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. Cost of Capital

    Cost of capital is the required return necessary to make a capital ...
  3. Debt Financing

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

    An optimal capital structure is the mix of debt, preferred stock and common ...
  5. Capital Note

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

    A corporate bond is a debt security issued by a corporation and ...
Related Articles
  1. Small Business

    Explaining Cost Of Capital

    Cost of capital is the cost of funds used to finance a business.
  2. 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.
  3. Investing

    Target Corp: WACC Analysis (TGT)

    Learn about the importance of capital structure when making investment decisions, and how Target's capital structure compares against the rest of the industry.
  4. Investing

    The Top 5 International Bond Funds for 2016

    Understand the opportunities available within the international bond market, and learn about the top-rated global bond funds for 2016.
  5. Financial Advisor

    How Rising Rates Impact Bond Mutual Funds

    The interest rate increase by the Fed was one of the most widely anticipated in history. Here's what it means for bond mutual funds.
  6. Investing

    Corporate Bonds for Retirement Accounts

    Corporate bonds are usually the preferred choice in retirement accounts. Here are some of the benefits of corporate bonds, and strategies for a portfolio.
  7. Investing

    Corporate Bond Basics: Learn to Invest

    Understand the basics of corporate bonds to increase your chances of positive returns.
RELATED FAQS
  1. How does a company choose between debt and equity in its capital structure?

    Learn about the benefits and drawbacks of debt and equity financing. Find out how to compare capital structures using cost ... Read Answer >>
  2. What is the difference between cost of equity and cost of capital?

    Read about some of the differences between a company's cost of equity and its cost of capital, two measures of its required ... Read Answer >>
  3. How do interest rates affect the weighted average cost of capital (WACC) calculation?

    The interest rate is one of many external factors that can change the inputs in the weighted average cost of capital (WACC) ... Read Answer >>
Trading Center