Piggy has witnessed the growth in alternative financing methods such as crowdfunding. This is an internet-based funding method for the realization of an initiative through online distributed contributions and micro-sponsorships in the form of pledges of small monetary amounts by a large pool of people within a limited timeframe. Funders can donate, pre-purchase the product, lend, or invest based on their belief in an appeal, the promise of its founder, and/or the expectation of a return. Crowdfunding can be used to bring to life artistic projects, products for sale and personal ventures. It also aids entrepreneurs in gaining the wide exposure that will eventually help them to raise further funding.
A good case-study is the funding of the Statue of Liberty. This was a joint project between the United States of America and France. Originally proposed back in 1865 by Frenchman Edouard de Laoulaye, the sculpture was commissioned over 10 years later, in 1876. It was decided that the Americans would be responsible for building the pedestal, and on the other side of the Atlantic, the French people would take care of the Statue and its assembly in the USA. A lack of funds posed a problem for Lady Liberty, and fundraising events were held in both countries. The American Committee of the Statue of Liberty raised some money but fell short of the necessary target. Publisher Joseph Pulitzer came to New York’s rescue. He successfully launched a fundraising campaign via his newspaper, The New York World. This was one of the first successful crowdfunding campaign on a large scale basis.
The Statute of Liberty
Today, platforms such as Kickstarter and IndieGoGo have been built on the same concept and are providing an avenue for entrepreneurs all over the world to fund projects. In this article, Piggy focuses on the two ways in which businesses can raise capital is through equity and debt.
These are individual investors who buy equity in small private firms. For many start-ups, the first round of outside private equity financing is often obtained from angels. Frequently, these investors are friends or relatives of the entrepreneur. Because their capital investment is often large relative to the amount of capital already in place at the firm, they typically receive a sizable equity share in the business in return for their funds. As a result, these investors may have substantial influence in the business decisions of the firm. Angels may also bring expertise to the firm.
Venture Capital Firms
This is a limited partnership that specializes in raising money to invest in the private equity of new firms. Typically, institutional investors such as pension funds are the limited partners. Venture firms invest in many start-ups, so limited partners get the benefit of this diversification. Venture capitalists use their control to protect their investments. They may also control a key nurturing and monitoring role for the firm.
Private Equity Firms
A private equity firm is organised very much like a venture capital firm, but it invests in the equity of existing privately held firms rather than start-up companies. Often, private equity firms initiate their investment by finding a publicly traded firm and purchasing the outstanding equity, thereby taking the company private in a transaction called a leveraged buyout (LBO). In most cases, the private equity firms use debt as well as equity to finance the purchase.
Institutional investors such as pension funds, insurance companies, endowments and foundations manage large quantities of money. They are major investors in many different types of assets. They are also active investors in private companies. Institutional investors may invest directly in private firms, or they may invest indirectly by becoming limited partners in venture capital or private equity firms.
Initial Public Offering (IPO)
The process of selling stock to the public for the first time is called an initial public offering (IPO). The two advantages of going public are greater liquidity and better access to capital. By going public, companies give their private equity investors the ability to diversify. In addition, public companies typically have access to much larger amounts of capital through the public markets, both in the initial public offering and in subsequent offerings. Below is an infograph on how to set up a business and fund it through equity;
Bank loans are a good example of private debt that is not publicly traded. The private debt market is considered much larger than the public debt market. Private debt has the advantage that it avoids the cost of registration but has the disadvantage of being illiquid. There are two segments of the private debt market: term loans and private placements.
Banks usually provide revolving lines of credit to corporates. This is a credit commitment for a specific period up to some limit which a company can use as needed. Also, debt can also take the form of a syndicated bank loan: a single loan that is funded by a group of banks rather than just a single bank. Usually, one member of the syndicate (the lead bank) negotiates the terms of the bank loan. Most syndicated loans are rated as investment grade.
A private placement is a bond issue that does not trade on a public market but rather is sold to a small group of investors. Because a private placement does not need to be registered, it is less costly to issue. Instead of an indenture, often a simple promissory note is sufficient.
Corporate bonds are debt securities issued by corporations. A public bond issue is similar to a stock issue. A prospectus or offering memorandum must be produced that describes the details of the offering. In addition, for public offerings, the prospectus must include an indenture, a formal contract between the bond issuer and a trust company. The trust company represents the bondholders and makes sure that the terms of the indenture are enforced. In the case of default, the trust company represents the bondholders’ interests. While corporate bonds almost always pay coupons semi-annually, a few corporations have issued zero-coupon bonds. The face value or principal amount of the bond is denominated in standard increments, most often USD1,000.
Bearer Bonds and Registered Bonds
In a public offering, the indenture lays out the terms of the bond issue. Most corporate bonds are coupon bonds, and coupons are paid in one of two ways. Historically, most bonds were bearer bonds. Bearer bonds are like currency: Whoever physically holds the bond certificate owns the bond. To receive a coupon payment, the holder of a bearer bond must provide explicit proof of ownership. Besides the obvious hassles associated with clipping coupons and mailing them in, there are serious security concerns with bearer bonds. Losing such a bond certificate is like losing currency. Consequently, almost all bonds that are issued today are registered bonds. The issuer maintains a list of all holders of its bonds. Brokers keep issuers informed of any changes in ownership. On each coupon payment date, the bond issuer consults its list of registered owners and directly deposits the coupon payment into the owner’s brokerage account. This system also facilitates tax collection because the government can easily keep track of all interest payments made.
Chapter 5 of the Investor 101 Handbook covers capital raising options available for businesses. Download the Handbook below;
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