What’s it: Company funding is an injection of money from funders to companies. Sometimes, we also refer to it as corporate financing.
In general, two sources of funding: equity and debt. We refer to equity funders as stock investors, shareholders, or company owners.
For debt, it can take various sources, ranging from bank loans, issuance of corporate bonds, medium-term notes, or commercial papers. Thus, debt funders can take various names such as creditors, debt securities investors, bondholders, or bond investors.
Purposes of company funding
Funding is the fuel for a business to run. Companies need funds for a variety of purposes, including:
- Starting a new business, for example, to rent an office, new equipment, and pay for advertising.
- Doing business, for example, to meet short-term liquidity and working capital or to finance commercial research.
- Business expansion, for example, establish new branches, buy production machines, or build new production facilities.
Why is it difficult for new companies to get funding?
Compared to established companies, it is difficult for new companies to raise funds. Their risk is high because they do not have a track record of operations and success in running a business. It makes funders reluctant to lend their money.
On the other hand, funders want their money to increase. They compare the risks and rates of return before deciding to lend money. When they perceive a company as a high risk, they are reluctant to inject money. If they are willing, they require high returns or interest to compensate for the high risk.
New companies have a high risk of failure because it only has a few customers. They rely on external financing to run their business, rather than from selling products. They have limited revenue because they only have a few customers. Also, they may have to face competitive pressure from other, more established companies.
Types of company funding
Companies can take a variety of sources to raise funds. New companies usually rely on the injection of funds from the owner. Because of the high risk, they may find it challenging to access funding from the capital market or banks.
In general, we can classify the types of business funding in several ways. First, we can categorize by timeframe.
- Short term funding. Usually, the company must pay it back within a year or less. Examples are factoring, bank loans, and commercial papers.
- Medium to long term funding. The maturity date is two years or more. Examples are medium-term notes, corporate bonds, and stocks.
Second, we can classify funding by source.
- Internal funding
- External funding
Money comes internally, namely from retained earnings. Of the total net income, the company distributed a portion as dividends to shareholders. For the rest, they keep it as retained earnings. Companies can use retained earnings to meet operating needs or to support business expansion funding.
Money comes from external parties, either for equity or debt capital. Companies can raise money from the capital market by issuing bonds or shares or borrowing from banks.
External funding is usually for expansion, such as establishing a new production facility or acquiring another company. Such corporate action usually requires significant funding, greater than can be financed internally.
External sources include a variety of types, including the following:
Factoring. Companies sell their invoices to financial institutions such as finance companies. They do this to get some cash right away.
Overdraft facility. The bank allows the company to take more money than is in its bank account up to an agreed limit.
Capital stock. The company asks the owner to add capital to the company. Or, companies can issue shares on the capital market to raise funds.
Line of credit. This is an unsecured bank loan. The bank determines the maximum loan amount that can be drawn by the company during a specific period, usually one year. The company must pay a certain fee or a certain percentage of the loan in a bank checking account.
Revolving credit. This is similar to a line of credit with an additional charge in addition to interest. The duration may be two until five years.
This loan has no fixed repayment amount. The company can withdraw the loan, pay it off, then withdraw it in any way and at any number of times until the end of the revolving credit arrangement.
Commercial papers. These are money market securities and represent unsecured loans. The company issues it with obtaining short-term funds to meet trade receivables or other liabilities with maturities of one year or less.
Medium-term notes. These are medium-term debt securities. Companies issue them by offering fixed or floating coupons. In contrast to corporate bonds, companies can offer them continuously through various brokers instead of issuing the full amount at once. In Indonesia, the trade is over the counter, not in the capital market.
Corporate bonds. These are long-term debt securities, usually transacted through the capital market and with a larger nominal value than medium-term notes. This instrument can take various types, fixed-rate bonds, floating-rate bonds, zero-coupon bonds, putable bonds, callable bonds, convertible bonds, unsecured bonds, senior bonds, or subordinated bonds.
Mortgage. This is a bank loan, secured by property and has a long term.
Grant. This funding usually comes from charities or governments to help businesses with specific criteria such as being environmentally friendly or providing jobs in certain areas.
Crowdfunding. Funding comes from many people, each contributing a relatively small amount of money. This funding model is usually through websites or social media.
Venture capital. This is private equity funding and is usually given to startups. Private equity firms raise funds from wealthy individuals, investment banks, or other financial institutions.