Corporate Funding: Purpose, Type

By | Januari 5, 2022

What: Funding for the company (company funding) is an injection of money from donors to the company. Sometimes, we also refer to it as corporate financing.

In general, there are two sources of funding: equity (shares) and debt. We call equity fund holders as stock investors, shareholders or company owners. 

For debt, it can take various sources, ranging from bank loans, issuance of corporate bonds, medium term notes or commercial papers. Thus, debt funders can take various names such as creditors, debt investors, bond holders or bond investors.

Corporate funding objectives 

Funding is the fuel for a business to run. Companies need funds for a variety of purposes, including:

  • Starting a new business, for example to rent an office, new equipment and pay for advertising.
  • Running a business, for example to meet short-term liquidity and working capital or to finance commercial research.
  • Expanding the business, for example to add new branches, buy production machines or build new production facilities.

Why new companies find it difficult to get funding

Compared to established companies, new companies find it difficult to raise funds. Their risk is high because they do not have a track record of operations and success in running a business. It discourages funders from lending their money.

On the other hand, funders want their money to grow. They compare risk and rate of return before deciding to lend money. When they perceive a company as high risk, they are reluctant to inject funds. And, if they are willing, to compensate for the high risk, they require high returns or interest.

A new company has a high risk of failure because it only has a few customers. They rely on external financing to run the business, rather than from selling products. They have limited income because they only have a few customers. In addition, they may have to face competitive pressure from other, more established companies. 

Type of company funding

Companies can take a variety of sources to obtain funds. New companies usually rely on an injection of funds from the owner. Due to the high risk, they may find it difficult to access funding from the capital market or banks.

In general, we can classify the types of business funding in various ways. First, we can categorize by timeframe.

  • Short term funding. Usually, companies have to pay back in a year or less. Examples are factoring, bank loans, and commercial papers .
  • Medium long term funding. Maturity of two years or more. Examples of medium-long-term funding are medium-term notes, corporate bonds, and stocks.

Second, we can classify funding based on its source.

  1. Internal funding
  2. External funding

Internal funding

The money comes from internal company, namely from retained earnings. Of the total net profit recorded, the company distributes a portion as dividends to shareholders. For the rest, they keep as retained earnings. Companies can use retained earnings to meet operating needs or to support business expansion funding .

External funding

Money comes from external parties, either for equity capital or debt. Companies can raise money from the capital market by issuing debt securities or shares, or, companies borrow from banks.

External funding is usually for expansion such as establishing a new production facility or acquiring another company. Such corporate actions usually require significant funding, more than can be financed internally.

External sources include various types, including the following:

Factoring ( factoring) . Companies sell their invoices to financial institutions such as finance companies. They do this to get some cash right away.

The overdraft facility (overdraft facility). The bank allows the company to take out more money than is in its bank account up to the agreed limit.

share capital . The company asks the owner to add capital to the company. Alternatively, companies can issue shares in the capital market to raise funds.

Line of credit . This is an unsecured bank loan. The bank determines the maximum amount of loan that the company can withdraw over a certain period, usually one year. The company must pay a certain fee or a certain percentage of the loan in a checking account at the bank.

Revolving credit . This is similar to a line of credit with additional fees other than interest. The term may be two to five years.

This loan has no fixed payment amount. The company can withdraw the loan, pay it off, then withdraw it in any way and how many times, until the end of the revolving credit arrangement period. 

commercial papers . These are money market securities and represent unsecured loans. The company issues it to obtain short-term funds to meet trade receivables or other liabilities maturing in one year or less.

Medium term notes . This is a medium term note. Companies issue them by offering fixed or floating coupons. In contrast to corporate bonds, companies can offer them continuously through various brokers instead of issuing the full amount at once. In Indonesia, the trade is over the counter , not in the capital market.

Corporate bonds. These are long-term debt securities, usually transacted through the capital market and with a larger nominal value than medium term notes . This instrument can take various types, fixed rate bonds, floating rate bonds, zero-coupon bonds, putable bonds, callable bonds, convertible bonds, unsecured bonds, senior bonds or subordinated bonds . 

Mortgage . This is a bank loan, secured by property and has a long term.

Grant. This funding usually comes from charities or the government to help businesses meet certain criteria such as being environmentally friendly or providing jobs in certain areas.

Crowdfunding . Funding comes from a large number of people, each contributing relatively small funds. This funding model is usually through a website or social media.

venture capital . This is private equity funding and is usually awarded to start-ups or startups. Private equity firms raise funds from wealthy individuals, investment banks, or other financial institutions.

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