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A capital investment is the purchase of fixed assets (such as land, machinery, or buildings) to further a business's long-term goals. The money used for a capital investment could come from cash reserves, other business assets, investor funds, or loans. When funding for this type of spending comes from an outside source, such as a lender or investor, that capital is typically referred to as a “capital investment.”A capital investment can launch a small business into a new stage of growth. Depending on where the funding is coming from, however, there are often costs involved with capital investment. 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?
The term capital investment actually has two meanings. Simply defined, a capital investment is the acquisition of fixed assets for a business. A company might do this using its own funds. The term capital investment is also commonly used to describe the money invested in a business by a lender or investor with the understanding that the funding will be used to purchase fixed assets, rather than used to cover the business's 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.How Does It Work?
Whether you’re a seasoned business owner or just starting your own company, a capital investment can help you expedite business growth and achieve your long-term business goals. Some types of capital investments, like 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 external capital investment 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 a number of reasons for a business to make capital investments. The most common ones 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 business.
- To Increase employment Using capital investment to hire new staff can help increase production and profits.
- To 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: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 based on 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 current liabilities from your current 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 may be able to 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 exploring loan options without making any type of commitment, Lantern by SoFi can help. With our online lending tool, you can access a range of different business financing options all in one place and receive an offer that is matched to your needs and qualifications.Find the right financing solution for your small business on Lantern's marketplace. Photo credit: iStock/3alexd
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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.
