Examine and discuss the different types of investors and financing options for n

Question

Examine and discuss the different types of investors and financing options for newly formed companies and existing companies that are looking to expand and/or engage in new business and marketing activities in order to maximize their level of success. In addition, identify companies that have used each of these different types of investors and financing options, including analyzing and describing the success or failure of these efforts to obtain needed investment funding and financing. Lastly, if you were an entrepreneur attempting to raise money for a new business venture, identify, describe, and justify some specific actions that you would take.

Explanation / Answer

The two most popular methods of financing for both existing business and new businesses are equity financing and/or debt financing. Equity financing would involve issuing fresh shares to either common shareholders, preferred shareholders, institutional shareholders or all of these. This fresh issue can be either in the form of Qualified Institutional Placements, follow on IPO, retail common stock placements and more. These fresh shares are issued from a company's reserved shares which are more popularly known as "Treasury Stock". The financing methods described are however mostly applicable for existing businesses. For new businesses, angel investing or seed capital in return for equity is more common. Angel investing or seed capital refers to the initial investment required to start a business and is usually very valuable to company founders. Angel Investors however prefer quasi-equity instruments such as convertible preferred stock instead of common stock as they have certain upside benefits and quite a few donwside protections as well (e.g preferred stocks are eligible for dividends before common stock and preferred stock holder's have rights over a bankrupt company's liquidation proceeds before any of the company's common stock holder).

Additionally, a crude but effective method of financing for existing businesses majorly in the export sector is factoring. Factoring involves pledging the future account receivables of a company to get a fixed up front cash financing. This is usually popular with companies that have immediate liquidity crisis coupled with diluted equity base and poor credit ratings. However, this financing method might prove to be quite expensive more often that not.

Another popular method of financing exclusively employed by new business owners is crowdfunding. Crowdfunding involves sourcing funds from multiple smaller investors (most of whom are strangers to the new business founder) in return for a pledge to return the money when the business turns profitable. However, creditors cannot claim written or legally backed guarantees of repayment and also cannot write it off as an expense to avail tax rebate. Depsite its aforementioned shortcomings this idea has gained a lot of mileage in the start up funding scene across the country.

Yet another method of funding especially for existing and highly profitable businesses to expand and implement new marketing activities is through usage of "retained earnings" accumulated through their earlier years of business. This option is not available to new business owner's though.

Finally we have the most popular method of raising fresh capital for businesses which is debt financing. This method is particularly popular with large existing businesses with several years of business experience under their belt. Debt financing can take a number of forms such as bond issue, mezannine debt (which are usually convertible bonds) , convertibel debentures, bridge loans, revolving credits, long term capital expenditure loans, working capital financing and more. All of these debt financing options come with repayment mechanisms some with high interest rate and some low. For existing businesses using debt financing as opposed to equity issue and/or retained earnings usage makes more sense as debt is most often very cheap. The benefits of insterest tax shields accruing to the company is also substantial. However, debt beyond a certain level is harmful as it creates excessive debt servicing (interest expense) and repayment burden for the company leading to fears of defualt, downgrading of company credit ratings, pressures on the company's future cash flows and more.

Hence, the cost of capital of an existing business initially benefits from issuance of debt, but suffers a beating once debt goes beyond a certain level. For new businesses though debt financing is out of question as lenders usually require some form of collateral before issuing debt which is absent for new businesses in most cases (except when new businesses are backed by establised businesses in some other sector or maybe even a related sector)

Some popular examples of companies who use retained earnings to grow would be Alphabet Inc. and Apple Inc. who have paid our either very low dividends or no dividend in the past many years, so as to be able to plough their earnings into growing the business and giving higher returns to stock holders through capital accumulation (ensured through rising stock prices).

Companies in the capital heavy sectors such as energy, infrastructure and aviation are usually debt laden as it makes more sense for them to use cheaper debt financing to fund huge capital expenditures of their expansion projects.

While starting a new business venture it is most sensible to raise money through angel investors willing to invest money in return for convertible preferred stocks as debt financing would be unfeasible and so would be common stock issue owing to mandatory minimum issuing requirements.If the founder has a established and reputed existing business to back up the new venture then debt financing would obvsiously make more sense.

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