Corporate finance is the process of matching capital needs with a company’s operations.
It differs from accounting, which is the process of historical recording of the activities of a business from a monetized point of view.
Capital is the money invested in a company to create, grow and sustain it. This differs from working capital, which is money to prop up and sustain trade: the purchase of raw materials; equity financing; the financing of the necessary credit between the production and the realization of the benefits of the sales.
Corporate finance can begin with the smallest round of money from family and friends that is invested in a start-up company to finance its first steps in business. At the other end of the spectrum are the multiple layers of corporate debt within large international corporations.
Corporate finance essentially revolves around two types of capital: equity and debt. Equity is the shareholders’ investment in a business that carries ownership rights. Equity tends to stay within a company for the long term, in the hope of generating a return on investment. This can come through dividends, which are payments, usually annually, related to the percentage of stock ownership.
Dividends only tend to accrue within very large, long-established corporations that already have enough capital to more than adequately fund their plans.
Younger, growing, less profitable operations tend to be voracious consumers of all the capital they can access, and therefore do not tend to create surpluses from which dividends can be paid.
In the case of younger and growing companies, equity is often continually sought.
In very young companies, the main sources of investment are usually individuals. After the family and friends already mentioned, high net worth individuals and experienced industry figures often invest in younger, more promising companies. These are the pre-startup and seed phases.
In the next stage, when there is at least some sense of a cohesive business, the main investors tend to be venture capital funds, which specialize in taking promising early-stage companies through rapid growth to a highly profitable sale or sale. a public offering of shares. Share.
The other main category of investment related to corporate finance comes from debt. Many companies seek to avoid dilution of their ownership through ongoing stock offerings and decide that they can create a higher rate of return on loans to their companies than the cost of servicing these loans through interest payments. This process of preparing the business and capital aspects of a company through debt is generally known as leverage.
While the risk of raising capital is that the original creators become so diluted that they ultimately make very little profit on their efforts and success, the main risk of debt is corporate: the company must be careful not to be seen overwhelmed and therefore unable to make your debt payments.
Corporate finance is ultimately a juggling act. You must successfully balance ownership aspirations, potential, risk, and returns, optimally considering an adjustment of internal and external shareholder interests.