When raising capital for a business venture, a company can either raise debt capital, equity capital or a combination of the two. Debt capital is money loaned to the company at an agreed interest rate for a fixed time period. Conversely, equity capital is money invested by owners (shareholders) for use in business operations that need not be repaid. Combinations include convertible securities which may be debt that can be converted into equity at some point in the future.
The simplest form of equity capital is common stock. Common stock has many distinguishing factors as follows:
Common stock is not convertible into another type of security
Each share enjoys one vote
Dividends are payable without limit but only when declared by the board of directors
In liquidation, common stock holders are the last priority to which to distribute assets
In venture capital transactions, there may be two types of common stock which are issued. The first is Class A common stock, which is like preferred stock without the special voting rights which some statutes require in shares labeled “”preferred.”” A second type of common stock is junior common stock. While this type of stock is not used very frequently, it allows companies to get cheap stock into the hands of key employees at minimal tax cost.
Determining what type of capital to raise and how to structure the financing transaction is of critical importance to growing ventures. As such, it is crucial to understand the key terms and consult the appropriate legal and business advisors when embarking on the capital-raising process.
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