Every modern enterprise needs capital to start its business, therefore an investment is the best way to run and for the betterment of the enterprise. It is an asset which is purchased to generate income in the future. It is also important for a business to expand, though, even the inflows from the business can fund that. Capital is essentially obtained in two forms, equity, which is popularly termed as an investment, and, debt, which is the loan that a company takes to start a business. A company has various options that it can exercise to raise capital. The reason attributable to this is the structure. A potential investor would usually repose more faith in a business that is structured as a company, than in other forms, such as sole proprietorship or a limited liability partnership.
With this basic background in mind, it becomes pertinent to explore the area of types of investment to understand how capital is raised in a company.
Who can be an Investor in a Company?
Anyone can be an investor in the Company. An Investor is the one who invests in the company by allocating the capital for the profit in the future. The following can be an investor in the Company:
Individual purchases small amounts of securities, as opposed to an institutional investor, called as Retail Investor or Small Investor. An Investor can invest in any company such as Sole Proprietorship, Public Company, Private Company, Limited Liability Company, Partnership or any other Company.
A Shareholder of the Company
A shareholder is the one who invests in the company who buys a stock in the Company.
Any other companies can invest in the other company to secure the future earnings. Investing will create partnerships and form relationships with companies relating to their products and services.It is a strategic attempt to gain specific assets.
A foreign individual can also invest in the company of India. It is considered as Foreign Direct Investment (FDI) where investment is made in equity shares, fully and mandatorily convertible preference shares and fully and mandatorily convertible debentures with the pricing being decided upfront as a figure or based on the formula that is decided upfront.
Objectives of Investment
Every investor has certain objectives behind the investment which may be monetary/financial in character. There are three financial objectives:
- Safety and Security of the fund invested, i.e., Principal Amount.
- Profitability, which is through interest, dividend and Capital Appreciation.
- Liquidity which is convertible into cash when required.
Period of Investment
There are three terms of the period for the investment:
- Short-Term- It is up to one year.
- Medium-Term- It is from 1 year to 3 years.
- Long-Term- It is of 3 years and above.
Types of Investment
Debt investment is, as the name suggests, in the form of a debt to the company. In this setup, a person basically loans the money to a limited liability company in the form of money in exchange for the promise of interest income on the principal amount and an eventual repayment of the principal amount. Debt capital is most often provided either in the form of direct loans with regular amortization or the purchase of bonds issued by the business, which provide semi-annual interest payments mailed to the bondholder.
Features of Debt Capital
- The striking feature of debt capital, amongst others, is that since it is in the form of a loan, the person lending it becomes the creditor of the company and thus, naturally holds a privileged place in the capitalization structure.
- The basic implication of this would be that if the company goes bankrupt, and the liquidation process must take place, it would mean that the assets of the company would first be utilized to pay off the secured creditors of the company, in this case, a person advancing debt capital would become a secured creditor. This essentially puts them on a higher pedestal than the equity investors.
- The highest level of debt is a first mortgage secured bond that has a lien on a specific piece of valuable property or an asset, such as a brand name.
For an instance, would be that if someone loans a certain amount of money to a departmental store and is given a lien on the real estate and building, he/she would be eligible to foreclose upon it in the event the company goes south. However, it may take a certain amount of time, effort and money, but they ideally they will be able to recover the loan from the proceeds of the sale that they make of the confiscated property.
Another way of investment would be a debenture. This is understood as the lowest level of debt. This is essentially a debt that is not backed by a lien, which means that it is not secured by any specific asset but, rather, but the company’s goodwill and credit.
Strategic investments are usually made by cash-rich giants, such as corporations with huge capital to invest in smaller and younger companies. This is essentially done as a business strategy to develop a business synergy. This works as a related industry, investing into another related industry, which is usually running in cohorts with the bigger giant.
Purpose of the Strategic Investment
- The basic intention behind such investments is using the investee company to increase the profits of the investor company.
- Another purpose that this sort of investment solves is that it preempts competition from achieving higher efficiency through profitable business synergy or synergies.
- They essentially want control over the management, however, more often than not, it is in the form of an indirect control. The usual business practice is that the investor company acquires a controlling stake in the investee company, or alternatively, they merge into the investee company. Due to this basic difference, they reap exponentially larger benefits than the financial investors.
- Another popular method includes forming a joint venture company, wherein they incorporate a third entity to carry out the proposed business. They keep the investor and investee business separate and thus, the investee company doesn’t have control over the investor company. However, the investor company may exercise direct or indirect control in the joint venture company.
Financial investments are made with the expectation of making only financial returns in terms of cash flow from which investment is made. It would essentially boil down to the dividends that the investor gets from the profits of the company. Investor here looks forward to much more.
Some financial Investors in a company
Venture capitalists, angel investors and private equity investors are essentially financial investors in a company. They are the money managers who make high-risk, high-return investments. Venture Capitalists essentially raise a fund in millions of dollars from private and institutional investors and thereafter invest those funds in a company, usually termed as “portfolio companies”, in expectation of a substantial return. They are rewarded in various ways. Venture Capitalists are paid a percentage of the fund’s value as a management fee and also have a “carried interest” in the company. This means that they get a percentage of profits above a certain pre-decided point.
An angel investor (also known as a business angel, informal investor, angel funder, private investor, or seed investor) is an affluent individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity. A small but increasing number of angel investors invest online through equity crowdfunding or organize themselves into angel groups or angel networks to share research and pool their investment capital, as well as to provide advice to their portfolio companies.
Purpose of the Financial Investment
- The sole purpose of financial investments is that they want the dividends from their shareholding and the value of their shareholding to increase over the years.
- They are generally not interested in running the business unless the business is running profitably. They, therefore, rely on the existing management for running the affairs of the company. However, they might appoint professionals to run the business rather than taking it over themselves.
- They are also interested in the controlling stake in the business, which is generally at more than fifty percent of the stake. Along with that, they inject funds into the company by investing into freshly allotted shares.
- They usually specify the number of years in which they would want to exit from the company, for instance, venture capitalists want to exit in five to six years of their investment. When that happens, they recover the amount invested, along with a portion of the profits.
For entrepreneurs, this is the perfect time period to engage in startup and start a business of their own.
- The country has committed itself to reducing the red-tapism to a minimum, much of which was flaunted by our Prime Minister Shri Narendra Modi in Davos recently.
- This has been reflected in the increasing rank of the country in World Bank’s Ease of Doing Business. The Prime Minister’s vow to encourage startups by opening avenues for emerging business by way of Foreign Direct Investments (FDIs) and Make in India campaign, has made the financial environment of growing market for investments.
- The updation of the Company Law via the amendment in 2013 has been an effort towards this goal. Along with that, the passing of the Insolvency and Bankruptcy Code, 2016, is also a brilliant effort towards this. The changes in the Double Taxation Avoidance Agreement with Mauritius are also one of them.This has led to a general trend that Angel Investors are naturally keen to invest in startups.
With the advent of an increase of use of apps and especially in this technological era, there are more opportunities to start a business with less capital. It is thus an exciting time to weigh options and invest.