Every year, thousands of European start-ups, founders, and other companies embark on a search for suitable corporate financing. They require funds for their business projects. Raising capital is crucial—whether in the initial phase, for expansion, or specific project financing, as it can significantly influence the investment decision, determining if a business succeeds or fails. However, unlike the classic treasure hunt, where a map leads to the goal, the path to financing is often less clear and riddled with numerous hurdles.
Especially for newly founded or fast-growing SMEs, access to traditional bank loans can be difficult, making the exploration of alternative financing solutions necessary. In this complex terrain, various financing options become central tools in the entrepreneur's toolbox. From angel investors to crowdfunding, government funding, and the strategic involvement of investment banking, the landscape of corporate financing is more diverse than ever before. So, how do you navigate this labyrinth to locate the right source of funding that aligns with your investment decision and meets your needs and goals?
We'll take you on a journey of discovery through the world of corporate financing and highlight the advantages and disadvantages of different funding sources below.
First things first … what is corporate financing?
The generic term “corporate financing” covers companies' options to obtain financial resources to promote ongoing operations, future cash flows or growth. Corporate financing comes in a wide variety of types and forms, with financing always provided either internally by the company itself or externally by raising capital. Which route is taken to capital financing depends on a range of factors. The numerous financing options and strategies often directly address a company's specific needs and objectives. Accordingly, to name just a few examples, they can be based on:
- the financing requirements of the company,
- the cost of the business equipment,
- the availability of collateral for inventory financing,
- the desired financing term,
- or whether the financing should be earmarked for a specific purpose or not.
In principle, however, choosing the right form of financing is crucial for the success and stability of any company.
A thousand and one types of financing: What types of corporate financing are there?
There is external and internal financing. Both types or forms of corporate financing describe the main sources from which companies can obtain capital for their business activities and investments.
In the case of external financing, capital is raised outside a company. The required funds are therefore obtained from external sources that are not part of regular business operations. Equity financing is an example of external financing. It can also be an example of internal financing—namely, when new capital is raised externally by taking on new shareholders or issuing new shares.
With internal financing, on the other hand, companies generate capital from their own business operations—for example, by retaining profits, depreciation and amortization, provisions or asset reallocation. Internal financing also happens when existing owners contribute additional capital.
Unsurprisingly, internal financing is often considered a sign of an economically healthy company. After all, internally financed companies are in a position to invest and grow from their resources. External financing, on the other hand, is required if the company's internal funds are not sufficient to drive forward planned projects or growth.
What is the difference between equity financing and debt financing?
Debt financing is always external, but equity financing can sometimes be external and sometimes internal. Sounds confusing? Let us shed some light on the matter …
Equity comes from company owners, shareholders or retained earnings, i.e., profits left in the company and not distributed as dividends.
So, what are the advantages and disadvantages of equity financing?
Equity investors are entitled to a share of the company's profits and typically have voting rights in company decisions. In the event of liquidation, their claims are only honored after those of the lenders. Equity capital does not have to be repaid and does not result in ongoing interest payments. It, therefore, does not represent a direct financial risk for the company but increases the risk for the providers of capital.
Debt capital comprises all externally borrowed funds that must be repaid, including interest. Bonds, supplier credits or even bank loans are typical examples of debt capital and oblige companies to repay them under the agreed conditions.
So, what are the advantages and disadvantages of debt financing?
In contrast to equity investors, debt investors generally have no voting rights in the company. However, in the event of liquidation, they have priority over equity providers when it comes to repayment. Moreover, debt capital must be repaid with interest, which represents an ongoing financial burden. These regular interest payments increase the company's gearing ratio, which indicates the debt to equity ratio. A high gearing ratio can limit the company's flexibility in future financing and is often considered an indicator of higher financial risk.
A brief overview of various sources of financing
Internal sources of financing …
Retained earnings: Undistributed but recognized profits that are reinvested in the company. This process is also known as open self-financing.
Good if such profits are available. Profit retention helps to remain financially independent and can be a prudent choice before considering share buybacks, which directly affect the value of the company by reducing common stock and potentially increasing shareholder value.
Depreciation and amortization: With depreciation financing, depreciation income is used for investments.
Good to reduce the taxable profit and thus the company's tax burden.
Provisions: Long-term provisions can be used temporarily for investments.
Good for future, already foreseeable expenses or liabilities whose exact amount or time of occurrence is unknown, acting as a form of hedging against future financial uncertainties.
Disposal of assets: Sale of non-essential assets or fixed assets.
Good if companies have such assets and benefit from their sale, for example to reinvest more funds in their core areas. This can be the case, especially in restructuring situations.
External sources of financing …
1. Options for self-financing
Equity contributions: Direct contributions from owners or shareholders.
Good to improve the equity ratio of a company. A strong equity base improves the company's credit rating and creditworthiness, which can lead to better conditions when borrowing capital.
Share issue: Raising capital by issuing shares.
Good to raise significant amounts of capital without having to take on additional debt. In certain financial restructurings, especially in times of crisis, companies may decide to convert debt into equity by offering creditors shares in exchange for debt repayment.
Venture capital: Investment companies that receive company shares in exchange for so-called venture capital (or risk capital) provide this externally financed equity financing.
Good for companies with high-growth potential in innovative and technology-intensive sectors for start-up and early-stage financing, scaling the business model, or bridge financing before an IPO. This influx of capital can significantly impact the company's valuation and the allocation of resources for growth and development.
Business angels: Private individuals seeking investment opportunities and who often also have expertise in start-ups or young companies.
Good for start-ups and young companies looking for more than capital, but also mentoring, industry expertise, and an extended network to accelerate their growth and success. This form of financing can improve the company's position without adversely affecting the weighted average cost of capital (WACC) as significantly as other debt forms might.
2. Options for external financing
Bank loans or corporate loans: Loans from banks or business loans from other financial institutions with fixed repayment terms and interest rates.
Good to obtain funds on fixed terms, which helps companies to organize their financial planning, forecasting and capital budgeting more precisely. However, it is important that companies carefully assess their ability to repay to avoid getting into financial difficulties.
Bonds: Issue of debt securities that can be traded on the capital market.
Good for large financing volumes, long-term financing or refinancing of existing debt. This flexible and versatile source of financing is suitable for a wide range of financing needs.
Supplier credit: Deferred payment for goods or services granted by suppliers.
Good to bridge seasonal business fluctuations, build business relationships, secure negotiating advantages and trade cost-efficiently. In addition, supplier credits are usually available quickly and help companies that are denied access to traditional credit.
Leasing: A type of sales financing of fixed assets where ownership remains with the lessor.
Good for lower upfront capital investments. Leasing mitigates the risk of obsolescence, and facilitates access to the latest technologies without the financial burdens associated with purchasing.
Hire purchase: Here, an asset (e.g., a machine, vehicle, or property) is initially rented with the option to buy at the end of the rental period.
Good for companies that want to acquire capital goods without burdening their liquidity with an immediate full payment.
Purchase financing/financial trading: Financing of goods orders by a financial intermediary (the finetrader) acting between the company (buyer) and the supplier.
Good to optimize a company’s working capital management, and specifically merchants looking for a form of short-term financing.
Revenue-based Financing: RBF is financing based on sales revenue. Companies receive capital from investors and repay it as a fixed percentage of their monthly revenue until the agreed repayment amount is reached.
Good for companies that are already generating revenue and have a proven track record of growth, but may not yet be profitable or cannot offer collateral for traditional loans.
Venture debt: Venture debt is a form of financing specifically designed for high-growth start-ups and growth companies already receiving venture capital funding. This type of debt financing offers a supplement or alternative to further equity financing.
Good to provide start-ups and growth companies with additional liquidity to extend their runway and bridge a longer period until the next financing round or until they reach break-even.
3. Mezzanine capital
Convertible bonds are financial instruments that combine elements of bonds and shares. Under certain conditions, this type of bond can be converted into company shares, i.e., equity, at a predetermined time and ratio.
Good to raise capital without diluting the shares of existing shareholders. Convertible bonds are also interesting for strategic investors interested in a long-term investment and who would like to acquire equity in the company later, possibly on more favorable terms.
Profit participation certificates: Securities that combine features of equity and debt capital.
Good for companies looking for flexible and potentially cost-efficient financing. Profit participation certificates can be customized in terms of maturity, interest rate, repayment terms and participation in the company's success. This enables a customized financing solution that meets the company's needs and investors' expectations.
Silent partnerships: A type of equity financing without direct influence on company management.
Good to bridge short to medium-term liquidity bottlenecks without entering into the long-term commitments associated with traditional loans.
But wait, there are even more sources of financing …
… including strategic financial mechanisms like mergers, which can significantly enhance shareholder value through synergies and efficient allocation of resources. Mergers involve combining two or more companies, potentially opening up access to new capital, markets, and technologies. They require a rigorous analysis of net present value (NPV) to ensure that the long-term benefits outweigh the costs, thereby maximizing shareholder value while considering the interests of all stakeholders involved.
Additionally, funding programs that release funding, i.e., grants, subsidized loans, or guarantees from state institutions or the EU, often target specific projects or sectors. These programs can provide essential financial support, especially in the start-up phase of a company when initial investments and operating expenses need to be covered, but little or no revenue is being generated. They are also suitable for entrepreneurial projects in areas like regional development, environmental and sustainability, or research and development. Here the allocation of resources can have a profound impact on society and the environment, aligning with the interests of broader stakeholders.
Start-up loans, also known as loans for business start-ups, are specifically designed to provide financial support to founders and young companies in the initial phase. Although they are a form of debt financing, their specific focus and often customized conditions, such as flexible repayment plans and lower interest rates, give them a place among other sources of financing.
Crowdfunding and crowdlending have become popular among young entrepreneurs, too, as they offer a way to raise funds directly from the public. These methods stand out because they leverage the power of the crowd to support a project, company, or idea financially, demonstrating a unique approach to resource allocation that is driven by community support and conviction.
And last but not least, let's not overlook factoring, a method where companies sell their outstanding trade receivables to a factoring company. This can be an effective strategy for improving liquidity, optimizing receivables management, and minimizing payment default risks. By converting receivables into immediate cash, companies can better manage their cash flow and allocate resources more effectively, ensuring they meet their operational needs and strategic objectives while considering the impact on stakeholders.
How do you determine your financing requirements?
Whether you are setting up a business, expanding or making new investments … there is a whole range of factors to consider when calculating your financing requirements. The fundamental question always comes down to: How much money do we need to reach our business objectives? Or, at the very least, to meet our day-to-day operational expenses? Incorporating financial modeling into this process can significantly enhance the accuracy of your financial planning. Financial modeling involves creating a comprehensive mathematical model of a company's financial situation to predict future financial performance based on various scenarios and assumptions.
We recommend the following steps to determine your specific financing requirements:
- Analyze business plans
- What is the expected income over what period of time?
- What are the expected expenses over what period of time?
- Estimate costs further
The expected expenses associated with the planned business activities and recorded in the business plan include
- Initial investment: costs of starting the business, buying or renting property, purchasing equipment, machinery, and vehicles.
- Operating expenses: running costs such as wages and salaries, rent, insurance, marketing, raw materials and other inputs.
- Reserves for unforeseen expenses: a buffer for unexpected costs.
- Liquidity planning
Liquidity planning should include all expected income and expenditure over the period for which the financing requirements are calculated.
- Calculate capital requirements
Initial investment (+) ongoing operating expenses (+) necessary reserves (-) expected income (=) your capital requirements
- Check internal financing options
Are there funds from business operations, retained earnings or depreciation?
- Determine external financing requirements
Your capital requirements (-) internally available financing (=) your external financing requirements
- Review and adjust financing requirements regularly
Business conditions change, and so should your financial decisions. Market changes, unexpected costs or changes in revenue often require a new calculation of financing requirements. Ultimately, the aim is always to identify and secure suitable sources of financing in good time.
How does your capital structure affect the search for a matching corporate financing solution?
A company's capital structure is usually determined by the ratio of equity to borrowed capital in the balance sheet. Exactly what this ratio looks like has a significant impact on the cost of capital, a company's financial risk management, the return on equity, taxes and entrepreneurial flexibility, its valuation and reputation. It influences not only the costs and availability of capital but also the company's risk and strategic options. Careful planning and adjustment of the capital structure are, therefore, an essential part of strategic corporate management.
Equity and debt capital, for example, incur different costs. As a rule, debt capital is more favorable than equity capital due to the tax deduction of interest payments. However, as debt increases, so do the risks and, therefore, the interest costs for additional debt capital.
A high level of debt (i.e., a high proportion of borrowed capital) increases a company's financial risk. This can impair creditworthiness and increase the cost of borrowing further capital. In times of economic crisis, a high level of debt can also jeopardize the company's existence, as interest and principal payments have to be made regardless of the earnings situation.
At the same time, using debt capital can increase the return on equity (ROE) as long as the return on investment (ROI) is higher than the cost of debt capital. This effect is known as the leverage effect. Moreover, this strategic use of debt capital can also positively influence the Internal Rate of Return (IRR) by enhancing the efficiency of an investment. This occurs because leveraging increases net cash flows relative to the initial investment, provided the ROI exceeds the cost of debt, further illustrating the benefits of financial leverage.
Consequently, your capital structure is crucial to carefully consider financing decisions. This involves a thorough analysis of the company's current situation, a profound understanding of its financial accounting, and a detailed examination of its capital structure – all of which are fundamental to informed decision-making. Only then should one seek corporate financing that aligns with the company's objectives.
Example: Alternative financing can strengthen the relationship with your bank
Utilizing alternative sources of financing can improve your company's balance sheet structure and liquidity, and, therefore, your creditworthiness. You strengthen your negotiating position and demonstrate financial management expertise. You also spread your financing risk when you access different sources of financing. Not only that, but you reduce your dependence on bank loans and thus also minimize the risk for the bank itself.
What type of corporate financing does Silvr offer?
Silvr offers SMEs in every sector a forward-looking form of business loans for various business purposes. Our financing solutions are aimed at companies that want to improve their liquidity, finance inventory, promote growth, finance working capital or optimize their corporate finance activities overall. It is entirely up to you what you use the funds for. Our loan amounts range from €5,000 to €1,000,000.
Unlike some house banks, our flexible corporate loans do not require traditional guarantees or other collateral. We assess your creditworthiness with our state of the art data-based scoring technology in real-time. Our in-house financial analysts stay with you along the way.
Why not give it a try and start your financing inquiry with us today?
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