Methods of Raising Capital: Short-Term, Medium-Term, and Long-Term Financing Options for Companies

 Different Ways to Raise Capital

Capital is to business what nutrition is to life. Whether you are starting a new venture or expanding an existing one, securing the right funding at the right stage is crucial, as capital fuels growth. You may have brilliant ideas, solid plans, and a talented team, but without adequate funding, even the best visions cannot come to fruition.

Raising capital is often perceived as a challenge, but it doesn’t have to be complicated or intimidating. As an entrepreneur, you have a wide array of options from diverse funding sources to various types of investors allowing you to choose the path that best aligns with your business goals.

Methods of Raising Capital

A company may raise funds for different purposes, depending on the duration of its financial needs, which can range from very short-term to long-term. The total capital required depends on the nature and size of the business, while the scope of raising funds is influenced by the sources available.

For sole proprietorships and partnerships, opportunities for raising funds are relatively limited. They can finance their business through:

1. Investment of personal savings
2. Loans from friends and relatives
3. Advances from commercial banks
4. Borrowing from finance companies

For companies, there are several structured methods to raise capital, particularly for long-term and medium-term financing:

1. Issue of Shares 

Issuing shares is one of the most important methods of raising capital. Shareholders’ liability is limited to the face value of shares, and shares are generally transferable.

• Private companies cannot invite the general public to subscribe, and their shares are not freely transferable.
• Public limited companies face no such restrictions.

Types of shares include:

• Equity Shares: Dividend depends on available profits and directors’ discretion, so there is no fixed financial burden. Each equity share typically carries one vote.
• Preference Shares: Dividends are payable at a fixed rate but only if profits exist, meaning there is no compulsory burden. Preference shares usually do not provide voting rights.

2. Issue of Debentures

Companies can raise loans by issuing debentures, which carry a fixed interest payable even if profits are not available. Debentures are generally secured by the company’s assets and are mainly used for long-term financing. They do not carry voting rights.

3. Loans from Financial Institutions

Long-term and medium-term loans can be obtained from institutions like the Industrial Finance Corporation of India, ICICI, and state-level industrial development corporations. Loans are granted for up to 25 years against approved schemes or projects and must be secured through assets such as property, stocks, or shares.

4. Loans from Commercial Banks

Medium-term financing can be raised from commercial banks against the security of company assets. These loans are often used for modernization or renovation and typically involve minimal legal formalities, aside from creating a mortgage.

5. Public Deposits

Companies can invite shareholders, employees, and the general public to deposit their savings. The Companies Act permits deposits for periods up to 3 years. Public deposits are popular due to:

• Lower interest rates compared to bank loans
• Ease of mobilizing funds, especially during credit crunches
• Unsecured nature
• No need for credit-worthiness evaluation

6. Reinvestment of Profits (Ploughing Back of Profits)

Profitable companies often retain a portion of profits instead of distributing them entirely as dividends. These retained profits form part of the company’s ownership capital and can be used for:

• Expansion of the business
• Replacement of obsolete assets and modernization
• Meeting permanent or special working capital needs
• Redemption of old debts

Benefits of This Source of Finance to the Company

1. Reduces dependence on external sources of finance.
2. Enhances the company’s creditworthiness.
3. Helps the company withstand difficult financial situations.
4. Allows the company to maintain a stable dividend policy.

Methods of Raising Short-Term Capital

To meet short-term financial requirements, companies can use the following methods:

1. Trade Credit - Companies often purchase raw materials, components, and other supplies on credit from suppliers. Typically, suppliers grant credit for 3 to 6 months, effectively providing short-term finance. The availability of trade credit is linked to the volume of business: as production and sales increase, so does the volume of purchases and the credit available.
2. Factoring - Amounts due from customers for credit sales, known as book debts, can be assigned to a bank. The bank provides cash in advance and takes over the responsibility of collecting debts, charging a fee for this service. This method, known as factoring, allows companies to convert receivables into immediate working capital.
3. Discounting Bills of Exchange - When goods are sold on credit, companies can draw bills of exchange on buyers. Instead of waiting until maturity, these bills can be discounted with a commercial bank for immediate cash, after deducting the bank’s discount charges. The discount is treated as the cost of raising finance.
4. Bank Overdraft and Cash Credit
• Cash Credit: The bank allows the company to withdraw money up to a specified limit against the security of stock, promissory notes, or marketable instruments.
• Overdraft: Permits the company to overdraw from its current account up to an agreed limit, usually against security.

Both facilities are commonly used for short-term funding, though the interest rates are typically higher than standard bank deposits.

Other Sources of Funding

1. Leasing - Leasing is an agreement where the lessor owns an asset but allows the lessee to use it in exchange for payments over a specified period. It is a form of rental and comes in two main types: operating leases and finance leases.
2. Government Assistance - Governments may provide cash grants or direct financial support to companies, particularly in high-tech industries or regions with high unemployment, as part of economic development policies.
3. Venture Capital - Venture capital involves investing in a business with high growth potential, recognizing the risk of total loss if the venture fails. Entrepreneurs often combine personal investment with venture capital to fund new businesses.
4. Franchising - Franchising allows businesses to expand using less capital than would otherwise be required. It provides an alternative method of raising funds for growth. Examples of franchisors include Budget Rent-a-Car, Wimpy, Nando’s Chicken, and Chicken Inn.

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