Comparison of equity and debt finance Complete the table below showing how a number of commercial considerations/factors will influence a company's choice between debt and equity funding. In light of each of the listed factors, consider the impact of raising additional funds through an issue of shares (equity) or borrowing from a bank (debt). Factor Effect on the balance sheet and future ability to raise money The gearing of the company will therefore decrease, making them more lucrative to future investors and more able to borrow from lenders. Funding costs (consider e.g. the return the investor may expect to receive) Restrictions on the company affecting its ability to raise funds Equity The total equity on the balance sheet will increase. Highly geared companies are seen as riskier to lenders, making it harder to borrow in the future. (The bank may require earlier repayment of the loan or impose security over the assets of the company borrowing.) Earnings per share will decrease so the company will arguably become less attractive to future investors. Gearing ratio = total non- current liabilities / total equity will go down Dividends are only payable to shareholders if they are declared. The Board can postpone declaring a dividend if annual profits are insufficient. Dividends are not tax deductible. Shareholder's will likely need to pass a resolution to allot new shares. Private companies are unable to offer the public shares (s 755), making the market for Debt There will be an increase in liabilities on the balance sheet. Gearing ratio = non-current liabilities/ total equity will be higher as there will be a higher ratio of debt to equity Earnings per share will increase if the company ultimately makes a profit. If the debt- equity ratio is too high, then a company will be less likely to provide a return to its investors. Debt finance requires interest payments which must be paid regardless of the company's profitability. Floating rate interest - if interest rates are low, debt may be cheaper than equity. Loan interest payments are tax deductible so the company may save. Highly geared companies will likely have increased restrictions placed on them by the lender. Debt security may also give the lender control over the assets which are subject to security (e.g., a fixed
Degree of regulation and procedure (what steps will the company need to take to implement each type of financing?) Effect on balance of power within the company Degree of scrutiny of the company's affairs (consider the level of operational control the investor will be able to exert over the company) Future profitability raising equity finance more limited. Must target investors only. There may be limits on the company's authorised share capital depending on the articles of association, or on the director's powers to issue new shares. For example, authorisation of new share capital requires an ordinary resolution (s 55(1) CA 2006). Pre-emption rights may also pose an obstacle in the issuance of new shares, as will the nature of the shares