Finance for Dummies: Corporate Finance Basics Finance for Dummies: Corporate Finance Basics Hi, everyone. So toda...
Finance for Dummies: Corporate Finance Basics
Hi, everyone. So today, I have a very, very interesting topic for you. The topic is about finance. Now, finance, the word itself is very scary. And a lot of you have written to me saying, "Hey, we don’t understand finance. Can you make a blog covering the basic terms of finance?" So I thought, why not simplify it for you?
I’m going to tell you two stories, and if you listen to these stories intently and do a little bit of further research, you will be able to demystify a lot of things related to finance. So with that said, let’s get started!
What is Corporate Finance?
Essentially, finance can be categorized into a wide variety of domains, but for the purposes of our discussion, we are going to categorize it into two domains. One is called corporate finance, and the second is called personal finance. Today, we’ll focus on corporate finance.
1. You Have Launched!
Let’s imagine that you’re starting your own venture. Congratulations! You are an entrepreneur, and you are starting your own venture. What is the first thing that you need? You will say, "Okay, we need an idea." And what are the things that you would need? The second most important thing would be, "Hey, I have an idea, but I need to develop my product. I need to set up my office or hire my first employees." So what do you need? You need money.
That is the precise thing that you need, and what are your options in terms of getting this money in the initial or inception stage of your venture?
Option 1: Friends, Family, and Fools (FFF)
They are called friends, family, and fools because they don’t look at your idea; they just literally give you money. For example, if you ask your friend, "I have started a venture, and we have been friends since childhood. Would you want to give me like a thousand dollars so that I can start my product development?" Your friend will say, "You know what? I don’t even want to hear the idea. I will just give you the money." So it’s a foolish way of investing, but it’s a very heartfelt way of investing. This is called FFF or friends, family, and fools way of financing. This is your number one option.
Option 2: Bootstrapping
Bootstrapping sounds very fancy, but bootstrapping literally means that essentially you have your own savings, and you put that money into your venture. For example, a majority of the startups that I have built have been bootstrapped. We have not externally raised funds, not because we can’t, but at this stage, we don’t want to. And I’ll explain to you the reason why in point number three.
Option 3: Equity Financing
This is where it starts getting a little bit tricky. So let me explain what equity financing means. Imagine that this is your company. This is like 100% of your company. And what you do is that you literally carve out a piece of this pie. So let’s imagine this is going to be 25% of your company, and then you sell it off to different investors. Now, this could be your friends, this could be VC funds, this could be private equity funds, etc. But the bottom line is that you lose a certain part of your company, and in return, what do you get? You get money.
Is that the only thing that you lose? That you’re losing 25% of your company? No, that’s not the only thing. You also lose freedom. Freedom in the sense that, for example, when you’re bringing an external investor on board, they will start giving you a lot of inputs. You have to acknowledge that because they are your investors now. It can be both good and bad because many investors are very supportive. They get along with you really, really well. So it’s a match made in heaven. But if you end up onboarding a bad investor, they can literally derail your entire company. So it’s a risky proposition, and that’s the equity way of raising money for your company.
Option 4: Debt Financing
If there is equity, there is always debt. So debt means that let’s say you have this entire company of yours. You say, "I don’t want to sell any of my company. Sounds very risky. I don’t want to bring external people. What can I do then?" The simple thing is that you go and take a loan. So a loan is called debt. You literally go with your company to a bank, and then the bank gives you the loan. "Hey, here is 1 crore rupees for you. Start your venture," and you promise the bank that, "Hey, I will start paying this amount of money from this month onwards." So that is the debt way of financing your company.
2. You Are Expanding!
Now, let’s imagine that you have to expand your company. You started the company, you got the money, you poured in that money, you developed the product, and that product is doing well. But you need to literally reach millions and millions of people. So you are in that expansion stage of your company. What are your options now?
Seed Funding
You would say, "I’m looking for a seed round of funding." This is again a finance term that you should be aware of. Seed round of funding means that, hey, it’s up to 2 million dollars. Your product is doing well in the market, and it’s making a little bit of money, but it’s not fostering organic growth. Swiggy and Zomato started out; they were losing money. And up until last year, they were still losing money on every order that they used to deliver. So what do they need to do? They still need millions and millions of dollars more. So that part is called seed money. It is usually up to 2 million dollars, and usually, this is the first round of external VC investment that generally happens.
Series Funding (A, B, C, etc.)
After this, as your company starts depicting more growth and starts getting more revenues and profits, you move to series funding. Now, series funding, you might have heard of series A, series B, series C. All it simply means is that more and more VC funds come into your mix. They start pouring in more money. Sometimes it’s the same VC, and sometimes there are usually a combination of VCs who will pitch in with a lot of money. So when you hear all these terms that a company has become a unicorn, essentially what is happening is that a lot of people are pouring money into that company. It’s not as if their balance sheet is that here are one billion dollars in your bank account. No, it doesn’t work that way.
3. You Are at the MASSIVE GROWTH Stage!
Now, what you feel is that, "You know what, enough with the Indian market. I have already captured it. Let me now go abroad and try to capture the world, become like the Roman emperor who wants to capture everything." So what is that stage called? This is called the massive growth stage. And here, firms usually execute two types of options.
Corporate Bonds
One is called issuing corporate bonds. This is a part of debt financing. Again, you’re not losing any control or part of your company. You’re just taking more loans. But these are now issued in a structured way by the corporation because your company grew. It was a small player, and it became like a massive, massive player over time. And then you get the power to issue bonds in the public market. So you’re issuing bonds, and these bonds are then analyzed by different credit rating agencies, and they will analyze and give ratings to your bonds. Then you can raise public money from those bonds, or major corporations or other organizations can pour in money and give you loans.
IPO (Initial Public Offering)
The second and the most exciting part is launching their own IPO. So let’s talk about IPOs. IPOs are called initial public offerings. Now, your first question would be, can they not just keep doing this and bring more and more VC investors and keep growing their company, making more money? No. Because even investors, for example, when I invest in companies, even I would need an exit to make money from the investments that I have made. So the majority of the times, and this is a controversial statement, that majority of the times when IPOs are launched, especially for loss-making companies, it’s done with the intent of giving VC investors an exit. So that term is called exit.
Another reason why an IPO is launched is to build the brand and get visibility for the firm. Now, this can be very easily explained if I ask you a simple question. So would you go and work with Facebook, or would you go and work at a very high-growth startup that you haven’t heard of? You most likely are going to work with Facebook because Facebook is a listed company. You keep reading about it. There is so much scrutiny, and Facebook has that brand. So you have this massive brand going for you. It becomes easy for you to recruit better talent.
Key Takeaways
- FFF (Friends, Family, and Fools): The simplest way to raise money.
- Bootstrapping: Using your own savings to fund your venture.
- Equity Financing: Selling a part of your company to investors.
- Debt Financing: Taking loans to fund your business.
- Seed Funding: Early-stage funding to kickstart growth.
- Series Funding: Multiple rounds of funding to scale your business.
- IPO: Going public to raise money and give investors an exit.
“Finance doesn’t have to be scary. It’s just about making smart decisions with money.”
What’s Next?
In the next part of this series, I’m going to tell you a personal finance story, which will help you understand the basics about personal finance. Stay tuned!