The capital infusion is a widely used term for investments made in entities under financial difficulties. It comes in the form of debt and equity.
Let us discuss what is capital infusion and how it works.
What is Capital Infusion?
Capital Infusion refers to investment in a company or project through debt, equity, or both. It is often linked to capital investments during times of economic distress and financial instability of the receiver.
Capital infusion or capital injection can be a one-time investment or a series of funding through a long-term plan. It can be arranged for business growth or to relieve financial distress.
The capital infusion is commonly associated with banks, private companies, corporations, and even small businesses. However, it can refer to bailout packages or investments for government entities as well.
Capital investment may come from existing shareholders or external investors. Either way, the investors will hold substantial stakes in the entity they’ll be investing in.
How Does Capital Infusion Work?
Capital infusion can come at any stage of the business lifecycle. Startups and established businesses alike take advantage of capital infusion for various reasons.
Large companies may transfer capital from one division to another. If one of the divisions or geographical segments of a company is under financial distress, it can move funds from that division from the center or another division.
Similarly, startups look for private equity and external funding during the growth stages. Private investors usually look for short to medium-term financial goals when investing in startups.
Established companies may for an initial public offering (IPO) to raise capital. However, this route is expensive and requires substantial resources.
Struggling businesses often seek government help and financial aid during economic downturns. Governments around the world including the US have distributed billions of dollars among small and medium businesses during the recent Covid-19 hardships.
Similarly, governments announce different types of subsidies for the procurement of technology, machinery, and imports for certain sectors. This is also a form of capital infusion.
Equity Capital Infusion
Private equity (PE) investment has been a booming business in recent years. The PE sector looks for short to medium-term financial gains through capital investments in startups.
When a business receives capital from a private equity firm or through selling stocks, it is termed an equity capital infusion.
Investors receive a direct stake in the company according to their investment. Existing shareholders can buy more shares and inject further capital through this method as well.
Equity capital injection may come through an IPO or a Rights Offering as well. Raised capital through this method becomes a permanent capital for the receiver though and it does not need to be repaid unless a share buyback program is there.
Debt Capital Infusion
The second method of capital infusion is through debt financing. Commercial banks, governments, and private lenders can help a business through debt financing.
The receiving business does not offer shareholding for debt financing. The financing costs are also tax-deductible expenses for the company.
However, debt financing during financial distress can be costly and may come with covenants for the business.
Debt capital injection can be obtained for business expansion and is common for established businesses rather than startups without substantial assets on their balance sheets.
What are the Purposes of Capital Infusion?
Unlike the common notion, capital infusion is not only linked to businesses in financial distress or during economic recessions.
Businesses can obtain capital infusion for different purposes.
Capital infusion for startups is a common phenomenon. Businesses in their early years look for external funding to fund their growth plans.
Startups face a shortage of capital due to their rapidly expanding needs. Capital injection or infusion helps them to quickly make a mark in the market.
Any form of capital for startups is vital but any investment coming at a growth stage is termed “infusion” or “injection” as it provides quick financial relief.
Established businesses looking for internal or external financing for expansion plans. When they’ve already pledged assets and taken commercial loans, they seek alternatives.
Capital infusion for established businesses provides them with reliable financial solutions. It can be in the form of equity through new shares/IPO or debt financing.
Businesses would often use this form of capital for launching new products or entering new markets with existing products. They utilize this investment for several expansion expenses including extensive marketing and new hiring.
Established and new businesses alike seek capital infusion for growth plans. For example, a business may want to start a new project and face a financial crisis.
Similarly, a business acquiring new technology to upgrade its operations will need new investments. Another use of capital infusion can be to open new business locations or expand existing ones.
One of the most common purposes of capital infusion has been to make a business survive during economic downturns and recessions.
Government entities and global financial institutions provide a capital infusion to large corporations and commercial banks during such hard times. The aim is to protect the global and regional economies from further meltdowns.
Small and medium entities also receive capital infusion during recessions through soft loans, subsidies, and tax concessions.
Another common purpose of capital infusion is to pay off the existing debt of a business. Although debt financing is cheaper, it may cost a business more than it benefits in certain situations.
Similarly, debt restructuring and refinancing are also common forms of capital infusion for financially distressed businesses.
Capital Infusion and Strategic Investors
Venture capital (VC) and private equity (PE) are two prime forms of strategic investors. While both serve the same purpose of capital infusion for the receiver, their methods differ drastically.
Venture capitalists commonly put their money into startups with new business ideas. Startups and founders having good business ideas need money to execute their plans.
VC funding is common for startups and it may provide technical and strategic support to the receiving company as well.
On the other hand, private equity is common for established businesses. It offers the same kind of capital infusion as a venture capitalist.
PE firms usually buy a significant percentage of shares or wholly acquire a business. They usually invest in firms seeking financial help but with established business track records.
Both PEs and VCs provide a capital infusion to struggling businesses. The common theme is that receiver firms cannot go public due to a lack of resources or don’t want to.
The exit strategies are usually the same and both types of investors may seek an exit through initial public offerings.
Examples of Capital Infusion
Suppose a company ABC has different divisions; kitchen utensils, bed & bath accessories, vacuum cleaners, and furnishing items.
ABC company’s all divisions are profitable and generating sufficient cash. However, its furnishing item segment is making a loss and requires more capital for machinery upgrades.
ABC company decides to transfer $10 million from its other divisions collectively to its furnishing items segment. This is a simple example of internal capital infusion.
One of the real-world examples of capital infusion came through the US treasury providing critical funding to struggling banks and financial institutions during the global financial crisis of 2008.
American International Group (AIG) received one of the biggest capital infusion amounts leading up to $182 billion in different funding rounds from the US treasury at that time.
The US government provided this capital infusion in the form of debt, equity, and mortgage-backed securities. It also acquired 80% of stakes in AIG and recovered the invested amount by 2012.
Pros and Cons of Capital Infusion
Capital infusion mainly helps the receiving entity. However, commercial lenders can benefit from capital investments as earning opportunities as well.
- The receiving entity can utilize capital injected for various expenses.
- It helps the receiver survive financial distress during economic recessions and meltdowns.
- Businesses can use the capital infusion for growth and expansion plans.
- Capital infusion often comes into play as alternative funding when a business cannot receive commercial bank loans or go for an IPO.
- Investors earn a handsome rate of return on such investments as the interest charged is usually higher.
- Capital infusion does not guarantee financial success.
- It comes at a higher cost as compared to normal financing.
- Investors usually seek stakes against such capital investments.
- The receiving entity may lose control over operations and strategic management if the capital infusion is significant.