As a student
studing in finance, I cannot imagine the difficulty for a company to raise
capital for some projects. The financing process is complicated which involves
many factors.
When
a company grows rapidly, for example when contemplating investment in capital
equipment or an acquisition, its current financial resources may be inadequate.
Few growing companies are able to finance their expansion plans from cash flow
alone. They will need to consider raising finance from other external sources
to achieve their objectives (Arnold G, 2008).
Before raising
capital, an important term needs to be addressed is the rate of return (Arnold G, 2008). If
the rate of return is too close to the cost of capital, it risks profitability
of the project if any unforeseen circumstances arise. As the example of Sky, after
they released their broadband package in 2006, they predicted a post tax return of 15% by
2011. It would be expected that to ensure profitability, the return however
shrinks to 10.5 per cent post tax, compared with
Sky's group weighted average cost of capital (WACC), estimated at about 9 per
cent. The new investment that does little more than meet its cost of capital in
five years is hardly compelling - particularly given that Sky's assumptions on
further price deflation in broadband provision may prove conservative.
Another
important issue is to find the best method to fund these returns. The two main methods are debt and equity.
In debt, bankers request interest payments and capital repayments, while in
equity, the borrowed money is usually secured on business assets or the
personal assets of shareholders and/or directors. It should be noted that bank
also has the power to place a business into administration or bankruptcy if it
defaults on debt interest or repayments or its prospects decline. In contrast, equity investors take the
risk of failure like other shareholders, whilst they will benefit through
participation in increasing levels of profits and on the eventual sale of their
stake (McNulty, J., Yeh, T.D., Schulze, W. & Lubatkin, M,
2006).
Today, the most
popular and secure method is selling its shares on a stock exchange. Usually
there is no obligation to pay dividends. Additional, the capital does not have
to be repaid. However, this method suffers limitations that the return required
to satisfy shareholders, moreover, it may loss of control and dividends cannot
be uses to reduce taxable profit. If the company can give up an amount of
ownership in the business, raising finance through equity is an optimal choice.
It is should be note that raising equity finance need a long time, and the cost
of listing shares on the stock market, you have to plan a hell of a long way in
advance (Brealey, Richard, Myers, Stewart & Allen Franklin, 2006).
The
main source of business finance is venture capital (Lumby S, 2003). It is a general term to describe a range of ordinary and
preference shares where the investing institution acquires a share in the
business. Venture capital is intended for higher risks such as startup
situations and development capital for more mature investments. Replacement
capital brings in an institution in place of one of the original shareholders
of a business who wishes to realize their personal equity before the other
shareholders. There are over 100 different venture capital funds in the UK and
some have geographical or industry preferences. There are also certain large
industrial companies which have funds available to invest in growing businesses
and this 'corporate venturing' is an additional source of equity finance.
Raising
finance is often a complex process. Business management need sto assess several
alternatives and then negotiate terms which are acceptable to the finance
provider. During the finance raising
process, accountants are often called to review the financial aspects of the
plan. Their report may be formal or informal, an overview or an extensive
review of the company's management information system, forecasting methods and
their accuracy, review of latest management accounts including working capital,
pension funding and employee contracts etc. This due diligence process is used
to highlight any fundamental problems that may exist.
Reference
Arnold, G.
(2008). Corporate financial management (4th ed.). Harlow: Financial Times
Prentice Hall
Brealey, Richard,
Myers, Stewart and Allen Franklin (2006). Principles of Corporate Finance, 8TH
Edition
Lumby, S. and
Jones, C. (2003) Corporate Finance- theory and practice, 7th ed. Thompson.
McNulty, J.,
Yeh, T.D., Schulze, W. & Lubatkin, M. (2002) What's Your Real Cost of
Capital? Harvard Business Review.
