Pondering corporate finance

Corporate finance is a topic what will never stop to start a discussion between people who are interested in business. There has been a wide range of ideas how it should be arranged. Still in my mind there is no absolute truth how it should be done. Still people widely admit that capital markets works pretty well (Current challenges for corporate finance, 2010, 7). One absolute truth is that the players in this field try to find the most profitable and the safest option.

The history of the finance is old. Questions asked back then were:

  • Where I can find funds? Who will supply them and what terms?
  • What projects are open to me? How much profit can I make on these investments?

(Current challenges for corporate finance, 2010, 8-9). To me these questions seem to be pretty relevant compared to questions what are asked now days. So basically a corporation think if they have a promising project and only after that there comes the question where to find the funds. After figuring out where the corporation is willing to invest in they need to make decisions on the funds. Will they fund it by themselves when the expected return is greater compared to external funding?

Not to make things too easy there are taxes which are highly different compared to different countries (Current challenges for corporate finance, 2010, 18-19). Basically equity and debt receive unequal treatment. For example in Finland the government taxes companies by 20% (Verohallinto, 2013). In Estonia the same figure is 0 % if the company leaves the income to company for making further investments (Investestonia, 2013). One problem is that there is always a problem with the information ether investing funds or starting a project. Each time one or more participants know more than other. The result is a considerable information imbalance (or asymmetry) example between managers, shareholders and providers. That makes the markets not to operate on their full potential (Current challenges for corporate finance, 2010, 19).

Different forms of funding

Today there is a wide range of different possibilities to raise funds outside the public capital market. This makes new kind of chances to startups and fast-growing businesses to get the finance what they need. The new possibilities are entrepreneurial finance, venture capital, private equity and hedge funds. In the past, the general risk aversion of traditional investors was often the downfall to startups and fast-growing businesses. Within these circumstances there has been and is going to be high risk corporations getting funds and be able to start their journey. (Current challenges for corporate finance, 2010, 63).

The primary aim of venture capital companies and venture capital funds is to generate high returns by providing venture capital and specialized business knowledge to innovative young firms They receive their income by selling their stake which has been growing during the investment period. (Current challenges for corporate finance, 2010, 64). I guess that everyone has seen the show called Dragons’ Den.

Private equity (PE) equity funds focus more on established firms that are either unwilling (due to their legal form, for example) or unable to meet their need for venture capital on the public market. These kinds of companies operate along in trade, commerce and real estate. There are also equity investments whose aim is to restructure or save ailing companies. The last on is a viable option if investors expect high profit for investments. (Current challenges for corporate finance, 2010, 64).

Hedge funds aim first and foremost to make direct use of companies’ financial resources. This is done by disbursing free cash flows whose ostensible purpose is to fund external growth in the form of special dividends to hedge funds and their investors. (Current challenges for corporate finance, 2010, 65). So basically hedge funds always try to beat the market’s benchmark index and particularly the normal investment fund index.

Bottom line

The way how corporation chooses that what project is reasonable to execute is very often to calculate what the discounted cash flow is. It must exceed the initial costs of the project. The net present value, NPV, should be positive to accept the project. Corporate can compare that which funding option receives the biggest income. (Quantitative corporate finance, 2007, 415).

As I mentioned before the legislation which the corporation is affected by will influence on the decision. So based on that there is no one right way to arrenge corporates finance when starting a new project. In my mind this makes the whole thing so interesting and a thing that should be studied and questioned

 

Sources

Quantitative corporate finance, 2007, Guido Eilenberger, Sascha Haghani,Alfred Kötzle,Kurt Reding,Klaus Spremann. Springer.

Current challenges for corporate finance, 2010, John B. Guerard Jr, Eli Schwartz. Springer.

Invest Estonia. http://www.investinestonia.com/en/investment-guide/tax-system.

Read 8.3.2014

Verohallinto. http://www.vero.fi/fi-FI/Yritys_ja_yhteisoasiakkaat/Osakeyhtio_ja_osuuskunta/Tuloverotus.

Read 8.3.2014

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