Capital Investment for Small Businesses

Lauren Ward

Updated December 4, 2021

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Capital investments are the funds used to buy fixed assets for a business. The money could be in the form of cash reserves, other business assets, investor funds, or loans. For small business owners, capital investment from internal and external sources can be a means to launch into a new stage of growth. However, there are usually some costs involved with capital investment, especially if the money is coming from an outside source. You may have a loan that must be repaid or an investor to report to and share profits with. Read on to learn more about capital investment, how it works, and how to raise capital to grow your small business.

What is Capital Investment?

Capital investment is money used by a business to purchase fixed assets, like real estate or equipment. Typically, It is not used for day-to-day operating expenses. There is usually a performance-based goal tied to capital investment, such as expanding the company with a new location or increasing production with new machinery.The money for capital investment can come from the operations of the business or be raised from debt or equity financing.

How Does It Work?

Whether you’re a seasoned business owner or just starting your own company, a capital investment can give your business the money it needs to achieve its goals. Some types of capital investments, like equity and debt financing, increase a company’s liabilities. Using cash reserves (known as working capital), on the other hand, keeps debt low but can either hinder cash flow or slow the growth of the company. The goal with any type of capital investments is typically to earn a higher return than the capital's costs. It can be a delicate balance to find the best capital structure that doesn’t add too much debt to the balance sheet but also doesn’t prevent you from accessing growth opportunities.

What Is It Used For?

There are typically three main reasons for a business to make capital investments. These include:To expand sales. Capital investments are often used to increase sales, whether by boosting current production, adding more value to a product, or developing new products for the businessIncrease employment. Using capital investment to hire new staff can help increase production and profits.Replace older assets. At some point, a business will likely need to replace existing equipment, whether it’s a restaurant’s kitchen equipment, or laptops and printers at an office. This doesn’t necessarily drive new growth, but does prevent slowing growth because of issues with old equipment.

Financial vs. Physical Capital

Capital can come in two forms: financial (liquid) and physical (illiquid). Financial capital typically includes funds that are currently liquid or can easily be liquidated in order to cover operating expenses. It can include:

Cash on hand
Money market assets
Stocks
Bonds
Mutual funds
Inventory
Accounts receivable

Physical capital consists of tangible goods that assist in the production of a product or service. It can include:

Equipment
Inventory
Commercial real estate (like factories, warehouses, and office buildings)
Raw materials used in production

What Are the Different Types of Investment Capital?

There are several different sources of capital that you can tap in order to make a capital investment in your company, and each comes with its own pros and cons. Below are some options to consider.

Equity Financing

Equity financing refers to selling a portion of the company to an investor in exchange for an infusion of capital. The funds aren’t repaid; instead, they’re invested into the company. Since the investor now owns part of the company, they share in any profit distributions or exit made by the company at the percentage they own. They may have performance expectations and you may be required to use the funds for specific capital investments, depending on the terms of the arrangement. In addition, getting equity financing can be a slow process, which can involve identifying a potential investor, needing to submit financials and other documentation, as well as negotiating the terms of the partnership.However, there are a number of benefits to equity financing. When you partner with an experienced investor, you can gain access to their advice and professional network, which could help you grow faster. Plus, you may be able to ask them for future funding as you continue to grow the company.

Debt Financing

Debt financing for capital investment purposes entails borrowing money. This often means taking out a loan from a bank or other financial institution. The principal needs to be repaid over a certain amount of time, along with interest and other fees (like lender origination fees, if applicable). So while you get that capital infusion, the funds must be repaid for more than the original amount borrowed. Types of debt financing include small business loans, business lines of credit, merchant cash advances, invoice factoring, equipment financing, and business credit cards.One of the benefits of debt financing is that applying for a small business loan is often quick and easy, especially when working with an online lender. In addition, there may be few (if any) restrictions on how the funds can be used. That can give you the leeway to split up the funds between capital investment and operating expenses as you see fit. The downside is that those debt payments could hurt your cash flow, especially if the company experiences an unexpected slow period. A personal guarantee may also be required, which puts your personal assets at risk if your business can’t make the payments.

Working Capital

Working capital is the money a company has available to meet their operating costs. To get a quick snapshot of your current net working capital, you can subtract your liabilities from your assets. If you have high profit margins, you may be able to use the company’s cash reserves for capital investment opportunities. Using working capital to fund capital investments means you won't have to worry about loan payments or sharing equity with investors. Working capital lets you keep total control over your company. On the downside, using working capital to fund growth opportunities could put the company at risk if you’re over-leveraged and leave little room for a financial buffer.

Trading Capital

Trading capital is used for brokerage companies and other businesses in the financial services industry. It refers to the amount of capital invested in the stock market in order to create profits. While businesses in any industry may invest some of their cash reserves, trading capital generally refers to money used by companies that trade large amounts each and every day.

How Do You Find Capital Investment?

The process for finding capital investment varies depending on the type you’re looking for. In order to get equity financing, a small business will likely need to network with potential partners, angel investors, and venture capital firms. These investors essentially become part owners of the business.Once a company becomes large and successful, it may choose to get more capital from issuing stocks, known as an initial public offering. This allows any investor to purchase the company's stock.Debt financing can be easier for a small company to secure. Online lenders, for instance, make it easy to apply online and get funds delivered to your business bank account in a relatively short amount of time. They often list their minimum requirements, which may include a certain credit score, length of time in business, and amount of revenue.

The Takeaway

A capital investment can remove speed bumps and put your company on the fast track to success. Major sources for investment capital include your business’s working capital, funds from investors, and loans.It can be a good idea to explore all of your options to find the right structure for your company that balances both short-term needs and long-term goals. If you’re interested in investigating loan options without making any type of commitment, Lantern by SoFi can help. With our online lending platform, you can explore rates from multiple small business lenders with just one application.

Photo credit: iStock/3alexdThe tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.SOLC1021222

About the Author

Lauren Ward

Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.

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