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By the end of this section, you will be able to:
  • Describe financial capital and how it relates to profits
  • Discuss the purpose and process of borrowing, bonds, and corporate stock
  • Explain how firms choose between sources of financial capital

Firms often make decisions that involve spending money in the present and expecting to earn profits in the future. Examples include when a firm    buys a machine that will last 10 years, or builds a new plant that will last for 30 years, or starts a research and development project. Firms can raise the financial capital they need to pay for such projects in four main ways: (1) from early-stage investors; (2) by reinvesting profits; (3) by borrowing through banks or bonds; and (4) by selling stock. When owners of a business choose sources of financial capital, they also choose how to pay for them.

Early stage financial capital

Firms that are just beginning often have an idea or a prototype for a product or service to sell, but few customers, or even no customers at all, and thus are not earning profits. Such firms face a difficult problem when it comes to raising financial capital: How can a firm that has not yet demonstrated any ability to earn profits pay a rate of return to financial investors?

For many small businesses, the original source of money is the owner of the business. Someone who decides to start a restaurant or a gas station, for instance, might cover the startup costs by dipping into his or her own bank account, or by borrowing money (perhaps using a home as collateral). Alternatively, many cities have a network of well-to-do individuals, known as “angel investors,” who will put their own money into small new companies at an early stage of development, in exchange for owning some portion of the firm.

Venture capital firms make financial investments in new companies that are still relatively small in size, but that have potential to grow substantially. These firms gather money from a variety of individual or institutional investors, including banks, institutions like college endowments, insurance companies that hold financial reserves, and corporate pension funds. Venture capital firms do more than just supply money to small startups. They also provide advice on potential products, customers, and key employees. Typically, a venture capital fund invests in a number of firms, and then investors in that fund receive returns according to how the fund as a whole performs.

The amount of money invested in venture capital fluctuates substantially from year to year: as one example, venture capital firms invested more than $48.3 billion in 2014, according to the National Venture Capital Association . All early-stage investors realize that the majority of small startup businesses will never hit it big; indeed, many of them will go out of business within a few months or years. They also know that getting in on the ground floor of a few huge successes like a Netflix or an Amazon.com can make up for a lot of failures. Early-stage investors are therefore willing to take large risks in order to be in a position to gain substantial returns on their investment.

Questions & Answers

identify and quantify five social costs and social benefits of building a school
Mokgobo Reply
identify and quantity five social costs and social benefits of building a hospital
Mokgobo
short run vs long run
Jean
is it true that the opportunity cost of unemployed labour is zero?
Wisdom Reply
no
Oigebe
give two forms of collusion
nondumiso Reply
1.Explicit Collusion: Also termed overt collusion, this occurs when two or more firms in the same industry formally agree to control the market .
Gafar
2.Implicit Collusion: Also termed tacit collusion, this occurs when two or more firms in the same industry informally agree to control the market, often through nothing more than interdependent actions. A prime example of implicit collusion is price leadership .
Gafar
explicit collusion: this occurs when two or more firms in the same industry legally agree to control the market
Panashe
implicit collusion this occurs when two or more firms in the same industry illegally agree to control the market
Panashe
what is responsible for investigating cases of collusion
nondumiso
reasons why a country maybe involved in international trade
Nde Reply
state five similarities and differences between money market and capital market
Victoria Reply
Give a Zimbabwean example of firms operating in an oligopoly market and illustrate using diagrams how a manager in such a market maximize profit
Pam Reply
what is an industry
EWAH Reply
An industry is the production of goods and related services within an economy
Prabhu
an industry is place where goods and services are produced for human consumption....
Usman
scarcity is the major course of economics problems. discuss
Abdulhameed Reply
please say about that it is interesting for us
Abayneh
what is economics
Michael Reply
economics is a social sciences that deals with the production distribution and consumption of goods and services produced.its study of behaviour between economic agents
rkesh
what is the formula for elasticity of demand
Ridwan
change in demand/change in variable variable may be price, income,
rkesh
seasonal unemployment
Enoch Reply
example agriculture
lungku
want and scarcity
Prince
why the average of revenue AR fun
Abba
What is monopoli
Gadrey Reply
What is monopoly
Gadrey
monopoly
Hanan
monipoly ..where one firm controls all the market
RAM
what is demand
Jafar Reply
demand is what one willing and enable to purchase at a given price over period of a time.
Micheal
what is marginal revenue
just
distinguish between commercialization and industrialization
Alhassan Reply
why division of labour increase economy level of production
Henry Reply
what is opportunity coast
Henry Reply
a benefit profit or value of something that must be given up to acquire achieve something else
ammara
thx
Henry

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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