About 1 in 5 businesses will fail within the first year that they’ve started.
If you want to increase the odds of your business surviving, you need to know about corporate finance law.
Keep reading to learn about how you can use corporate finance law to increase your understanding of business and help you make strategic decisions.
What Is Corporate Finance Law?
Corporate finance law is all of the legal rules that dictate how a business can set up its financial structure. This could be for a brand new business, like a startup, or it could be for an expanding business.
This finance law is its own segment, but it also has cross sections with corporate law, contract law, property law, and securities law.
It specifically refers to any funding or capital that you’ll use to grow and start your business. These laws will govern anything that you use to improve the value of your business, raise operating costs, or improve any financial results for shareholders.
In some cases, people use the term investment banking to also mean corporate finance law. An investment bank and banking lawyers will help evaluate your company’s financial needs.
Why Is It Important?
Corporate finance is important because it covers the matter of needing funds to start your business, keep it running, and then expand it. You may need to acquire more capital to keep your business running or to expand it later on.
You’ll need to decide whether or not you want to apply for a bank loan or ask shareholders to finance the capital. Regardless of which route you choose, there are legal processes in place for each one that you’ll need to be mindful of.
For example, if you get shareholder financing, then you’ll need to know whether or not to track shares, have shares with voting rights, or have limited shares.
Even when other shareholders buy more stock in your company, you’ll need to use corporate finance law. You’ll be using their finances to operate your company, and you’ll need to know all of the rules and regulations that stipulate what you need to do with it.
Four Important Metrics Of Banking And Finance Law
When it comes to banking and finance laws, there are four important pillars that can help you understand how it works.
The four important ones are operating flows, invested capital, the cost of capital, and the return on the invested capital.
Operating Flows
Each business defines its operating flow differently. For some, they define it as their net income. However, others describe it as their gross income or any cash flow from a certain list of operations.
The best operating flow to track is your net operating profit after taxes (NOPAT). This KPI can be found on your company’s income statement, along with any tax adjustments.
This allows you to understand your business’s cash flow before you have any interest expenses, and a true operating flow can be decided on. You’ll be able to use this number to fully understand how your business is operating in the current economy and determine if it’s worth expanding your business.
Invested Capital
Invested capital is another important factor in corporate finance. Again, some people have different ideas about what invested capital metrics they should track to understand how their business is doing.
However, the best metric is any long-term investment you’ve made that you expect to make a return on. You’ll also want to incorporate any equity and debt that you might have because these will affect your invested capital.
Cost of Capital
The third metric you can track to understand the health of your business is the cost of capital. This is one of the most important concepts.
The cost of capital is the amount of return that you need to get from your equity and debt. Both debt and equity contribute to your business’s capital, and you need to ensure that you can make a return on investment. This is why you need to understand the cost of your capital.
The cost of capital can be a hurdle, and you’ll need to overcome that cost for your shareholders to consider your company worth something. To find the cost of capital, you can calculate it by taking the cost of your debt capital and the cost of your equity capital.
You’ll then need to compare those costs to the percentage of equity and debt that your company has. This number will also help you understand the health of your business and give you guidance on whether or not to expand.
Return on Invested Capital
Lastly, the return on invested capital is another important metric, and you can find it by using your NOPAT.
Take the NOPAT and divide it by the amount of invested capital your business has. Once you divide it, you’ll be able to get a percentage.
The return on invested capital will help represent how your business is doing for the time being, and the cost of capital will represent what investors expect to earn as shareholders.
If your return is below the cost of capital, then your business is failing, and it may not be the best time to try and expand your business. If you can exceed the cost of capital and actually create a return on your invested capital, then your business is more likely to succeed.
Learn More About Expanding Your Business
These are only a few things to know about corporate finance law, but talking with a lawyer can help you fully understand all of the implications.
However, if you’re still unsure of whether or not it’s a good idea to expand your business right now, we’re here to help.
Check out some of the other articles on our website to learn more about running your business.
