Question

Compare the costs and drawbacks of each of the three types of capital financing.

Answer 1

Financial capital is any economic resource measured in terms of money used by entrepreneurs and businesses to buy what they need to make their products or to provide their services to the sector of the economy upon which their operation is based, i.e. retail, corporate, investment banking, etc.

The three types of capital financing are:

1.Equity capital

2.Debt capital

3.specialty capital

Equity capital

• The cost of equity capital is high since the equity shareholders expect a higher rate of return as compared to other investors.
• And also the cost of issuing equity shares is usually costlier than the issue of other types of securities. Such as underwriting commission, brokerage cost, etc. are high for the equity shares. The Drawbacks are:
• With the more issue of equity shares, the ownership gets diluted along with the control over the management of the company.
• The cost of equity is relatively more, since the dividends are paid out of profit after tax, but the interest payments are tax-deductible.   

Debt capital

Cost of debt, along with cost of equity, makes up a company's cost of capital.Cost of debt can be useful when assessing a company's credit situation, and when combined with the size of the debt, it can be a good indicator of overall financial health.

Drawbacks are:

• The company and the owner must have acceptable credit ratings to qualify.
• Principal and interest payments must be made on specified dates without fail. Businesses that have unpredictable cash flows might have difficulties making loan payments. Declines in sales can create serious problems in meeting loan payment dates.
• Cash flow: Taking on too much debt makes the business more likely to have problems meeting loan payments if cash flow declines. Investors will also see the company as a higher risk and be reluctant to make additional equity investments.
• Collateral: Lenders will typically demand that certain assets of the company be held as collateral, and the owner is often required to guarantee the loan personally.

Specialty Capital

This is the gold standard, and something you would do well to find as a business owner

Speciality capital has no economic cost and can take the limits off of growth. They include things such as a negative cash conversion cycle,insurance float, etc.

As I think equity capital will be the best option for those who are risky shareholders. Moreover debt capital is also an important capital financing.