Sources of Capital -Definition types investment sources classifications

Sources of Capital

What are Sources of Capital?

Money is the currency of trade relations and the main means by which we acquire products, services, or experiences. Therefore, the search for a source of investment is a two-way street. We seek capital to invest in something to generate a return, that is, capital will provide the development of some activity to generate some result.

Types of sources of Capital

The main sources of capital investments can be divided into four kinds:

1. Sources for the initial phase of business (idea)
2. Sources of equity (Bootstrapping)
3. Sources with corporate participation, usually funds or strategic
4. Sources with high capital, which are normally loans and financing with banks

Investment sources for the initial phases in a business:

1. Seed capital

Seed capital is based on an idea at an early stage that plants a seed to allow the small business to grow. This is the first round of capital for a startup business. In this case, the entrepreneur must be committed and enthusiastic in the search for seed money, since it has little more to attract investors.

Seed investors hope to participate in the entrepreneur’s success and achieve a healthy return, as their investment is valued over time. However, seed capital is a risky investment and most investors know this, or at least they should.

2. Accelerators

The accelerators recruit and select companies at an early stage and geared to growth. In addition to financial resources, they also offer education and mentoring.

3. Equity (Bootstrapping)

Bootstrapping comes from the English expression “tighten the buckle of the boots”. Equity consists of a set of actions and strategies to start a business without using onerous capital, that is, without external financial assistance.

Ex.: Personal finance, subsidies or even from the company’s own operating income.

 4. Family, Friends & Fools

When launching an idea, family, friends, and fools are the people to talk to first. Less than 1% of startups increase their risk capital so that the 3 F’s are important.

Trusting friends who are willing to invest in you and your family, and who feel compelled to invest in you is a great way to start. That’s why entrepreneurs spend a lot of time cultivating their social network; after all, you never know who might be a potential financier for your idea.

Many entrepreneurs approach their family, friends, and colleagues to earn money after exhausting their finances. Once these investors know the entrepreneur, they are more likely to take the risk of financing a new venture than traditional sources of finance, such as banks or venture capital firms.

5. Subsidized Capital

They are sources of funds that make capital available to the entrepreneur and that he does not commit to returning in the future, offering something in return to society. The entrepreneur is committed to carrying out the project and achieving previously agreed objectives.

Main capital sources with a subsidy are:

• Foundations of great specific causes
• Governments
• Sovereign wealth funds
• Federal or state agencies
• NGO

6. Strategic Partnership

The first step in creating strategic partnerships are to identify complementarily And propose a difference for both companies.

To identify potential companies for strategic partnerships, just design your business network, identify the target segments and seek partnerships.

 7. Loans and Financing

They are conventional sources of costly capital, where the company goes through an approval process to determine the value, conditions, and costs of capital. They are formed mainly by public and private commercial banks and development banks.

The important thing for using this type of capital is to have the conviction that the ROI of investing that capital in the operation will be greater than the cost of capital (interest).

Classification of Sources of Funds

Businesses can raise capital through various sources of funds which are classified into three categories are:

1. Based on Period – The period basis is further divided into three dub-divisions are:

Long Term Source of Finance – This long-term fund is utilized for more than five years. The fund is arranged through preference and equity shares and debentures etc. and is accumulated from the capital market.

Medium Term Source of Finance – These are short-term funds that last more than one year but less than five years. The source includes borrowings from a public deposit, commercial banks, commercial paper, loans from a financial institute, and lease financing, etc.

Short Term Source of Finance – These are funds just required for a year. Working Capital Loans from Commercial bank and trade credit etc. are a few examples of these sources.

2. Based on Ownership – This source of finance are divided into two categories are:

Owner’s Fund – This fund is financed by the company owners, also known as the owner’s capital. The capital is raised by issuing preference shares, retained earnings, equity shares, etc. These are for long-term capital funds which form a base for owners to obtain their right to control the firm’s management and operations.

Borrowed Funds – These are the funds accumulated with the help of borrowings or loans for a particular period of time. This source of funds is the most common and popular amongst businesses. For example, loans from commercial banks and other financial institutions.

3. Based on Generation – This source of income is categorized into two divisions are:

Internal Sources – The owners generated the funds within the organization. The example for this reference includes selling off assets and retained earnings, etc.

External Source – The fund is arranged from outside the business. For instance, issuance of equity shares to the public, debentures, commercial banks loan, etc.