DEBT & EQUITY

Discussion on Debt & Equity Financing

Discussion on Debt & Equity Financing

Introduction

Companies tend to have two options to raise finance, either by issuing debt or by issuing equity. Depending on the nature of the industry the company operates in, companies make decisions regarding which financing approach suits them more than the other. As a common practice, every company employs a mix of raising a certain percentage of capital through debt and equity both. There is hardly any company which depends on raising capital entirely by debt or by equity.

There are reasons behind which approach a company should take. Companies, which operate in capital-intensive industries with a high level of brand loyalty and an inelastic demand for the products are often found to use more debt than equity. On the other hand, companies which are less capital-intensive prefer equity more than debt. As all the companies employ a mix of raising debt and equity both, it is often difficult to come up with an ideal debt-to-equity ratio. Each company, keeping their corporate goals in sight, employs a different debt-to-equity ratio.

In this assignment, we will critically discuss the purpose, advantages and disadvantages of both debt and equity financing. Not just that, we will also provide an example of two non-financial companies currently listed on London Stock Exchange. The contrast in their debt-to-equity ratios and the reasons behind that will also be discussed to provide a clear understanding. Real world examples of such companies will provide a better understanding than learning about debt & equity financing in theory alone.

For our example, we have selected two non-financial companies listed on London Stock Exchange. Both are operating in different industries from each other. One of them is British American Tobacco, operating in the Tobacco industry. And the other is Sage Group Plc., operating in the software industry. Comparing their debt-to-equity ratios and the reasons behind the differences will make our understanding of the concepts easier.

Equity Financing

Purpose

Equity financing is when a company raises capital from investors in exchange for an ownership in the business. This financing can be certified by issuing shares to investors in proportion to the amount invested. The main reason behind equity financing for a company is to raise capital without having an obligation to repay the invested amount to investors in a pre-determined period. The companies finance their projects from these investments and try to increase their profits. The investors, on the other hand, look for getting a share in the future profits earned by the company. There is risk involved for investors as the return on the investments is not certain and depends on the company's profitability. To compensate for the increased risk, investors have an option to sell their shares and realize profits if the price of the shares increase.

Advantages

Equity financing has various advantages depending on the nature of the companies. Usually small to medium sized businesses prefer equity financing more than debt financing. This is often because small businesses have lower credit ratings and find it hard ...