FINANCING THE BUSINESS

Financing the Business

Financing the Business

Task 1

Debt financing and equity financing are the two major types of financing for a business. Debt financing is a type of financing facility, in which a company obtains loan from a bank or any other financial institution (Davey & John, 1982, pp 238 - 249). While, equity financing is a type of financing, in which the company obtains the funds from the outside investors through issuing stock, common stock, or preferred stock. The main advantage of debt financing is the fact it will finish in the future, the company's obligation is only until the time, when the loan is on the company the moment the company pays off the loan, and their obligation is over. Another huge advantage of debt financing is the tax shield that comes with debt financing (Ross, Westerfield & Jordan, 2002, pp 137 - 141). However, the disadvantage of debt financing is that it increases the risk of the company, because there is always a chance of default from any company. Another drawback is the interest factor; the company has to pay interest on the debt on a regular basis (Guilding, 2002, pp 64 - 87).

The advantage of the equity financing is that there is no obligation to pay any fixed amount on a regular basis; the company can pay anytime to the investors. However, the disadvantage of equity financing is the lack of tax shield (Ross, Westerfield & Jordan, 2002, pp 137 - 141).

The decision by a company, whether to go for debt financing or equity financing depends on the risk orientation of the company. A company with strong financial background would go for debt financing, because they can bargain with creditors on the interest rate. Otherwise, the company would go for equity financing because of the lack of any obligation to pay a specific amount after a decided interval of time (Corsepius, Nunnenkamp & Schweickert, 1989, pp 120 - 131).

However there is another mthod of financing which is called Venture Capital. It is a form of capital investment which is intended to finance new, growing or struggling enterprises in the market of enterprises and therefore, involves relatively high degree of risk. It involves long-term investments in risky securities or businesses, in anticipation of higher profits. Venture capital is usually associated with innovative companies.

Furthermore, it is used for direct private investment, which is usually provided by outside investors for financing new, growing companies or companies on the verge of bankruptcy.

Venture capital does not fit all businesses. Venture capitalists are usually extremely careful in choosing which business to invest in. The venture capitalist may invest only in one out of four hundred opportunities presented to him. The need for high returns makes venture funding an expensive source of capital for companies, and the most suitable for businesses that require huge capital to start. Such businesses cannot be financed through cheaper methods, like debt financing.

Over the past years, the trend of debt Vs Equity financing has ...