Introduction to Corporate Finance
Author: Malcolm Ritchie Joint Managing Director, Qwerty Films
What is Corporate Finance
Corporate finance is the funding provided to support the operations of the venture itself, as distinct from project finance which is provided for developing and producing individual film projects. The main sources of corporate finance are:
Debt: money borrowed from a lender and secured against certain assets of the company in return for a promise to pay interest on the outstanding amount and to repay the principal of the loan on or before an agreed date. The rate of interest charged will usually depend upon the term of the loan and whether the principal is to be paid in instalments throughout the term or in a lump sum payment at the agreed maturity date. Lenders tend to be risk averse and are looking for solid evidence of the lenders ability to re-pay the interest and principal as agreed. They should be kept informed at all times of any issues relating to the ability of the company to repay the debt.
Equity: shares in the ownership of the company acquired at the risk of the purchaser and not secured on the company's assets; any return will be in the form of a share of the profits made by the company. Equity investors will want to be assured that the company has solid growth prospects and a sound business plan (see below). They will also need to see a clear exit strategy explaining how they will recoup their investment (and ideally a significant profit) in due course.
Quasi-equity: other forms of shares such as preference shares and convertible shares which pay a fixed dividend but do not convey any voting or management rights on the owner. Convertible shares can be exchanged for ordinary voting shares subject to certain conditions specific to each investment situation.
Other funding: for example central government grants or other local support funds to encourage investment in a particular sector or location.
Each of these sources of funding has a different risk and return profile. The greater the risk carried by the financier, the higher the return that they should receive for committing their funds. Equity investors will seek a greater return than lenders because of the greater risk that they carry.
Approaching Banks and Financiers
The key to unlocking any finance, be it debt or equity, is to have a good business plan. The business plan is the document that will explain to the potential backer what the company does and what its future prospects are. The main elements of a good business plan are:
Of these elements, the two that carry the most weight with financiers are the credibility and track records of the key players - can the backers be confident that these people can deliver the plan? - and the cash flow forecast - are the figures realistic and achievable? Will the company generate enough cash to meet its interest repayments and run its operations?
The Time Value of Money
Future cash flows are worth less than current cash flows. This is partly because they are more uncertain but also because the actual value of money declines with time due to the impact of future inflation on the purchasing power of the cash and the fact that cash received today can be invested and earn interest. In order to account for the time value of money, future cash flows should be discounted back to their present day value when evaluating business plans and investment proposals. Investors will apply a discount rate to future income flows based on their current risk free rate of interest (ie. the amount that they can earn on their cash without taking any risk whatsoever) plus a premium to cover the risk of the venture. The present value of the investment can then be calculated by converting all of the future cash flows back to present day values using the discount rate. To arrive at the net present value of the investment, the original investment amount should be deducted from the present value. Investors will also calculate the Internal Rate of Return (IRR) for an investment by calculating the discount rate required to give a net present value of zero. The IRR can be used as a way of evaluating the riskiness and likely return from a number of different investment opportunities to determine which, if any, are worth pursuing, or to set a "hurdle rate" of return required from any investment that they make.
Corporate Finance Options Available
The range of financing options will generally depend on the length of time for which the finance is required.
Short term (less than one year):
- bank overdraft
- trade credit
- discounted receivables (ie. selling the company's outstanding debts to a third party at a discount to their full value)
Medium term (one to five years)
Longer term (over five years)
- private equity
- public equity (ie. through an initial public offering on one of the recognised stock exchanges)
- convertible debt
- loan stock with warrants (which can be converted into shares)
- grants
· fiscally supported funding, such as the Enterprise Investment Scheme which gives tax benefits to private investors to encourage them to back smaller companies.
Top Tips
- Corporate finance is the funding provided to support the operations of the venture itself, as distinct from project finance which is provided for developing and producing individual film projects
- The main sources of corporate finance are debt and equity. Different types of financing might be more appropriate to meet the short, medium and long-term needs of the company
- The main sources of corporate finance are debt and equity. Different types of financing might be more appropriate to meet the short, medium and long-term needs of the company
- Future cash flows are worth less than current cash flows because money loses value over time. Financiers discount future income to work out the net present value of investment opportunities and to provide a way of comparing different, and possibly competing, projects
