Understanding how corporate financing works will help you grow and sustain your business.
What is meant by corporate financing?
Corporate finance refers to activities and transactions related to raising capital to create, develop and acquire a business. It is directly related to company decisions that have a financial or monetary impact. It can be considered as a liaison between the capital market and the organisation.
What are the two types of corporate financing?
There are two main types of financing available for companies: debt financing and equity financing.
Equity financing is a loan from a bank for a specific amount that has a specified repayment schedule and a fixed or floating interest rate. For example, if you’re looking to borrow a large sum of money and have a property on hand, you may be able to “cash out” the property’s value by taking a term loan or an home equity loan.
Many banks have equity term loan programs that can offer small businesses the cash they need to operate from month to month. Equity financing is very useful for small businesses to purchase fixed assets such as equipment for its production process. Term Loan is not the most accessible option for everyone in the market, and approval is highly conditional upon the bank, but it is possible.
Whether you call it an equity financing, home equity loan or a term loan, they all mean the same thing. A term loan lets you borrow money, while using your house as collateral. Equity term loan is another option available to homeowners who may have a tight cash situation but have have a valuable house at their disposal, which they may sell and downgrade. But a home equity loan lets you get money out of your house, without having to lose it.
If your property has increased in value over time, you may take a term loan by using the equity of your property as collateral and at a relatively low interest rate. The term loan extended against your property means that its equity becomes collateral.
There are plenty of advantages of taking an equity term loan by using your house is the collateral. For example, the bank feels a lot more secure knowing you can’t exactly pack up your house and run away with it. Because there’s something they can foreclose on, banks consider term loans to be low-risk, secured loans.
That means banks charge a super-low interest rate, seldom above 1.3 per cent per annum. For reference, that’s less than a third of your CPF Ordinary Account rate (up to 3.5 per cent per annum), and about 1/6th of a personal loan rate (about six per cent per annum). That super-low interest rate means home equity loans are quite cheap, and can provide a much bigger loan than you’d get through, say, a personal installment loan. Most other, unsecured loans can only lend you up to four times your monthly salary.
On top of this, the government in 2017, made regulatory changes to equity term loan restrictions. If your house is already paid up, you can borrow up to half its value, without having to meet Total Debt Servicing Ratio (TDSR) restrictions.
This is how an equity term loan works:
Suppose you have purchased a property in 2010 for $650,000.
Loan was 80% = $520,000 amortized over 30 years.
In 2018, a new valuation was done and the property is worth $1 million.
The current loan amount is $440,000.
If this property loan is the only one you have in Singapore, then you may qualify for 80% lending on valuation, which is $800,000.
Equity home loan amount = (80% * valuation) less current loan amount less CPF usage including accrued interest.
Assuming you have used $160,000 CPF with accrued interest, this is the home equity loan amount you would get:
$800,000 – $440,000 – $150,000 = $200,000
Together with the outstanding loan, the total debt on the property now would be $640,000.
Debt financing on the other hand, occurs when a company raises money by selling debt instruments to investors. Debt financing is the opposite of equity financing, which entails issuing stock to raise money. Debt financing occurs when a firm sells fixed income products, such as bonds, bills, or notes.
But for companies looking for Corporate Financing, there is one big difference between debt financing and equity financing.
Debt financing involves the borrowing of money whereas equity financing involves selling a portion of equity in the company. The main advantage of equity financing is that there is no obligation to repay the money acquired through it.
What are examples of debt financing?
- Loans from family and friends.
- Bank loans.
- Personal loans.
- Government-backed loans.
- Lines of credit.
- Credit cards.
- Equipment loans.
- Real estate loans.
A big advantage of debt financing is the ability to pay off high-cost debt, reducing monthly payments by hundreds or even thousands of dollars. Reducing your cost of capital boosts business cash flow.
There are also several disadvantages with debt financing. The biggest one being you need to qualify. Also, the company and the owner must have acceptable credit ratings to qualify. And the business must be ready to do fixed payments, in that principal and interest payments must be made on specified dates without fail. This means businesses that have unpredictable cash flows might have difficulties making loan payments.
In debt financing, to calculate how much to lend, investors or lenders divide the company’s total liabilities by its existing shareholder equity. Both figures can be found in a company’s balance sheet as part of its financial statement. The Debt-to-Equity ratio shows clearly how much a company is financing its operations through debt compared with its own funds.
In which situation is debt financing advisable?
If equity financing is used to raise money from investors for business obligations, the investors may want a seat on the board of directors or may require that a percentage of ownership becomes theirs. If a business owner does not want to give up a portion of the control of the firm, then debt financing is preferable.
But be careful because although debt can be used as leverage to multiply the returns of an investment but also means that losses could be higher. Margin investing allows for borrowing stock for a value above what an investor has money for with the hopes of stock appreciation.
As a high number of applications for corporate financing are unsuccessful, it is important for passionate business-owners to consider term loans to grow and sustain their business operations. It is also important for them to work with trusted hands, and with people who know the industry.
One recent research report said that up to 81 per cent of SMEs in Singapore do not qualify for business financing. Many applications for bank loans are delayed or rejected because business owners are not familiar with the qualifications for the loans or of how to apply for such loans.
Access to crucial credit facility is often hindered by the lack the relevant financial knowledge and / or the resources to engage professional business consultancy services to manage and address their obligations and financial liabilities as business owners. The terrain to apply and qualify for loans is also uneven because creditors are not just banks but finance companies and other licensed lending entities whose security arrangements may be different or more complicated.
What is the role of corporate financing?
The role of corporate finance is to raise the money that the company needs to operate. Then, the department is responsible for controlling these funds, and growing them through investing and other ventures in order to cover the liabilities, or expenses, that the company has.
What is Corporate Financing?
It includes any decisions made by a business that affect its finances. And the three major decisions are:
- Investments – Where should a firm invest its (scarce) resources? This must come with project analysis and security analysis.
- Financing – How should the firm raise (additional) resources? And this should be a consideration of if the financing should consist of equity/debt/hybrids and if it should be long/short term.
- Dividends – What should the firm do with excess resources? Should it reinvest in business or should it distribute as dividends/return on capital?
When thinking of corporate financing, it is good to take a Balance Sheet perspective.
Why should all business owners and project managers understand the options they have for corporate financing?
Corporate finance provides managers the ability to identify and select strategies, and projects. Additionally it allows for business owners and managers to forecast funding requirements for their company, and creates the ability to plan strategies for acquiring funds.
So, the importance of corporate finance is equally divided between the following phases:
- Planning finances
- Capital raising
- Risk management and financial monitoring
- Investments & Capital Budgeting
- Capital Financing
- Dividends & Return of Capital
In this regard, it is good to talk to Corporate Finance consultants as they are responsible for implementing actions and strategies in managing budget and structuring a business capital including overseeing the working capital.
Corporate financing is based on a simple idea: someone gives you money and you promise to pay it back, usually with interest. Loans are so common that you probably are familiar with the mechanics, but nevertheless it makes sense to review the basics.
The success or failure of your business can hinge on borrowing money sensibly: you want to borrow enough that your company can reach its potential but not so much that you have severe difficulty paying it back.
When borrowing money sensibly, you must be aware that some lenders will require you to put up a collateral which they can sell to collect their money if you don’t make your loan payments.
A lender may also require that someone cosign or guarantee the loan. That means the lender will have two people rather than one to collect from if you don’t make your payments. When asking friends or relatives to cosign or guarantee a promissory note, be sure they understand that they’re risking their personal assets if you don’t repay the loan.
If you have organised your business as a limited liability entity, such as a private limited company, the lender will probably ask you – the business owner – to personally guarantee the loan and/or pledge your personal assets to guarantee repayment.
This is because small businesses have high failure rates and lenders feel more comfortable if business owners have a personal stake in repaying the money. Before borrowing money sensibly, be aware that guaranteeing or personally cosigning your business’s loan circumvents your limited liability status. All of your separate property, and either half or all of any property you jointly own with a spouse, could eventually be seized if you default on the loan.
Finally, if you are married, the lender may insist that your spouse cosign the promissory note. If your spouse cosigns the loan, not only is your jointly owned property completely at risk for this joint debt, but also any assets that your spouse owns separately – a condo, for example, or a joint-bank account. What’s more, if your spouse has a job, his or her earnings will be subject to garnishment if the lender sues and gets a judgment against the two of you.
So there are many factors to consider when considering corporate financing. Especially if you do not want your personal loans to turn into a noose around your neck to strangle you sometime in the near future.
Businesses owners ought to remember that you need to borrow when you do not need money. When your business is struggling and you need additional funding to tide over a tough patch, then you will find that your access to funding is completely cut off and end up with very expensive funding.
Getting loans means you have to be aware of different kinds of loans and lending tactics that can put you at financial risk.
QUESTIONS FOR YOUR LENDER
Ask these questions of several different lenders to ensure that you are choosing the best lender. Each question should be carefully considered based on your situation.
Ask your lender:
How much are my monthly payments?
How big a monthly payment can I handle, given my income and my other financial responsibilities? What is the smallest loan I can take out that will satisfy my needs?
Ask your lender:
How many years will I be making payments on this loan?
If it will be a number of years before the loan is paid off, do I have an income that is secure enough to know that I will be able to make payments well into the future?
Ask your lender:
Is the annual percentage rate (APR) fixed or adjustable?
If the APR is adjustable, will I be able to make sufficient payments if the rate increases?
Ask your lender:
Will I be charged any additional fees?
Are these fees reasonable? How do they affect my ability to pay off the loan? Are these fees refundable if I refinance my loan?
Ask your lender:
Will the interest rate increase if I default on my loan?
If the interest rate increases, will I be able to make the necessary payments?
Ask your lender:
Does it help me in the long run to refinance my loans?
If I refinance, I may pay a lower monthly premium, but may end up paying more in the end. Is it worth it for me to refinance?
BEFORE GETTING LOANS, AVOID ANY LENDER WHO…
- tells you to indicate on your loan application that your income is higher than it actually is.
- pressures you to apply for a loan or to apply for more money than you need.
- pressures you into monthly payments you can’t afford.
- pressures you to sign documents you haven’t read.
- promises one set of terms when you apply and gives you another set of terms to sign—with no legitimate explanation for the change.
- tells you to sign blank forms and says they’ll fill them in later.
- says you can’t have copies of the documents you have signed.
- asks you to sign a loan that has credit insurance or any extra products you didn’t want.
OTHER TIPS BEFORE GETTING LOANS
Make sure you talk to someone you can trust before making any decisions about a loan. Mortgage consultants, financial advisers, and credit counseling services are good sources to help you make the best decision about getting loans.
Negotiate. You can always ask your lender to lower the APR, take out a charge you don’t want to pay, or remove a loan term that you don’t like.
Make sure you understand all of the items on the forms before closing.
Don’t be afraid to ask questions and be assertive about what you want, what you don’t want, and what you can and can’t afford.
Be sure to keep all copies of all the actual documents you are asked to sign.
Remember: Trust your instincts before getting loans. It is important that you feel comfortable with the amount of debt you owe. If it feels like it is more than you can handle, you should consider ways to make your loan more manageable or think about ways to avoid taking out a loan altogether.