Methods of Corporate Financing, Risks Associated with them and Solution to those Risks
Whether one is in search of how to register a limited company in UK or a company of any other form. Financing is a crucial element required for entering the business field in UK or in any other part of the world.
A study on Corporate Finance
- To register a new company UK, the registration fee might be affordable, but there are certain other expenses that are required to stabilise the business. So after register a business in UK, one may have to arrange for some initial finance of newly registered company.
Corporate Finance is the analysis of funding sources and methods to provide financial support for the assets. The main motto of corporate finance is to bring a rise in the worth of shareholders’ shares. Following are the two common finance origins:
- Company Funding: The company funds can be used for the provision of monetary assistance to the company. Nevertheless, these funds cannot be benefitted from at the time of setting up the company. As, this finance mainly generates from the profits, earnings, auction of stock or resources of the company and arrearage etc. Hence, these funds can be used only when the company is in the working state already.
- Extraneous Funds: A company may get funds from external sources such as via shareholders. They may offer their capital, or via public or equity offerings etc. Another source of external funding are the organizations that are commercial in nature. Following are the two examples of commercial organizations:
- There are companies that are more interested in providing the newly formed companies that are private, with finance in return of ownership of some shares. However, the newly formed companies must have a good record and profit earned in past. Such organizations do not aim for long term goals. Instead they are more concerned with the current earnings or cash flow of the company where they want to invest. Their goals may counter with the goals of the newly formed company. This process of financing is known as “Venture Capital Financing”.
- Other than Venture Capital Financing, there is another common practice of extraneous funding known as “Angel Investors”. The financial aid given by them may be smaller than the amount given by venture capitalists generally. However, they rather believe in assisting the small scale businesses in their survival and growth. Nevertheless, they also strive for an investment that provides a good earning in return.
One may ask how to create a company in UK if any of the above techniques fail to provide the required finance. As both of them are eligible for companies that have already started working and require finance for growth. The external sources of funding are not limited to those mentioned above. Following methods also may provide a good financial assistance for the new comers in the field of business.
- Banks may provide loans subjected to different conditions to help the business grow. Also, it may give help in form of factoring. One may borrow money from the Bank through overdraft financing.
- Asset based lending is a method that helps the company get a loan based on the worth of the company’s assets. Hence, the asset based lenders may provide loan in return of the collateral. Moreover, the loan may be granted via hire purchases and leases.
- Another method of financing is that the company gets its supplies from the suppliers on Trade credit. The company may get a pre-paid amount by the customers for the goods that the company has to supply.
- One may use internet to raise funds for his company in the form of small sums contributed by different people. This way of fundraising is known as Crowdfunding.
- Grants can be given to support a business.
- Friends and family may add some contribution in the fundraising. They may give some relaxation in terms and conditions on the return of money.
Hence, once the new entrant in the field of business has completed the task of register a new company UK, he or she may go for any of the above mentioned methods to raise funds for the company.
Finance may be classified into different types. This topic defines them as follows:
- The first one is finance gained via equity or simply, Equity Finance. The investors ask for an ownership of the shares of the company. They provide monetary assistance in return. Hence, they have the same status as any other shareholder in the company. The investor can exercise the same rights, has the same duties and liabilities as others. They also have a share in the profit gained by the company whenever it becomes successful.
- One may borrow the amount and return it later under the terms and conditions of an agreement. This classification of finance is commonly known as Debt Finance. Hence, the one who does the funding is the creditor and as the company is in debt, it may be known as the debtor. Interest is applied on the borrowed none, hence the money is to be returned with interest added in it. Moreover, whether the company faces loss or profit, debt has to be paid in any case.
Comparison of Equity and Debt
- Equity results in the authorisation of exercising powers in the same manner as regular shareholders do as stated in Section 168 of Companies Act. The investor benefits from the profit of the company. However, Debt provides the creditor with a hold over the assets or stock of the company in form of security. If the debt is not paid, the stock might get confiscated by the creditor.
- In case of Equity Financing, the investor may pass resolutions in his interest if he holds majority of the shares. In case of Debt financing, the covenants signed at the time of giving loan may incorporate terms and conditions according to the will of the Creditor. Hence giving him substantial power.
- The investors of equity financing get rights mentioned in statutory law. Whereas the creditor in debt financing may exercise the rights mentioned in the contract.
- However, the investor of equity financing may not get any priority of redemption rights. The Creditor does have priority of redemption rights.
- A variable amount of dividends may be disbursed in case of equity. However, in case of debt finance, appointment of administration may be done by the creditor
- The amount of funding is not to be returned as it is in equity financing. Nevertheless, in the latter case, an interest has to be payed but the amount of debt remains fixed.
When a borrower borrows something valuable, generally money, on this condition that he may return it after some time with some additional payment such as interest, it is known as Credit. It may seem beneficial, but it does have some risks associated with it. To better understand how to create a company in UK that flourishes to the fullest and is least prone to dangerous risks, one needs to study the associated risks with financing methods and the techniques to mitigate them.
- The following topic discusses these risks.
The risks of credit may be either external or internal.
- The external risks are as follows:
- Chaos in the system:
- The fluctuations in stock market determine the riskiness of the Credit. Fluctuations leading downfall of the market may create danger for the Credit.
- If any war hits the area, the Credit may fall into danger
- The situation of credit crunch takes place. Credit crunch is a scenario where creditors are hard to find as there is a shortage of money to be given on Credit.
- Policies of government subjected to any change may affect the terms and conditions of Credit in a negative way. For instance, the government of Switzerland stopped to cap the Franck to Euro.
- Technology is changing with the passage of time. Certain innovations in technology may increase the risks of Credit.
- The internal risks are as follows:
- Consider that different creditors lend money to a company at different instants, provided that the assets of the company are just as they were at the time of borrowing money from the first creditor. And the assets run short for paying all the creditors. Hence, the claim is diluted. The scenario is known as “Claim Dilution”. It means that there is a risk that the first creditor will not get the full amount back.
- Another risky scenario is when the entrepreneurs show assets of great worth to the Creditors and succeed in acquiring a loan. However, after sometime they may switch their worthy assets with assets of cheaper worth. Thus, the assets may not give sufficient amount in return to the Creditor upon selling.
- There may arise a situation where the debtor is indebted to an extent that he may not find it possible to return the money to all the Creditors simultaneously. As a consequence, all his assets must be confiscated, sold and later disbursed amongst the Creditors. Unfortunately, nearly in half of the cases of UK, the Creditors that have no security are given nil in return. This is known as “Insolvency Risk”.
There must be some solutions to the above mentioned risks. They are discussed in this topic:
- If any one seems like not repaying the debt, his loan may be subjected to a higher rate of interest. However, the borrowers may avoid taking loan because of the high interest. The business may also get endangered because of it.
- Insurance of different kinds may secure a creditor from any loss. However, this cannot be benefitted from by every creditor. For example, tort creditors. For further elaboration, go through Cape Industries.
- Credit derivatives is a condition where the risk of not paying the loan is purchased by any party other than the creditor. Hence in case of unpaid loan, the loan is compensated by a third party. It is an unregulated insurance.
- The statutory laws provide security in case of risk of unpaid loans. Due to this guarantee by statute, people trust banks with their valuable assets.
- Creditor may exercise some rights, termed as “Personam Rights”, as a reaction, if the borrower or third party fails to return the money.
- There are some proprietary rights as well, termed under “Rem Rights”. The houses’ proprietary rights guarded subprime mortgages. However, the property’s worth fell and as a result there was crises.
Debt Finance Types
As mentioned in the text above, debt finance is a finance that involves lending of money to the businessmen by a lender, termed as Creditor. The following types of financing techniques fall under debt finance:
- Overdraft Financing: Small companies may continue taking money from the bank despite the fact that there is no amount left in their accounts or the amount left is insufficient to pay the debts. It is more like taking a loan from bank.
- Trade Credit: The suppliers may be kind enough to provide their provision on credit to the companies. The customer may pay the cost of company’s supplies beforehand.
- Taking money on loan: Any type of loan including term loan falls under the category of debt financing techniques. However, it may be taken into consideration that term loans may cause an increase in burden of the borrower.
- Financing base on Assets: Any loan whose security is given via assets is known as Asset-based lending. The lender of loan puts his investment in the assets of the company and the amount of loan is returned to him later.