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Financing Your Business
DISCLAIMER - The information provided here is of a general nature and may not apply to any specific or particular situation. It is not to be considered as a legal advice nor presumed to be indefinitely up to date.
1. Capital Structure of Corporation
Many startup companies require capital beyond the means of their founders in order
to finance continued growth. Expenses quickly add up, and a business that
cannot manage its cash flow will not survive.?
Because startup companies typically have a limited operating
history and are considered to be risky ventures, obtaining even simple
financing arrangements can be a difficult task.
Theoretically, financing alternatives include
debt or equity financing. Debt financing is borrowing money with a final
obligation to repay the debt.?Equity
financing is selling to investors an opportunity to own part of the company. In
reality, however, an early stage enterprise is limited to raising money
through equity financing. A new company just starting operations
will have difficulty obtaining a bank loan without substantial cushion of
equity financing. As far as a bank is concerned, a startup has little proven
capability to generate sales, profits, and cash to pay off a loan. Even the
underlying protection provided by a startup’s assets used as loan collateral may
be insufficient to obtain bank loans. Asset values can erode with time, and in the
absence of adequate equity capital and good management, they may provide little
real loan security to a bank.
Having chosen an equity financing an entrepreneur can sell two types of equity securities in a
corporation ?common shares and preferred shares. Common shares are a security
that gives its holders the right to participate in management control of a
company by choosing the directors and by voting on fundamental changes.?Also, common shareholders have the right to
receive declared dividends and to share in the distribution of net assets if
the business is dissolved.?Although
common shareholders have a claim to the net assets of the business if the
business is dissolved, that right is subordinate to the business's debtors and
the preferred shareholders.
Preferred shares are a
security that has some characteristics of equity capital and some
characteristics of debt. Preference shares are used in situations where the
investor wishes to be in a position somewhere between that of a full equity
shareholder (common shareholder) and that of a creditor who becomes entitled to
repayment of the debt due to him before repayment to any capital of any
shareholder of any class. Depending upon the rights attached to the shares, a
holder of preferred shares may be in a preferred and safer position than the
common shareholder, but not quite as safe as a holder of debt financing. For a startup, preferred shares may be one way to obtain equity capital
without diluting the control of the common shareholders or diluting their
participation in the growth of the business.
Generally, preferred shares
have the right to a preferential dividend entitling the holder of such shares
to the payment of a specified dividend before any dividend is paid upon common
shares. Preferential shares may provide for a further participation over and
above the cash dividend in the earning of the corporation after the specified
preferential dividend has been paid. Preferred shares may have cumulative or
non-cumulative dividends. Cumulative dividends, if not paid, continue to
accumulate and must be paid for all periods in arrears before dividends on
common shares. In the case of non-cumulative dividends, the right to receive
dividends in each year expires at the end of the corporation’s fiscal year, and
if a dividend is not declared, the shareholder forever loses the right to
dividends.
A corporation may structure
preferred shares to be redeemable.?
Where redemption is included as a right of the holder of preferred
shares, the corporation will be entitled to require the shareholder to sell his
or her shares to the corporation at a price pre-determined and established in
the share conditions. Similarly, the shareholder will be entitled to require
the corporation to purchase his shares at a price pre-determined and
established in the share conditions. Redemption rights are usually triggered
upon the expiration of a five to seven year period following the date of
purchase.?Preferred shares may be
converted into common shares at a predetermined ratio.?Preferred shares typically do not have
voting rights. However, often a voting right will be granted to holders of
preferred shares during a period in which preferred dividends are in arrears.
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