EXTERNAL FINANCING ALTERNATIVES

External financing alternatives

External financing alternatives

Introduction

Business experts often say that it costs less to buy an existing business than to build one from the ground up (Benoit, 2010). Individual entrepreneurs and even established gigantic multinationals seeking to purchase a business should carefully consider the various external sources of funds they intend to utilize in order to make the best financing decisions. This enables the finance managers to make better financing decisions that positively impact on the survival of the business in the long-term (Arjen, 2007).

Issue of extra shares

The company can issue ordinary or preference shares, or both, in order to raise the funds needed for the acquisition. The major advantage of share capital is its aspect of being “non-redeemable". It is a permanent source of finance and can never be returned to its contributors, unless under winding up of the company. On the other hand, the disadvantage of share capital is that it dilutes ownership as new shareholders come in. Loss of control of the company may follow, and decision making may become difficult as all or the majority of the owners have to consult and come to an agreement before any important decision is made.

Loans from banks and other lending institutions

Bank loans and loans from other lending institutions are a good source of large amount of injections of capital. However, this capital has to be paid at an interest. The cost of interest depends on many factors, but generally market rates are applied. In taking up the loan, the company does not lose control of the direction of the business. The challenge is however for the company to generate revenues and profits enough to pay off not only the periodic interest charges, but the loan principal. If the interest rate is variable, the company could expose itself to changes in interest rates, with increasing costs and consequent profit squeeze or loss realization (Joseph, Nekoranec, and Steffens, 1993).

Debentures

Acme can also raise the required acquisition amount through issuing dentures, which are a secured loan in the form of certificate that can be traded by their holders just like shares. They are a legal for of fixed finance; a form of borrowing at a fixed or variable rate of interest from a finance house, another company or wealthy individual. Their advantages and disadvantages are similar to those of bank loans.

Property mortgages

Through this form of external financing, a loan is sought from a bank or any other financial institution for the purpose of purchasing a specific property. The company pays the bank a mortgage in return, which enables the bank to secure the loan by retaining the title to the property. Except for having a fixed charge on them, property mortgages are just bank loans, and whose advantages and disadvantages are discussed under bank loans.

Hire purchase agreements

Companies can select to acquire properties and equipment through hire purchase. This arrangement enables them to pay for the acquired equipments through manageable periodic installments. The advantage of it is that companies can use the revenues generated ...