Equity is capital that external lenders make available to the company. As a result, lenders are entitled to the right to inspect the firm.
Equity capital includes the resources the founder or third party (for example friends, acquaintances or other investors) make available to the company in the form of shares or an interest in the share capital.
The term “foreign fund” is generally used to refer to funds made available to the company in the form of a loan, for instance. Such lenders impose conditions that are prerequisites for the granting of credit and demand interest proportional to the risk.
Golden rules of financing...
Equity and foreign funds should be proportional. However, the issue is to determine the correct proportion. No general formula is available for such calculations; however, the “golden rule of financing” decrees that:
- Equity, the foundation of any business, should be equal to foreign funds.
For most business creators, this is hardly ever possible. To get off to a good start, venture capital should account for at least 40% in industrial companies and 30% in commercial companies.
However, the 450,000 companies registered in the Trade Register only list equity of 25%. And one company out of three only lists 20%. A company can be considered as truly healthy when it lists equity of 30% to 60%.
...and the golden rules for banks
Another classic rule of financing (the golden rule for banks) relates to capital maturity and asset immobilization (maturity matching).
- Long-term assets (investment value) must be financed with long-term funds (long-term equity and foreign funds). The total amount of long-term funds should therefore equal the investment value. This rule also applies to short- and medium-term foreign funds, in relation to short-term assets (current assets).
In practice, however, these principles are controversial since they do not consider the specific features of the branch or company. It is more important to consider the financing of the company from the point of view of liquidity, security and profitability. The intention is that the company should, in the near future, be able to finance itself.