Question

Michael and Sofia decided to open a new chain of restaurants, and they want to open 2 branches in the city. What is the most appropriate source of finance? a. Sale of Assets b. Share of capital c. IOU d. Loan from a bank

Answer 1

To answer this accurately we need to look at each of the option:

1. Sale of Assets

Assuming that they have assets that can be sold and monitized and if the expected cash flows generated from the business are higher than the existing cash flow then this should be kept as a first preference because the asset would be earning higher returns and thus reducing the burden of fixed debt payments

2. Share of Capital

If they raise capital in form equity then they would be able to get money and there would be no fixed payments like debt but they will have to offer part ownership to their venture thus reducing profit in future as the profits would be shared by the partners

3. IOU

IOU are generally loans taken from parties other than Bank and thus they would bear a higher rate of interest. If IOU are well documented then they are as good as Loan from Bank thus you would just give out more interest and thus would pay out fixed interest payments

4. Loan from Bank

When a loan from Bank is taken then a property might be mortgaged and LTV would be 80% thus you will have to bear 20% of property value and thus incure fixed costs for interest payments.

Here the business is very uncertain as the chain is new and might not get traction in the begining thus they might feel pressure of the Banks/IOU or to some extent partners but if they go by sale of property then they would be reducing interest payments and can also focus on increasing the business rather than worrying about the loans or partners.