Question

Critically review the advantages and disadvantages of the main funding options. include the different financing choices available through the equity and debt markets.

Answer 1

Equity financing: Equity financing refers to use the owner's money on which company does not need to pay the fixed loans, however dividends to the shareholders fluctuate according to the profits or losses of the company. In equity financing investors have ownership rights in the organization and also play a major role in the major decision making.

Advantages of equity:

1) Less risk: In equity financing there is less risk because there is no need to pay fixed repayment.

2) Credit problems: If you have the credit problems then equity financing is the only choice for funds in order to continue the finance growth.

3) Cash flow: Equity finance does not need the payment of fixed repayments therefore it does not reduce the cash flows of the company.

4) Long-term planning: Equity investors do not expect the immediate return and look for the long-term view.

Disadvantages of equity:

1) Cost: cost of equity is generally considered higher than the cost of debt because profit share is distributed to the shareholders that may be higher then the debts interest rates.

2) Loss of control: Ownership rights given to the shareholders.

3) Potential for conflict: There can be conflict among the partners in major decisions.

Debt financing: Debt financing refers to borrowing of the funds without giving ownership rights to the investors. And these investors get a fixed rate of interest on their investments.

Advantages

Control: No ownership rights are given to the investors.

Taxes: Use of debt reduce the tax expenses because debts are tax deductible.

Predictability: Principle and interest payments are stated in advance, loans can be short-term, long-term and medium-term.

Disadvantages:

Qualification: The owner and company must have acceptable credit ratings for qualifying for the debts.

Fixed payments: Fixed payments of interest even in loss bearing situation.

Collateral: Lenders need some collateral to secure their loan amount.

Under equity financing different choices are as follows-

Initial public offering, venture capital, royalty financing, angel investors

Under debt financing different choices are as follows-

Short-term loans, Long-term loans, Lines of credit, bonds etc.