Financial Capital

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Definition of Financial Capital:

Financial capital is the money used to help pay for the acquisition of plants, equipment, and other items needed to build products or offer services. Financial capital is also referred to as investment capital.

Detailed Explanation:

Capital is an asset that is used to produce goods and services. Machinery, equipment, tools, and buildings directly used to manufacture goods and services are capital goods. Financial or investment capital is the money used to purchase the needed capital goods. 

Sources of financial capital can be grouped into debt and equity. Debt includes bank loans and corporate bonds. Debt must be paid back with interest. The advantage of debt is the lender does not have an ownership position in the business. Financial capital can also be secured by selling an ownership interest in a company. This is equity. Investors may be willing to invest money in a company if they believe in the company's strategy and expect an acceptable return on their investment. Companies may then use the money to acquire the capital goods they need to generate a profit. As owners, equity investors share the risks and profits. Unlike lenders, these investors are not guaranteed any payments. 

Enough debt to acquire the needed capital goods may be unavailable to a startup. For example, an entrepreneur may need more money than she can personally borrow to acquire some large equipment. Banks are unwilling to lend enough money because they feel uncomfortable with the risk. Instead the entrepreneur may rely on an equity investor such as an angel investor (investors who provide seed money for start-ups, usually family members or wealthy individuals), or a venture capitalist to provide the financial capital to grow her business. When her business becomes well established it may be able to have an initial public offering to tap the public markets for the financial capital it needs. Once established, the company can continue to sell stock to raise money. However, the owners give up an ownership interest, or dilute the value of their shares each time new shares are sold. This is why business owners frequently prefer debt to equity because they do not give up an ownership interest when they borrow money. Large profits are shared with the owners. Only interest is paid to the lenders.

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