BusinessFinancing and the Capital Structure
Debt and Equity Financing Options
Debtfinancing revolves around obtaining money that is to be repaid at afuture date and, usually, at a certain rate of interest, while equityinvolves obtaining finances through selling the company’s orbusiness’ interests. The two options come with varied advantagesand disadvantages.
Inthe case of a debt, the ownership interests of the business would notbe diluted since the lender is not entitled to a claim of equity inthe entity. In addition, loans allow for proper forecasting andplanning since obligations pertaining to the principle amount andinterest are clearly spelt out (Mayo 34). On the same note, debtfinancing comes with considerably less complications since there isno requirement for the company to comply with the federal and statesecurity laws and obligations.
However,debt financing is disadvantageous as the interest comes as a fixedcost that may increase the break-even point of the company. On thesame note, debt instruments usually incorporate restrictions on themanner in which the company carries out its operations, therebyhindering the management from pursuing none-core businessopportunities or financing options.
Equityfinancing, on the other, comes off as advantageous as the businesswould not have to refund the money that is given (Mayo 39). Inaddition, this forms of financing introduces partners who have avested interest in the success of the business. This means that theywould assist the business in other ways such as advice,introductions, and feedback among others. Further, equity financingcomes with more flexible payback time compared to the rigidtimeframes of the debt financing (Mayo 41). However, equity financingis disadvantageous as decisions may be difficult to make sinceinvestors may not always see eye to eye. On the same note, thepartners will have to share profits, not to mention the fact thatgetting equity capital can be more time consuming compared toobtaining loans.
Advice on Investment Bankers
Investmentbankers refer to agents of an organization that assist privatecompanies undertake the conversion of ownership equity to securitiesin primary markets. Investment bankers particularly come in handy inthe course of issuing an Initial Public Offering, which would allowthe business entity to raise considerable capital for owners ofbusiness while also propelling the entity to the next stage. Moreoften than not, companies would choose investment bankers, who thengo ahead to guarantee the business entity of a particular amount ofcapital less a fee. After this, the investment banker would go aheadto raise the capital guaranteed via an IPO while also assuming everyrisk in case the IPO does not attract the required investors.
However,the success of business’ relationship with the investment bankerprimarily depends on two factors including the investment banker’squality, as well as the stage of life of the company (Mayo 46). Moreoften than not, investment bankers are interested in mature andestablished companies since younger business entities are bound tohave a fewer potential candidates thereby making it less profitable(Broverman45). In selecting an investment banker, it is imperative that oneexamines varied characteristics. First, the investment banker has tohave the necessary expertise regarding the all aspects of businessessimilar to the business entity in question, in which case it would becapable of undertaking proper valuation (Broverman46). Further, the investment banker must be sufficiently experiencedas to be confident in its capacity to attract the highest priceduring the IPO. Lastly, it is imperative that the investment bankerand the business in question have a relationship that is founded ontrust.
Risk and Return in Common Stocks vs. Corporate Bonds.
Indetermining the efficacy of any investment, it is imperative that oneconsiders the risk involved, as well as the returns that would beexpected. More often than not, however, individuals concentrate onthe possible returns, while ignoring or paying less attention to therisks involved (Broverman54). Historically, higher risks come with even higher returns.Different investments come with varying amounts of risk and returns.
Commonstocks of a company make their owner a shareholder in the businessentities. The returns from common stocks are usually in the form ofdividends usually paid on an annual basis subject to the number ofshares that an individual has. On the same note, profits would berealized in instances where the common stocks are sold at a higherprice than the shareholder bought them for (Broverman56). However, the ownership of common stocks is often threatened bythe likely loss of projected profits alongside the money that isremitted or paid for them in instances where the price of the sharesgoes lower than the price at which they were bought.
Corporatebonds, on the other hand, underline debt securities that are issuedby business entities and sold to investors usually backed by thepayment capacity of the business entity, which essentially is themoney that would be earned from its operations in the future (Mayo54). Of course, it is well acknowledged that bonds are less riskythan common stocks. However, they come with even fewer returns.
Broverman,Samuel A. Mathematicsof Investment and Credit.Winsted, CT: ACTEX Publications, Inc, 2010. Print.
Mayo,Herbert B. Investments:An Introduction.Mason, OH: South-Western, Cengage Learning, 2011. Print.