The Beatles, “The Office,” James Bond and Kate Beckinsale are some of my favorite British imports. But there's one British innovation I really wish we'd import that would significantly revive and accelerate our economic growth – venture capital trusts, or VCTs. They're certainly not as sexy as Kate Beckinsale, but for investors and public policy makers seeking economic arousal, VCTs might just do the trick…
Just like traditional venture capital funds, VCTs provide equity capital to fast-growing small and mid-sized businesses. However, unlike traditional venture funds, the underlying investors are not large institutions but individuals, like you and me. (Just as we are able to invest directly into mutual funds which are managed by professional fund managers, VCTs would enable us to invest directly into venture capital funds which are managed by venture capitalists). Thus, this individual investment creates both a new source of capital for private companies and an efficient, organized mechanism for individual investors to do so which does not currently exist in the U.S., as non-accredited individual investors (i.e. nearly every American) cannot invest into venture funds.
Before getting all Anglophile on you in proclaiming my love of VCTs, let me put this bizarre proclamation into context. As we enter 2010, U.S. political leaders continue to blame the lack of bank financing for the collapse of many small and mid-sized businesses and are pursuing policies that would expedite a return to the days of “easy money” lending practices.
However, my colleague, Charlie Rothstein and I contend that the loose lending standards adopted by the banking sector were a major reason for the financial industry meltdown itself and should not be revisited in policy or practice. Businesses which typically wouldn't have qualified for loans under more stringent regulations were granted unaffordable amounts of credit because the underlying loan officer compensation system was set on the basis of the volume lent, not on the performance of the loan portfolio. To encourage these organizations to resume those practices is like giving matches to an arsonist.
The real problem is not a lack of debt financing but rather a lack of equity capital. The last thing struggling companies need is more debt on their balance sheet. Unlike debt financing, which can choke a business when the economy stalls, equity is capital for all seasons. Equity allows a company to capitalize on a business opportunity, expand a product line, increase R&D or hire new employees without the pressures of principal and interest repayments that strain a business's cashflow or creates a risk of default – which, in turn, causes debt-financed management to be more cautious in pursuit of growth. Suffice to say, cautious businesses are rarely the engines of economic growth that will pull us out of a recession. So, as opposed to pressuring banks to “lend, baby, lend,” We suggest we foster the flow of equity capital into small and mid-sized companies, changing our mantra to “build, baby, build.” In order to accomplish this, we need to develop a new source of capital.
It makes sense for the U.S. adopt a U.K.-style VCT model which has successfully spurred private capital investment in the United Kingdom. In addition to offering access to the potentially lucrative returns that can be generated from venture capital, this program has another enticing aspect – investors are granted a significant tax credit, sometimes as much as 40% of the amount they put into a fund that can be claimed in the year in which they invest. Because the businesses receiving VCT backing are better capitalized, grow faster, and employ more workers in a variety of sectors, the cost of the tax credits offered by the government to VCT investors is more than offset in the long run.
Also, since the funds are managed by experienced venture capitalists who are paid based on the returns generated for their investors, there is a built-in discipline not found in a government-run program. By combining the prospect for premium returns with the certainty of federal tax incentives, the UK government has encouraged the capital raising process. Since the mid-90's, billions have been raised and ultimately invested in a new generation of emerging UK businesses.
Yes, there is a credit crunch. But, no, it's not an entirely bad thing. It is a dynamic of a market driven too far in one direction. Now is the time for us to respond in a thoughtful, long-term manner. The new paradigm should center on equity and business building, rather than debt; and we believe a government initiative meant to spur venture capital investment, like a VCT, could be the solution we've all been waiting for.
In full disclosure, our firm's London office has managed several VCTs for the past decade so we are familiar with the solution. But, as a result, we have first-hand experience in seeing the VCT model serve as a brilliant “win-win-win-win” for individual investors, small businesses, the government and overall UK economy. We, as Americans, should not hesitate to adopt this British innovation – if we have no shame in Susan Boyle sitting atop U.S. album charts, we certainly can swallow our “Not-Invented-Here” public-policy pride and embrace VCTs.
Our economic recovery is not a trivial problem. Situations like this call not just for thinking outside the box but also thinking outside the map – even if it does mean borrowing a successful idea from our witty, musically-inclined friends on the other side of the pond…
If you are in the market for a loan on the equity in your home, the way in which you prepare your application can make a sizable difference in the home equity loan interest rate. When it comes time to repay the loan, you will find that a rate fluctuation of only one-tenth of one percent can result in thousands of dollars difference in the interest charges over the payback period.
Understand What a Home Equity Loan is
The amount of home equity is the amount of cash you would receive if you sold the home at market value and paid off the existing mortgage. In practice, this is not usually what happens. Instead the home owner increases the amount of loan against the home based on the increased value of the home. Equity in the home can increase if the market value increases and if the principal portion of the mortgage has been reduced by regular payments.
Where are the Best Loans Found?
The Internet is a good place to start looking for a home equity loan. Many companies offer home equity loans along with regular mortgages. Other lending institutions specialize in second mortgages. You can start with the original mortgage lender on your home, but the wider market on the Web often makes interest rates more palatable.
What Factors Affect the Interest Rate?
Many factors affect the rate of interest that will be charged on a home equity loan. The creditworthiness of the homeowner is just one example. The amount of collateral accrued in the home is also taken into consideration. There is often a cap placed on the loan-to-value ratio of the second mortgage. The term of the loan and the size of the loan will also affect the rate of interest charged.
Pros and Cons of Fixed or Variable Rates
Interest rates on a home equity loan are usually either fixed or variable. Variable rates tend to be somewhat lower than fixed rates at the beginning, because they offer more protection to the lender. If interest rates in general increase, the rate charged on the individual loan can be adjusted upward. If interest rates in the economy are low, a fixed rate is advantageous for the borrower, since the cost of the monthly payment won\’t increase over the repayment period.
Why Do Borrowers Choose a Home Equity Loan?
A home equity loan is usually an option considered when the homeowner has upcoming major expenses and needs cash or credit. The loan may be taken to pay for major improvements on the home that will increase its value. It is sometimes used to pay for college expenses or for catastrophic medical bills. Another common use for a home equity loan is to pay off credit card bills with a higher interest rate.
Loan Term
The loan term is the length of time allowed for repayment of the loan. It may be as long as 25 or 30 years in some instances, or a short as two or three years. The lender is usually willing to structure a loan so that you can afford the payments within your budget.
No one wants to have an unbearable burden of debt, especially in shaky economic times, but sometimes a home equity loan is the best option to manage large financial obligations. Before signing on the bottom line make certain that you have the best home equity loan interest rate available.
You can learn more to get out of the painful cycle of debt now! Having a debt consolidation home equity loan, you will easily be able to pay all of your debts with one home equity loan interest rate!
Tags: consolidation, credit card debt, Debt consolidation, equity loan, finance, fixed rate, home equity loan, loan, mortgage, second mortgage
Cost of capital is the price that the company has to pay to obtain capital for funding of investment projects such as large purchases or expansions. Costs associated with the acquisition of capital will include after- tax interest expenses associated with debt or required rate of return required by shareholders for use of their investment dollars (CTU Online, 2008). The cost of capital should represent the minimum amount of return on investments that is required to earn sufficient cash flows from which those who have contributed capital can receive their expected returns.
For capital acquired from shareholders, cost of capital represents expected dividends, as well as assumed capital gains on their share values. For the loan holder, such as the bank, the cost of capital is the rate of interest on the loan providing the capital for a specific project. Accuracy in the cost of capital calculation is necessary in meeting the requirements of the investor, otherwise investors can be expected to place their capital dollars with an opportunity that provides greater promise (Malawi College of Accounting, n.d.).
The weighted average cost of capital is the percentile expression of the overall return the company must earn on its investments to maintain the value of their stock. This cost is used to gauge whether or not an investment opportunity is worth undertaking, as acceptable propositions will exceed the actual cost of capital and build shareholder value (Ross, Westerfield, & Jordan, 2008 and Value Based Management, 2008). The WACC seeks to estimate the firm's overall cost of capital by finding the weighted average of the costs relative to the individual financial sources of its unique capital structure. The WACC is the mean value of each source of capital in the firm's capital structure, found by multiplying the cost of capital of each source by its respective percentage of the total capital structure as presented on the balance sheet (Gallagher, Andrew, 2003).
Whether the capital for a project is drawn from the owners' retained earnings, or from the sale of additional stock, the use of that equity has an associated cost. However, the costs associated with tapping into the earnings of present stockholders vs. acquiring capital from new stockholders is different as drawing from retained earnings carries only the cost of the rate of return required by the stockholder, whereas use of new stock dollars requires an additional cost referred to as flotation costs. Flotation costs are the costs incurred as a result of the issuance of new securities and will include the fees and commissions paid to the investment banker(s) and attorneys (CTU Online, 2008 and Gallagher, et al.). This information is essential for planning, calculating, and appropriate choice as they each relate to using the correct cost of capital to ensure continual value.
As the company seeks to acquire additional capital, the cost of capital will change at the margin, and can be correctly accounted for by figuring the marginal cost of capital, or MCC. The MCC is the weighted average cost of the next dollar of capital to be acquired and can only be realized or figured once management has assessed and identified the point at which the firm's cost of capital will change the WACC, estimated the value of the change, and calculated the cost of capital up to and after the identified point of change. The change in the WACC with the addition of capital occurs due to the change in one or more of the components of capital that comprise the entire capital structure (Gallagher, et al.).
Cost of capital will be influenced further by current and fluctuating market rates. The market rate is the prevailing rate of interest for any given time; consequently costs of capital incurred through interest rates paid to lenders or expected by other investors will fluctuate with the rising and falling market rates of different periods (Web Finance, Inc., 2008). Cost of capital will require adjustment to ensure that additional costs associated with the market interest rate are met by the WACC that investment decisions are based upon.
Fluctuations in market risk are similarly going to demand adjustment to the WACC as the level of risk associated with investment is directly linked to the value of the expected return. Investment activities with greater risk require greater returns for the investor, and external market factors will cause decreases or increases in stock value (Gallagher, et al.). Regardless of the fluctuations in the market, investors will expect a minimum return value, and the company will have to meet that value to retain or acquire further investment. The additional costs that may be incurred with producing or providing that minimum return, regardless of market fluctuation, must be included in the firm's WACC to ensure all obligations are met and that capital remains available.
Sources Cited:
CTU Online (2008). Phase 3 course materials. Colorado Technical University Online. Colorado
Springs, CO. MGM625-0803B-02: Applied Finance for Decision Making.
Gallagher, T.J. and Andrew, J.D., Jr. (2003). Financial management: principles and practice, 3e.
Prentice Hall. Upper Saddle River, NJ.
Malawi College of Accounting (n.d.). Session 8: cost of capital. Kewl: Knowledge Environment
for Web Based Learning. Washington State University. Spokane, WA. Retrieved on
September 17, 2008 from Web site:
http://cbdd.wsu.edu/kewlcontent/cdoutput/TOM505/page41.htm
Ross, S.A., Westerfield, R.W. and Jordan, B.D. (2008). Fundamentals of corporate finance, 8e.
McGraw-Hill Irwin. Boston, MA.
Value Based Management (2008). WACC-weighted average cost of capital. Value Based
Management.net. Bilthoven, The Netherlands. Retrieved on September 18, 2008 from Web
Site: http://www.valuebasedmanagement.net/methods_wacc.html
Web Finance, Inc. (2008). Market rate: definition. Retrieved on September 18, 2008 from Web
site: http://www.investorwords.com/5654/market_rate.html
Tags: equity
Jimmy Galloway