It’s amazing just how difficult it is for large companies to raise capital for future projects.  An outsider would assume that this would be fairly straightforward, and yet when you look into it, the different methods and factors that need to be considered makes it far more complicated.

A phrase I have always carried with me is ‘Fail to plan, plan to fail’.  It’s incredible how relevant it is to this topic.

Before you even consider raising capital, you have to determine what your rate of return will be.  If the rate of return is too close to that of the cost of capital, you risk the profitability of the project if any unforeseen circumstances arise.  Looking at the example of Sky when they released their broadband package in 2006, they predicted a post tax return of 10.5% by 2011.  It would be expected that to ensure profitability, Sky would have aimed for an extremely low cost of capital.  With the estimated cost of capital being 9%, you have to wonder why they even considered opting into such a venture.

There are of course plenty of examples of ‘loss leader’ products, such as Sony with their PS3.  As seen in this link http://www.engadget.com/2010/02/05/playstation-3-still-a-loss-leader-six-cents-for-every-dollar/ , Sony was still yet to see a profit on their consoles in 2010!  Instead the money was clawed back through games and other add-ons.

Evidently, there are times when you need to look at the bigger picture when planning, as what could seem like a foolish venture that would see no profitability could see high returns that are directly influences from a ‘loss leader’ product.

After considering the rate of return, it is then necessary to find the best method to fund these returns.  Businesses can either choose to exchange equity or debt for finance.  Both options have distinct advantages and disadvantages, and both are far more complicated than I had anticipated.

Provided you can live with giving up an amount of ownership in the business, raising finance through equity seems like the way to go: no contractual agreement on dividend levels, no need to repay the investment and the ability to trade on brilliantly liquid and international market seems fantastic.  After looking at the timeline of raising equity finance being around 2 years, and the cost of listing shares on the stock market, you have to plan a hell of a long way in advance. 

Financing through debt is of course the other option.  The world of bonds is in my opinion overly complicated, and in some cases it seem to blur the lines of legality.  They offer ‘investors’ the comfort of knowing that they have a guaranteed repayment with a fixed percentage of interest.  The business gets a source of income and the benefit of having this debt tax deductable. 

There are other forms of debt finance including a variety of loans, I am however very conflicted with the whole concept of debt.  It seems every aspect of this capitalist world we have created has been built on money we do not have.  Through poor planning, arrogance or just plain stupidity, we have seen countries brought to their knees from this culture we have developed of spending more than they can afford.  When the bubble bursts, we see banks, bailed out with taxpayer money and governments put into situations where they are forced to negatively affect the livelihoods of millions of people.

For me, raising finance is something that should never be taken lightly and the restrictions imposed on the stock exchange are there to ensure a level of safety and security that is lacking in that of debt finance.  For business, debt can have huge advantages, but it seems as though eventually it will come at a cost that society has to deal with. 

Seems as though a collective failure to plan in the marketplace has resulted in the epic failure that is the 'credit crunch'.