repaid upon maturity.

What are Types of Funding?

There are three fundamental types of capital funding, including equity, debt, and venture capital, each with their own benefits and drawbacks.

1. Equity capital. The value of a company’s assets less its liabilities, this is working capital that a company gets from its owners and shareholders and need not be repaid. Types include private equity, public equity, and real estate equity. Freedom from debt is the primary advantage but note that a company founded exclusively on equity capital could face challenges when cash is scarce. 
2. Debt capital. With debt capital, which is provided by lenders, the capital owner usually agrees to regular lender payments in exchange for employing the lender’s money. Also, the interest rate is predetermined. While debt capital may be easier to secure than equity financing, the loan must be repaid by a certain deadline. Note that capital structure is the specific blend of equity and debt that a business employs to finance its operations and growth.
3. Venture capital. This form of financing goes to start-up or early-stage companies with high upside and equally high risk. The overarching goal is to profit from diversified holdings — In other words, if the company succeeds, shares will be sold at some future date. In addition to a consistent revenue stream, venture capitalists frequently have the technical expertise to improve business processes. Note, though, that VCs may seek some oversight of company aspects.

What is the Cost of Raising Capital?

A company’s cost of receiving capital through stocks, bonds, venture capital, bank loans, retained earnings, and the sale of assets is generally subject to robust analyses. For example, some companies will use what is called a weighted average cost of capital (WACC), which individually weights each cost of capital funding, to determine its average cost of capital.

If a company’s return on invested capital (ROIC) is greater than the WACC, the company will usually proceed with its capital funding plan. However, if the ROIC is lower, the company is better off reassessing its strategy to lower its WAAC.    

Also, when a company borrows money, it must pay interest rates, which is the cost of loan production, as well as the amount of money borrowed.

What are Examples of Raising Capital?

Some companies exist exclusively to provide businesses with capital funding. They may specialize in a certain sector or specific company type and may also operate to provide short-term or long-term financing only. Such companies, including venture capitalists, may also opt to focus on funding businesses that are just getting started, or are at some other business stage. 

What is the Best Way to Raise Capital?

There is an abundance of insights that point to venture capital as a viable option for startups or new companies, particularly those that are deemed risky and may not gain funding through other conventional means. Venture capitalists seek out projects and ideas that they believe will be successful and will lead to a favorable return on investment. The caveat, though, is that such companies must experience early growth.

How to Invest in Venture Capital

The alternative investment platform Yieldstreet aims to generate steady secondary income through investments in private-market offerings such as art and real estate. Alternatives are increasingly popular among investors looking to decrease portfolio volatility, due to their low correlation with ever-changing public markets, and to shield against inflation.

Yieldstreet’s platform, which renders alternative investments more accessible, and on which $4 billion has been invested to date, also offers opportunities in venture capital. That program exposes retail investors to private organizations that are creating new sectors or disrupting existing ones. During the venture capital stage, companies usually undergo fast growth as commercialization is boosted and permits scale.

Investing in the private market also allows investors to diversify their holdings, which is crucial to long-term investing success. Building a portfolio of varying asset types can mitigate overall risks and even improve returns. Alternative investments is a good way to help accomplish this.

Alternative Investments and Diversification    

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

Summary

Businesses often seek capital funding from shareholders and lenders to grow or fund its operations. The two main ways a company can take to secure such funding are through debt and stock issuances.

Note that other types of funding include venture capital, which can also serve to diversify portfolios.