Capitalization is the process that companies go through to raise money to finance operations and acquisitions that cannot be financed with revenues.
There are two basic ways to raise business capital: through debt or equity. Debt capitalization is the process of borrowing money to finance operations that need to be repaid. Equity capitalization is the process of obtaining money from investors that does not need to be returned in exchange for an equity stake in the company. Most companies use a combination of the two to finance business operations. For a large company, the way it is capitalized and the debt-to-equity ratio can significantly impact its valuation.
A business owner may decide to borrow money from a bank or himself to finance business operations.
Capitalization is the process that companies go through to raise money to finance operations and acquisitions that cannot be financed with revenues. Normally, every business must go through a capitalization process when it is first organized to establish ownership and finance start-up operations until it starts making money. Then, at critical points in the company’s growth, it often faces the need to raise additional cash for strategic moves, such as expanding operations or acquiring a building. A business owner must decide whether to raise business capital by taking on debt or giving up capital.
Debt involves borrowing money to get the capital you need. The company can borrow money from a bank, financing company, individual or any entity willing to provide a formal or informal loan. A business owner can even borrow money from themselves to finance operations, such as using personal credit cards to make business purchases. The end result of using debt to raise business capital is that that money must be returned. Lenders typically benefit from this type of transaction by charging interest on the company loan.
Equity, on the other hand, is a type of business capital that does not need to be returned. A company can raise business capital through shares, offering investors an equity stake in the company in exchange for their investment. The most obvious example of this is selling stock shares. When an investor buys stock, he is giving money to a company in exchange for the percentage stake that the stock represents.
Public companies practice the most advanced forms of capitalization practice. Corporate directors must decide how much inventory to make available for sale to the public, keeping in mind the various financial ratios and ownership percentages needed to keep current management in control of the company. A company 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 paid at the end of the loan term.