Also known as risk capital, Equity financing refers to own capital invested by the entrepreneur in addition to capital raised from family, friends and angel investors.
Advantages of Equity Financing:
Expanded Capital Base:
The fund so raised during equity issue are used for Capital budgeting Decisions and to perform necessary Research & Development that are quintessential for a company’s growth which is possible only because of expanded capital base.
Though above discussed advantages may lure the company to go for Equity financing but the disadvantages it carry cannot be overlooked.
Disadvantages of Equity Financing:
The decision to accept equity financing leads to ownership dilution of the company and hence the company is vulnerable to takeovers in the future.
Debt Financing refers to the amount borrowed from the financial institutions in the form of bank loans or by issuing debentures. Debt financing are generally issued against some collateralized securities and the borrower carries the obligation to repay back the principal and interest payment at agreed time intervals.
Advantages of Debt Financing:
Both of the accounting standards, IFRS and GAAP allows that any interest paid on debt borrowed can be deducted from the Income Statement as an expense. Hence, this provision allows reduced Profit and thus lower tax liability for the company.
Disadvantages of Debt Financing:
Risk of Bankruptcy:
Unlike, equity financing, debt financing carries the obligation of repayment of debt. Thus, any discrepancy or failure to honor the debt covenant commitments may entitle the lending institution to sell the collateralised asset to claim their uncovered funds from the borrower. This not only will run the credit-ability of the borrower company in the market but can also force him to declare bankruptcy.
Role of an investment banker is crucial at the time of raising capital for the company and the managers must give due consideration to the following characteristics of an Investment Banker:
Experience: Since raising money is not a simple process, thus only a highly experience Investment Banker who have an established network of contacts and who knows what deal will maximize the value of the company, should be appointed by the company.
Support Team: Although an experienced Investment Banker can do a lot on his own but the data on which he place his decision on , is prepared by analyst and associates. Thus, the management should also ensure that the Investment Banker should have a team which is proficient in market research, financial analysis, legal proceeding etc. (Mahmood)
Tenacity: Since, capital raising is not a one day task, there will always be some issues along the way. Thus, an investment banker should be non-partial and most importantly should understand the objectives of the organization. Thus, he should always have a backup plan to ensure that the capital raising deal should end up successfully.
In a general perception, Corporate Bonds have lower risk associated with them, hence they offer lower returns. Contrary to it, common stocks have high risk and thus offer higher returns to the investor.
Portfolio Diversification is the process of eliminating unsystematic risk from the portfolio by adding securities or assets that are not perfectly correlated to each other. In other words, when an investor diversifies across the assets that are not perfectly correlated, the portfolio’s risk is less than the weighted average of the risks of the individual securities in the portfolio. Hence, diversifying the portfolio with non-correlated assets eliminates unsystematic risk and what remains is only systematic risk/market risk, which cannot be eliminated from the portfolio.
Mahmood, D. (n.d.). How to Choose the Right Investment Banker. Retrieved from Inc.com: http://www.inc.com/david-mahmood/how-to-choose-the-right-investment-banker.html