Capitalization is the process companies go through to raise money to finance operations and acquisitions that cannot be financed with revenue.
There are two basic ways to raise business capital: through debt or equity. Debt capitalization is the process of borrowing money to finance operations that need to be paid off. Stock capitalization is the process of getting money from investors that does not need to be paid back in exchange for an equity stake in the company. Most companies use a combination of the two to finance business operations. For a large company, how it is capitalized and the debt-to-equity ratio can significantly affect its valuation.
A business owner may decide to borrow money from a bank or from himself to finance business operations.
Capitalization is the process companies go through to raise money to finance operations and acquisitions that cannot be financed with revenue. Normally, every business must go through a capitalization process when it is first organized to establish ownership and finance initial operations until it starts to make money. Then, at critical points in the company’s growth, you are often faced with the need to raise additional cash for strategic moves, such as expanding operations or acquiring a building. A business owner must decide whether to raise business capital by borrowing or giving up capital.
Debt involves borrowing money to get the capital you need. The company can borrow money from a bank, a financial company, an individual or any entity willing to grant a formal or informal loan. A business owner can even borrow money from himself to finance operations, such as using personal credit cards to make business purchases. The bottom line of using debt to raise business capital is that money needs to be paid back. Lenders typically benefit from this type of transaction by charging interest on the business loan.
Equity, on the other hand, is a type of trading capital that does not need to be repaid. A company can raise business capital through equity, offering investors an equity stake in the company in exchange for their investment. The most obvious example of this is the sale of shares. When an investor buys shares, he is giving money to a company in exchange for the percentage of participation that the share represents.
Public companies practice the most advanced forms of capitalization practice. Corporate directors must decide how much inventory to make available for sale to the public, taking into account the various financial ratios and ownership percentages needed to maintain control of the business by current management. A company can also issue its own debt instruments, called bonds, which allow it to borrow money from the public in the same way as if the public were a bank. Bonds pay interest and must be paid at the end of the loan term.