Financing your Business ?
Companies can get external finance for their business through a number ways including borrowing(Debt), issuing ordinary shares and by issuing preference shares. The difference between these methods are significant in terms of risk, required rate of return, tax treatment , voting rights attached, and priority of repayment in the event of liquidation.
Debt can differ especially because companies may borrow in a foreign currency and for different time periods interest rate may be variable or fixed.
In addition the repayment terms can differ in that the principal mat is repayable in installments in installments in a lump sum.
The reason for outlining differences is that to show that in choosing a capital structure a company is essentially choosing a particular package of financial services which it supplies to investors- that is in raising different forms of finance a company provides financial assets that offer investors different combinations of risk, return, liquidity and voting power. Further the return the can consist of capital gains, compared to ordinary income, and in turn this will have taxation consequences.
Which is the best financing strategy for a business
If a business requires finance there are some things to consider:Short term financing or long term financing solution
Should the company borrow from the banks or issue marketable debt securites to lenders
What should be the term of the loan?
Should the interest be fixed or variable?
Are there any opportunities to add value by new features to the security
Investment decisions are important because the primary source of a companys value is the cash flows generated by its assets. By comparison, the financing decision is less important but it can also have important effects on investment decisions.
However given the primacy of investment decisions, it seems sensible to suggest that a companies financing strategy should be designed to complement and support its investment strategy.
A second important principle is that while it is not easy to add value by making GOOD financing decisions, it is certainly possible to reduce value by making BAD financing decisions. For example a high proportion of debt of debt can reduce shareholders wealth because expected costs of financial distress become significant.
Peirson and Bird's, 'Business Finance' ,7th edition, 2000 , 539-547
Some of areas of business financing to consider include :