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There are two basic ways to raise business capital: through debt or equity. Debt capitalization is the process of borrowing money to fund operations that has to be paid back. Equity capitalization is the process of obtaining money from investors that does not have to be paid back in exchange for an ownership interest in the company. Most businesses use a combination of the two to fund business operations. For a large company, the way it is capitalized and the ratio of debt to equity can significantly impact its valuation.
Capitalization is the process businesses go through to raise money to fund operations and acquisitions that cannot be funded from revenue. Ordinarily, every business must go through a capitalization process when it is first organized to establish ownership and fund initial operations until the business starts making money. Then, at critical points in the company's growth, it often faces the need to raise additional money for strategic moves, such as to expand operations or acquire a building. A business owner must decide whether to raise business capital by taking on debt or by giving up equity.
Debt entails borrowing money to obtain the capital needed. The business can borrow money from a bank, financing company, an individual or any entity willing to extend a formal or informal loan. A business owner can even borrow money from himself to fund operations, such as by using personal credit cards to make business purchases. The bottom line with using debt to raise business capital is that this money must eventually be paid back. Lenders typically benefit from this type of transaction by charging the business interest on the loan.
Equity, on the other hand, is a type of business capital that does not have to be paid back. A company can raise business capital through equity by offering investors an ownership interest in the company in exchange for their investment. The most obvious example of this is selling shares of stock. When an investor buys stock, he is giving money to a corporation in exchange for the percentage ownership interest that the stock represents.
Public corporations engage in the most advanced forms of capitalization practice. Corporate officers must decide how much stock to make available for sale to the public, while keeping in mind various financial ratios and the ownership percentages that are needed to keep current management in control of the company. A corporation can also issue its own debt instruments, called bonds, that allow it to borrow money from the public in the same way as if the public were a bank. Bonds pay interest and must be repaid at the end of the loan term.
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