Every business needs capital for development, growth, and expansion. Whether it is a start-up business or a relatively established company, fresh funding allows a business to scale up operations and hire more employees. The business may also purchase more tools and resources, invest in research and development and more.
Why is fundraising important?
Sometimes internal funding is not a viable option. This is especially so if the business has not begun to bring in adequate or stable profits. Business owners often turn to external funding from interested investors.
There are two main funding options when it comes to raising funds externally – equity investments and debt investments.
Equity Investments – Shares
Equity investments are basically shares or stakes in a company. Investors can buy into a company. The capital investors put into the company enlarges its equity. It also enables investors to receive a cut of the profits that the company declares (i.e. receive dividends). The return to investors depends on how well the company does in terms of revenue and profits.
There are two types of shares companies can issue – ordinary shares (also called common or normal shares), and preference shares.
One main difference between the two types has to do with voting rights. Ordinary shareholders are able to vote on major business decisions. This includes the setting up of a subsidiary company or a merger with another organisation. A number of shares they hold determine how many votes they can cast. Preference shareholders, however, often do not have the right to vote on such matters.
Preference shares are a special class of shares and shareholders of these shares receive other benefits. When the company declares dividends, preference shareholders are paid before the ordinary shareholders. In the event of liquidation (i.e. the company shuts down), preference shareholders will also be returned the value of their shares before the ordinary shareholders.
Thus, business owners will need to decide on the amount of control they are willing to share with their stakeholders, before deciding what sort of shares to offer.
Debt Investments – Convertible Bonds
The second type of investment option is called debt investment. These are bonds that the company can issue to its investors. The bonds often have a fixed maturity date (e.g. five years; ten years).
Bonds are instruments of debt and function like loans. A company borrows money from an investor for a specific period of time; with a guarantee that the investor will eventually receive it back with added interest (i.e. receive the principal sum plus interest).
This sets it apart from equity investments. Bondholders can be assured that they will receive their money plus interest once the bond matures. The return on equity investments, however, rely on the profits a company makes, before dividends can be declared.
As opposed to shareholders, bondholders do not own a share of the company and so, do not receive a cut of any profits made. They are simply creditors, having ‘lent’ money to the investee company.
Like preference shareholders, bond investors also do not have the right to vote on company matters. They are unable to interfere with the operations of the company unless otherwise agreed contractually. This means that the business owners have more control and autonomy over the running of the business.
What is a convertible bond?
The word ‘convertible’ in ‘convertible bond’ refers to the option the investor has of converting the bond into money or into shares when the bond matures. This means that the investor can request for his/her principal sum and interest back, or choose to convert it into ordinary shares of the company and become a shareholder.
The latter option may be desirable especially if the company has been successful in earning profits and increasing the valuation of its shares. If the business has been doing well, the investor may choose to convert the bond into shares and begin receiving dividends (should the company declare dividends).
Debt investments may be ideal for investors who do not wish to have control over the running of a company and would simply like a guaranteed return.
So how can we decide which is the best option for us?
Both equity investment and debt investment fulfil the purpose of acquiring money. It will be good if business owners can familiarise themselves with some of the fundamental differences between the two funding options before they strategise.
On the other end, both the investor and investee company should be aware of the various considerations in a fundraising transaction.Recommend0 recommendationsPublished in