Question

You are a small biotechnology firm and need the financial support and the set-up to perform clinical trials on your formulas, what might be your best, and least risky, source of funding? Why?

Answer 1

There are two sources of finance company can go through:

Debt or Equity.

Difference between Debt and Equity:

1. Debt has a maturity date of repayment and stock has no maturity date.

2. Incase of debt there is a legal obligation to pay interest, whereas there is no legal obligation to the dividend in case of equity.

As per Risk-Reward Relationship: The higher the risk associated, the higher the chances of returns or vice-versa.

The same applies to financial instruments.

From the company's perspective the risk:

Highest: Bond

Medium: preference

Lowest: Equity.

Explanation:

When a firm faces bankruptcy, it means that its liabilities are more than its assets.

1st Payment goes to bonds.

Equity shareholders sometimes called as residual shareholders are last in line to get any Payment.

It is most likely that they won't get paid of the company doesn't have enough assets in its balance sheet.

As the company is in initial stages of testing with formula, there is a higher chance of failure.

Hence the least risky and best source of Finance during clinical trials is equity financing.