Financing types of equity financing
So far, we have focused on companies or individuals investing in a company by contributing in-kind contributions or equity to the company. In the following, we will take a closer look at a few different financing options.
With self-financing , profits are retained in the company, which is also known as profit retention . These profits are therefore neither distributed nor used for investment purposes. In this way, capital is accumulated in the company that can be used at a later point in time.
Financing as retained earnings is a form of self and internal financing . Internal financing also includes other processes, such as financing from depreciation and financing from asset reallocations . An example of this is when a company carries out sale and lease back – for example, a piece of land could be sold and rented by the buyer. The sale generates high liquid funds that can be used differently, but the running costs increase due to the rent.
The debt financing is usually done from the outside , so for example in the form of a bank loan. However, it is also possible to use capital that is in the company and still classify this as external financing. Let us think of provisions that were created when an employee retires and then receives a corresponding payment. It is foreseeable that this capital will only be needed at a much later point in time; the capital is in the company, but is allocated in the provisions . This means that it can be outside financing, although the capital does not have to be brought into the company from outside.
With external financing , the company is supplied with external capital. This means that it can be equity or debt that comes into the company from outside. Equity would be, for example, if an existing shareholder brings in further capital from his private capital into the GmbH in order to increase the equity and to increase his shares. External financing and outside capital is given, for example, in the case of a bank loan .
Financing through loans is typically only relevant for established companies, as start-ups and young companies have neither the necessary track record nor collateral for banks. Apart from banks, however, loan financing can also be provided by specialized institutes that, for example, offer targeted loan financing for certain sectors.
In addition to the forms described, mezzanine forms of financing are also possible. To a certain extent, this is something in between, with a relatively formally flexible design. This hybrid capital cannot be clearly assigned to a category. Let us think of bills of exchange or convertible and warrant bonds, for example.
Difference between deposit and equity financing
With equity financing, the company receives a new capital contribution or contribution in kind from outside . It is therefore always external financing, which is a relevant difference to other forms of financing. Since these are always deposits that are brought in, the terms equity and deposit financing are used synonymously.
Equity financing process
According to TOPBBACOLLEGES.COM, the basis for any form of financing is the determined financing requirement . This means that you have to have your finances under control and have a precise overview of how much equity is currently available, how much debt is available to you and when you have to repay this debt. In addition to these metrics, you need to look at your liquidity planning. Which incoming and outgoing payments are to be expected and when? Is there a time when your liquidity could be jeopardized? If so, there is a need for financing in order to maintain operations and prevent bankruptcy .
With these considerations, also keep in mind that your company doesn’t have to be doing badly at first glance to get into this situation. A liquidity bottleneck can also arise from growth that is too rapid, for example if you buy large quantities of goods and have to pay for them in advance, while your envelope and your payment terms for customers are such that you will only receive incoming payments later.
The example described is only one of many, as there can be a number of reasons for the need for financing. It is therefore important that you know your current situation , have precise plans and can thus determine when raising capital is particularly attractive – or in the worst case even absolutely necessary.
The next step is to clarify which form of financing is best for your needs. There are no general answers to this, but you have to judge subjectively which form of financing is the right choice in your situation.