By Odhiambo Ocholla
There comes a time in most companies' lives when extra finance is needed to realise a business opportunity.
Fundraising is an important step in the life-cycle of every company. At some point, most companies will be faced with the opportunity to grow their business in new and exciting ways.
But unless the company has been extremely profitable, or the owners are willing to invest even more of their own funds, external finance may be required.
There are many forms that opportunities for growth may take.
A company may need funds to finance new premises, new equipment, hire extra staff, or the development of a new product line.
The intended use of the funds will determine which type of finance is the most appropriate.
It would make little sense, for instance, to attempt to use short-term loans to fund a major construction project. It is important to be aware of the fundraising options available, in order to ensure that the method selected is best for the company. There are two core forms of finance, debt and equity, which encompass almost every financing option available to small- to medium-sized businesses.
Debt finance refers to any money that a company borrows and is obliged to pay back usually with interest. Equity finance refers to money invested in a company in return for a share of the ownership and profits of the business. Just as opportunities for growth come in different forms, so too does debt and equity finance.
The most suitable type of debt finance for a company will depend largely on that company’s particular circumstances, and on the nature of the project they wish to undertake. Small- to medium-sized companies will usually rely on credit and loan from banks or other financial institutions.
Debt finance
Debt finance involves credit facilities, loans, overdrafts or for larger companies corporate bonds. Equity finance can involve share issues, equity or share placements. The most common form of debt finance is a bank loan.
Depending on the length and nature of the project, the loan may be short-term three to five years and unsecured, or a longer-term commercial mortgage, secured against the assets of the business.
The amount of security provided for the loan and the risk of the project’s cash flows will determine the cost of this type of finance.
In many cases, debt finance is also cheaper than equity finance. Interest paid on debt is tax deductible, making debt cheaper for any company with an operating profit. Raising debt is also less complicated than raising equity, since it is not subject to all of the laws and regulations governing the issue of shares by the Capital Market Authority regulations.
Where the risky nature of a project deters debt providers or where the business will not have enough cash to pay loan interest because it is needed for core activities or funding growth, equity finance is likely to be most suitable.
Equity finance
Equity finance can involve share issues, private equity or share placements. It is divided into two broad categories: public offers and private equity.
Public offers include Initial Public Offering (IPO), rights issues and institutional placements of shares. Private equity, in this context, includes business angels and venture capitalists. These types of private equity are most appropriate for companies at the beginning of their life cycle.
Share offers, on the other hand, are usually made once a company has become relatively established. New companies are usually too risky to attract debt finance on reasonable terms.
Both venture capitalists and business angels have the added advantage of bringing practical business experience to a new company, and making it easier to obtain other types of finance in the future.
Venture capitalists will prefer companies with a proven track record in the industry and the potential to generate a high return on their investment within a relatively short time frame.
Prospective venture capitalists will also require a clear business plan and set of financial projections, which may give rise to legal and accounting expenses.
Companies looking to undertake an IPO should be aware that the process is heavily regulated.
It is necessary to find a transaction advisor for the issue who usually play two roles in the IPO process: providing advice on the offer and to ensure compliance with the disclosure requirements in the Companies Act and CMA Act.
The type of fundraising appropriate for a company depends on many factors including the owner’s objectives, prospects for growth, the nature of the company, and its particular circumstances.
— The writer is an Investment Banker. Email: nyabolla@gmail.com
