What is 'Capital Funding'

Capital funding is the money that lenders and equity holders provide to a business. A company's capital funding consists of both debt (bonds) and equity (stock). The business uses this money for operating capital. The bond and equity holders expect to earn a return on their investment in the form of interest, dividends, and stock appreciation.

BREAKING DOWN 'Capital Funding'

To acquire capital or fixed assets, such as land, buildings, and machinery, businesses usually raise funds through capital funding programs to purchase these assets. There are two primary routes a business can take to access funding: raising capital through stock issuance and/or raising capital through debt.

A company can issue common stock through an initial public offering (IPO) or by issuing additional shares into the capital markets. Either way, the money that is provided by investors that purchase the shares are used to fund capital initiatives. In return for providing capital, investors demand a return on their investment (ROI) which is a cost of equity to a business. The return on investment can usually be provided to stock investors by paying dividends or by effectively managing the company’s resources so as to increase the value of the shares held by these investors. One drawback for this source of capital funding is that issuing additional funds in the markets dilutes the holdings of existing shareholders as their proportional ownership and voting influence within the company will be reduced.

Capital funding can also be gotten by issuing corporate bonds to retail and institutional investors. When companies issue bonds, they are in effect, borrowing from investors who are compensated with semi-annual coupon payments until the bond matures. The coupon rate on a bond represents the cost of debt to the issuing company. In addition, bond investors may be able to purchase a bond at a discount, and the face value of the bond will be repaid when it matures. For example, an investor who purchases a bond for $910, will receive a payment of $1,000 when the bond matures.

Capital funding through debt can also be raised by taking out loans from banks or other commercial lending institutions. These loans are recorded as long-term liabilities on a company’s balance sheet, and decrease as the loan is gradually paid off. The cost of borrowing the loan is the interest rate that the bank charges the company. The interest payments that the company makes to its lenders is considered an expense in the income statement, which means pre-tax profits will be lower.

While a company is not obligated to make payments to its shareholders, it must fulfill its interest and coupon payment obligations to its bondholders and lenders, making capital funding through debt a more expensive alternative than through equity. However, in the event that a company goes bankrupt and has its assets liquidated, its creditors will be paid off first before shareholders are considered.

There are companies that exist for the sole purpose of providing capital funding to businesses. Such a company might specialize in funding a specific category of companies, such as healthcare companies, or a specific type of company, such as assisted living facilities. The capital funding company might also operate to only provide short-term financing and/or long-term financing to a business. These companies, such as venture capitalists, could also choose to focus on funding a certain stage of the business, such as a business that is just starting up.

Cost of Capital

Companies usually run extensive analysis on the cost of receiving capital through equity, bonds, bank loans, venture capitalist, sale of assets, retained earnings, etc. A business may assess its weighted average cost of capital (WACC) which weights each cost of capital funding to calculate a company’s average cost of capital. The WACC can be compared to the return on invested capital (ROIC), that is, the return that a company generates when its converts its capital into capital expenditures. If the ROIC is higher than the WACC, the company will move forward with its capital funding plan. If it’s lower, the business will have to re-evaluate its strategy and re-balance the proportion of needed funds from the various capital sources to decrease its WACC.

RELATED TERMS
  1. Issue

    An issue is the process of offering securities as an attempt ...
  2. Debt Financing

    Debt financing occurs when a firm raises money for working capital ...
  3. Optimal Capital Structure

    An optimal capital structure is the mix of debt, preferred stock and common ...
  4. Income Fund

    Income funds pursue current income over capital appreciation ...
  5. Capital Note

    Capital note is short-term unsecured debt generally issued by ...
  6. Corporate Capital

    Corporate capital refers to the assets a business has available ...
Related Articles
  1. Investing

    Investors Need A Good WACC

    Weighted average cost of capital may be hard to calculate, but it's a solid way to measure investment quality.
  2. Investing

    Financial markets: Capital vs. Money Markets

    There are several key differences between capital markets and money markets as components of financial markets. Check out the similarities and differences between the two markets.
  3. Investing

    How Interest Rates Affect Mutual Funds

    Find out how changing interest rates impact mutual funds, including bond and money market funds, and how higher rates can discourage investors.
  4. Investing

    Bond Funds Boost Income, Reduce Risk

    Bond funds can provide stable returns for those who depend on their investment income.
  5. Managing Wealth

    Issued share capital versus subscribed share capital

    Learn the difference between issued share capital versus subscribed share capital. Get information about various types of capital.
  6. Investing

    The Top 5 Bond Mutual Funds for 2016

    Learn about bond mutual funds that investors may want to consider for 2016. Understand why the risk of rising interest rates is a concern heading into 2016.
  7. Investing

    Investing in High-Yield Corporate Bond Funds

    High-yield corporate bond funds provide an interesting investment option, particularly for private investors chasing returns and a broad diversification.
  8. Retirement

    Money Market vs. Short-Term Bonds: A Compare and Contrast Case Study

    Discover characteristics of money market and short-term bonds, including how the investments are alike and different, and the benefits and risks each offers.
RELATED FAQS
  1. Cost of Capital vs Required Return

    Though they may sound similar, they do have key conceptual differences. Take a look at the primary differences between an ... Read Answer >>
  2. determine the proper weights of costs of capital?

    Learn how to calculate the weights of the different costs of capital, as well as how this is used to determine the weighted ... Read Answer >>
  3. How does a company's capitalization structure affect its profitability?

    Learn about capitalization structure and how the combination of debt and equity a company uses to fund operations can affect ... Read Answer >>
  4. What is the formula for calculating weighted average cost of capital (WACC)?

    Weighted average cost of capital (WACC) is the average after-tax cost of a company's various capital sources used to finance ... Read Answer >>
Hot Definitions
  1. Gross Margin

    A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. ...
  2. Inflation

    Inflation is the rate at which prices for goods and services is rising and the worth of currency is dropping.
  3. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  4. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  5. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  6. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
Trading Center