Raising Capital: Exploring the Three Main Sources
Raising capital is an essential part of any business – whether you’re a startup or an established company – learn about share capital, debt capital & retained earnings.
Nellie A Carpenter 29/11/2023 4 minutes 21, seconds read
Raising capital is an essential part of any business. Whether you’re a startup or an established company, you need to know where to look for the funds you need to grow and succeed. The three main sources of capital for a company are share capital, debt capital and retained earnings. Retained earnings refer to any net income remaining after a company has paid all expenses and obligations.
This is the most basic source of funds for any company and, hopefully, the primary method that brings money to the company. But, as the old saying goes, you have to spend money to make money, and almost every company has to raise funds at some point to develop products and expand into new markets. Debt capital is the funding that a company obtains by borrowing money from lenders through loans or corporate bond offers. This could be done through the sale of common or preferred shares. You can’t do any business without funding.
To identify appropriate funding sources, there are three broad categories: short, medium and long term. Financial support usually includes loans, grants, or investor funding. Share capital is the cash that a public company obtains or earns by issuing new shares to shareholders in the market. Some of the main ways to raise capital are through angel investors, venture capitalists, government grants and small business loans. There are other funding methods, such as credit cards or bill financing, but you should only use them if you need cash quickly and know the risks involved.
Venture Capitalists
Venture capitalists are looking for technology-driven businesses and companies with high growth potential in sectors such as information technology, communications and biotechnology.
BDC has a venture capital team that supports cutting-edge companies strategically positioned in a promising market. Like most other venture capital firms, it participates in startups with high growth potential and prefers to focus on important interventions when a company needs a large amount of funding to establish themselves in their market.
Angel Investors
Angels tend to keep a low profile. To learn about them, you have to contact specialized associations or search for websites about angels. The National Angel Capital Organization, the Canadian International Angel Investors and Anges Québec can put entrepreneurs in touch with Los Angeles.
Crowdfunding
Crowdfunding is a form of fundraising in which a company asks the public for a contribution, usually in exchange for shares in the company.
It usually involves a private company asking large numbers of people for small contributions. This differs from the more conventional practice of raising money through angel investors or venture capitalists, in which a handful of actors inject larger sums into their business. In exchange for investing in your company, your followers will receive capital, although with less liquidity than they would receive with public shares. There are also more flexible rules governing crowdfunding than those governing IPOs.
Business Incubators
Business incubators (or accelerators) generally focus on the high-tech sector by providing support to startups at various stages of development.
However, there are also local economic development incubators, focusing on areas such as job creation, revitalization, and housing and distribution services. There can be strong competition and the criteria for awarding prizes are often strict.
Government Grants
Most grants generally require you to match the funds you receive, and this amount varies a lot from grantor to grantor. For example, a research grant may require you to find only 40% of the total cost. The Government of Canada’s business benefits search engine provides sources of funding, including government grants and subsidies.
Small Business Loans
Loans are the most used source of funding for small and medium-sized businesses.
Keep in mind the fact that all lenders offer different benefits, whether it’s a personalized service or a personalized refund. It’s a good idea to compare prices and find the lender that fits your specific needs. In general, startups have a harder time accessing loans than established companies. Entrepreneurs with a solid business plan and a good credit score are more likely to access loans.
You may also be interested in organizations that specialize in granting loans to new companies, for example Futurepreneur.
Indigenous Entrepreneurs
If you’re an Indigenous entrepreneur, you can access personalized business loans and other services through your local Aboriginal financial institution.
Selling Shares
Often, companies need to raise outside funding or capital to expand their businesses to new markets or locations. Financial analysts and investors usually calculate the weighted average cost of capital (WACC) to calculate how much a company pays for the combination of its funding sources. The sale of common shares of the company is another way to obtain financing without having to return the amount of money collected. A company can raise capital by selling shares in the property in the form of shares to investors who become shareholders. If a company is considered to be too risky, this can limit where it can obtain funding and it would have to rely on personal sources.
The decision about the source of funding depends largely on the purpose of the loan and the amount being borrowed. If you know where to look, you’ll discover that there are many different sources for entrepreneurs to raise capital. With so many options available it’s important that entrepreneurs do their research before deciding which source is best for them.
- shareholders
- venture capitalists
- angel investors
What are retained earnings — and why do they matter?
Owners’ equity is the difference between the assets and liabilities reported on your company’s balance sheet. It’s generally composed of two pieces: capital contributions and retained earnings. The former represents the amounts owners have paid into the business and stock repurchases, but the latter may be less familiar. Here’s an overview of what’s recorded in this account.
Statement of retained earnings
Each accounting period, the revenue and expenses reported on the income statement are “closed out” to retained earnings. This allows your business to start recording income statement transactions anew for each period.
Retained earnings represent the cumulative sum of your company’s net income from all previous periods, less all dividends (or distributions) paid to shareholders. The basic formula is:
Retained earnings = Beginning retained earnings + net income − dividends
Typically, financial statements include a statement of retained earnings that sums up how this account has changed in the current period. Net income (when revenue exceeds expenses) increases retained earnings. Conversely, dividends and net losses (when expenses exceed revenue) reduce retained earnings.
Significance of retained earnings
Lenders, investors and other stakeholders monitor retained earnings over time. They’re an indicator of a company’s profitability and overall financial health. Moreover, retained earnings are part of owners’ equity, which is used to compute certain financial metrics. Examples include:
- Return on equity (net income / owners’ equity),
- Debt-to-equity ratio (total liabilities / owners’ equity), and
- Retention ratio (retained earnings / net income).
A business borrower may be subject to loan covenants based on these ratios. Care must be taken to stay in compliance with these agreements. Unless a lender waives a ratio-based covenant violation, it can result in penalties, higher interest rates or even default.
Retained earnings management
Profitable businesses face tough choices about allocating retained earnings. For example, management might decide to build up a cash reserve, repay debt, fund strategic investment projects or pay dividends to shareholders. A company with consistently mounting retained earnings signals that it’s profitable and reinvesting in the business. Conversely, consistent decreases in retained earnings may indicate mounting losses or excessive payouts to owners.
Managing retained earnings depends on many factors, including management’s plans for the business, shareholder expectations, the business stage and expectations about future market conditions. For example, a strong retained earnings track record can attract investment capital or potential buyers if you intend to sell your business.
Warning: Excessive accumulated earnings can lead to tax issues, particularly for C corporations. Federal tax law contains provisions to prevent corporations from accumulating retained earnings beyond what’s reasonable for business needs. We can prepare detailed business plans to justify an accumulated balance and provide guidance on reasonable dividends to avoid IRS scrutiny.
For more information
Many companies consider dividend payouts and plan investment strategies at year end. We can help determine what’s appropriate for your situation and answer any lingering questions you might have about your business’s statement of retained earnings.
We highly recommend you confer with your Miller Kaplan advisor to understand your specific situation and how this may impact you.
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