What are the Sources of Funding?

Companies constantly seek sources of funding to grow their business. Funding, also called financing, represents contributing resources to finance a program, project, or need. Funding can be initiated for either short-term or long-term purposes. The different sources of funding include:

• Retained earnings
• Debt capital
• Equity capital

Retained Earnings

Businesses aim to maximize profits by selling a product or rendering a service for a price higher than what it costs them to produce the goods. It is the most primitive source of funding for any company.

After generating profits, a company decides what to do with the earned capital and how to allocate it efficiently. The retained earnings can be distributed to shareholders as dividends, or the company can reduce the number of shares outstanding by initiating a stock repurchase campaign.

Alternatively, the company can invest the money into a new project, say, building a new factory or partnering with other companies to create a joint venture.

Debt Capital

Companies obtain debt financing privately through bank loans. They can also source new funds by issuing debt to the public.

In debt financing, the issuer (borrower) issues debt securities, such as corporate bonds or promissory notes. Debt issues also include debentures, leases, and mortgages.

Companies that initiate debt issues are borrowers because they exchange securities for cash needed to perform certain activities. The companies will repay the debt (principal and interest) according to the specified debt repayment schedule and contracts underlying the issued debt securities.

The drawback of borrowing money through debt is that borrowers must make interest payments and principal repayments on time. Failure to do so may lead the borrower to default or bankruptcy.

Equity Capital

Companies can raise funds from the public in exchange for a proportionate ownership stake in the company in the form of shares issued to investors who become shareholders after purchasing the shares.

Alternatively, private equity financing can be an option, provided entities or individuals in the company’s or directors’ network are ready to invest in a project or wherever the money is needed.

Compared to debt capital funding, equity funding does not require paying interest to a borrower.

However, one disadvantage of equity capital funding is sharing profits among all shareholders in the long term. More importantly, shareholders dilute a company’s ownership control as long as it sells more shares.

Other Funding Sources

Funding sources also include private equity, venture capital, donations, grants, and subsidies that do not have a direct requirement for return on investment (ROI), except for private equity and venture capital. They are also called “crowdfunding” or “soft funding.”

Crowdfunding represents a process of raising funds to fulfill a specific project or undertake a venture by obtaining small amounts of money from many individuals. The crowdfunding process usually takes place online.