The lifeblood of a business
Capital is the lifeblood of a business. Without it, wages cannot be paid, supplies of components or ingredients cannot be purchased, operational expenses cannot be met. Without it, risk cannot be monetized or exploited in ways that invite responsible participation of the public and the investment community. For instance: let’s say you owne a business that manufactured cedar log furniture for both whole sale and retail. During the winter months you have to harvest your white cedar logs from the surrounding lands and bring it to your plant that debarks (takes off the bark from the cedar post) the tree trunks. All the cedar lumber and cedar post are stored under a roof to dry, until needed for the cedar furniture. The lumber and post are graded to strict quality standards for the cedar log furniture. Once the logs undergo a German peel making them smooth and clean, they are stored for future use, and cut to predetermined lengths that are blueprinted in the furniture plant. In the furniture plant the parts for the cedar furniture are assembled and then banded up. They remain in the warehouse where they will be boxed after an order is taken. All this work and time is put into the cedar log furniture without any monies being generated. Were does the capital funding come from to support all this front end work?
Capital can be sourced from retained earnings or sought from financial markets.
Often, a business must seek finance. In broad terms, there are two kinds: equity and debt. It is important to understand the difference because the consequences and responsibilities implied by each is significantly different. But each offers advantages in the form of equity, income stream, or other forms of risk management including long term investment and short term fund raising.
Let’s take a seat and discuss what Equity is as well as Debt. Equity involves an entity giving money to a business in return for ownership of a part of the business. Typically accomplished by selling shares of the enterprise in exchange for liquidity or capital, this is the principle that drives our stock markets.
Non traditional sources of capital are often available under certain circumstances.
Many small businesses rely on personal savings, inheritances, and gifts to provide startup capital. Benton Scheer was injured on an oil rig and spent a week in the hospital recovering from a broken hip. He was very fortunate that he was not killed or permanently maimed – offshore oil rigs are dangerous places to work. The company initially asked him to sign waivers to absolve them of responsibility, but with the help of a knowledgeable maritime lawyer he was able to negotiate a large settlement that financed his very successful tool and die operation.
Debt involves an entity lending money to the business in return for a payment of interest. The two have different risk and return characteristics for both sides of the agreement. This is the backbone of the bond markets, where debt is traded and valuations perceived are influenced by the perceived risk of repayment plus an interest premium based on time and risk.
In the game, equity based finance is raised through a sharemarket and debt based finance is raised through a bond market.
But these same principles can apply to individuals outside the business realm. For example one might raise capital before entering a gambling establishment found via the search for online casino us based on sharing the winnings or losses with the “investors.” The equity model works here.
A bit harder to demonstrate the debt model but here we go: you could issue bonds which pay a fixed return. If you are always a winner at the casino, then the bonds would have a higher price, lower real return. If you lose a lot when you play, the real interest rate would soar, and the price of the bond would collapse. Probably not a good model to use. But then again, what are you doing at the casino with your capital, my friend?