Which Type of Corporate Financing is Best for Your Business?

Tom
Tom February 2022 Content Creator 9 min

Table of contents

Every business, from the billion-dollar corporation to the startup in the garage, needs to ensure good financing. Running a business means having sufficient financial resources to achieve goals and continue developing your company. 

How do you choose the right financing options for your company? The choice begins by finding out which ones are available, and then determining from there which will best suit your company.

The facts at a glance

  • In corporate financing, there are crucial differences between both equity and debt financing, and between internal and external financing
  • Put into practice, corporate financing is usually a mix of equity and debt capital
  • It’s recommended to maintain and equity ratio of at least 30%
  • The financing that will suit you best is the one that fits your business model and the stage your business is at

What is corporate financing?

Achieving your business goals means maintaining capital over the whole course of your business activity if you want to achieve your goals, whether this means continued growth or financing the resources you need. 

Determining your financing requirements

Drawing up a business plan is the first stage of financing. Here, you need to determine the capital required to start the business and the capital required in the future to continue to grow. 

When determining how much capital your business will require, make sure to be precise:

  • Working capital financing: how much is required to cover production costs?
  • Growth financing: how much is needed to increase production and open up into new markets?
  • Financing investments:which necessary investments will expand your business?

Prerequisites for successful corporate financing

Determining suitable equity or debt financing clarifying the optional ratio between equity and debt capital will require you to answer a few questions first:

  • What stage is your business in?
  • How much of your own money can you invest in your company?
  • Is money from the company available to you for financing?
  • Do you need outside capital?
  • Will it be beneficial to bring in a partner to join your venture?
  • What is the ideal ratio of debt and equity capital to business model and current company phase?

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What types of corporate financing are there?

There’s an important difference between equity and debt financing and internal and external financing. The corporate financing type depends on the source of the capital and the form in which it’s made to your company.

  • Self-financing: in this case, capital is available to the company indefinitely and doesn’t have to be repaid. Self-financing can be either internal or external. Internal self-financing is when the company’s profits come from the sale of assets, for instance machines, tools, or company equipment. A business self-financed externally would receive capital from external financiers, for example investors with stakes in the company or subsidies that don’t need to be repaid. 
  • Debt financing: debt capital describes a company’s debts, its liabilities and provisions. Such capital is available for a limited amount of time and must be repaid. 

The following financing options are available to you as an entrepreneur:

Equity vs. debt capital

The equity ratio describes the relationship between equity and debt financing. Neither type is right or wrong, it just depends on your company’s situation.Conservative corporate financing would provide a limit of 60% for debt capital, thus avoiding high debts and repayments in difficult times. 

  • With more equity capital, your company is more likely to make a big impression, and it will become easier to raise debt capital at favourable conditions.
  • High equity shares may deter lenders
  • Low equity should be increased, like in the case of a bank loan. It’s important to note that this makes most sense in low-interest phases and if the return on equity is higher than the interest incurred. 

If, as an entrepreneur, you possess insufficient liquid funds at the beginning, it may make sense to finance that capital into the company. If not, you run the risk of paying negative interest to the bank. 

Internally financed self-financing

If you can increase your equity capital from within, you will be internally self-financing. There are two kinds: 

  • Self-financing: generated profits are retained. This is called profit retention). There’s also a distinction between open and silent self-financing: open financing is when the profits are left in the company; hidden self-financing is the release of hidden reserves.
  • Asset reallocations/depreciations: liquid funds are released, thereby offsetting reductions in the value of fixed and current assets. 

Externally financed equity capital

Capital provided by external financiers and indefinitely is referred to as externally financed equity. 

  • Bootstrapping: an attractive financing method for those who can afford it, bootstrapping is when you finance your startup on your own. This allows you to remain independent and capable of achieving success quickly. Fair warning though, depending on how much money you have to invest, bootstrapping may leave you no room for failure. 
  • Increase in shareholder contributions: your equity capital is increased by shareholder contributions. New shareholders can be admitted to make further contributions
  • Share issues: joint-stock companies increase their equity capital by issuing new shares. 
  • Private equity: investors buy into a company and also acquire a say in the company with their participation.
  • Venture capital: venture capital is provided by investors free of interest. They instead receive company shares which can be later sold at a profit. Benefit from their knowledge by joining professional networks.
  • Incubators and accelerators: here, too, you receive support in the form of capital as well as a network and the know-how of your backers. 
  • Business angels: business angels are experienced entrepreneurs only too happy to share advice and invest money into the startup scene. 
  • Crowdfunding and crowdinvesting: increasingly popular ways to generate capital, crowdfunding and investing are made possible by the internet and crowdfunding channels like Patreon. Investors in this case are usually happy to assist financially without much promise of return. It’s more about the belief in an entrepreneur or an idea. Crowdfunding will require you to have an already-established business idea, and some reward for their efforts. 

Debt financing

Debt financing ensures more entrepreneurial independence because it doesn’t allow financiers any say in the matter. On the flip side, the money provided is available for a limited period of time and must be paid back in that time. Within debt financing, there are a few alternatives to a traditional bank loan:

  • Provisions: money held back for tax, possible legal costs or pensions. These funds are available to the business until they are paid out.
  • Bank loans: the difficulty with bank loans is that a bank will always expect collateral and are bound by strict rules when granting loans. To have your loan application approved, you’ll need a solid and convincing business model. Paying off the loan can then become an enormous burden, especially at the beginning. That said, once the bank is convinced, the investors will come. 
  • Government funding programmes: startup founders whose ventures fit the startup portal of the Federal Ministry for Economic Affairs and Energy (BMWi) benefit from state support programs. The promotional loans offered by the state have favourable interest rates, long terms, and a repayment-free startup phase. Investment companies like Kreditanstalt für Wiederaufbau (KfW) and the High-Tech Gründerfonds (HTGF) will also provide financial support to startups in Germany. 
  • Friends and family: finding support from friends and family is another desirable option. You likely won’t have to pay interest and the collateral will be less severe, given that these are not usually professional contexts.
  • Factoring: often a good option in urgent situations, companies can sell outstanding receivables (e.g. invoices) to a third party at a discounted price. It’s usually a short-term solution to increase a company’s liquidity. 

All options at a glance

Self-financingDebt financing
Internal financingSelf-financingAsset restructuringDepreciationProvisions
External financingBootstrapping
Shareholder contribution increase
Share issues
Private Equity
Venture Capital
Accelerators & Incubators
Business Angels
Crowdfunding and crowdinvesting
Bank loans
Government grants
Friends & Family
Factoring

Corporate financing in the changing phases of a company 

Good corporate financing is about determining how much capital is required at each stage of a business. At the beginning or ‘startup phase’, once-off payments and investments must be accounted for to get the company off the ground. Costs of running the business and private costs of the founders. The beginning will see you spending more than you earn—this is to be expected. As you generate monthly surpluses, you can adjust accordingly your financing plan, along with your equity ratio and debt capital.

Which KPIs should be taken into account when financing a business?

The following key figures will assist you in measuring your company’s success:

  • The equity ratio: indicates the ratio of equity to the total capital of a company. 
  • The cash flow: determines the cash inflow or outflow of a company in a certain accounting period.
  • The return on equity: indicates the ratio between your profit and the equity capital employed. 
  • Return on Sales (ROS): indicates what percentage of the turnover remains as profit. 
  • Return of Investment (ROI): calculates the relationship between your profit and your investments. 

Which corporate financing suits you?

Your options for financing are as varied as your ideas for new projects and startups. It’s unfortunate, but there’s no one plan that fits all. Your financing strategy should fit your business model and the stage your business is at. Consider all the options that might work for you. 

Don’t just stick to one financing plan either. Change as your business changes—as your situation changes.

To ensure this, have a good idea of your finances at all times. We can support you with a Penta business account, offering innovating functions that make bookkeeping much easier. You’ll even be able to adjust your account as your business grows and changes. 

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