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Debt vs. Equity Financing
Emmanuel Jon Llegoon 1 October 2012
Transcript of Debt vs. Equity Financing
I. Things to consider for expansion of business
B. EQUITY Suppose you are raising money
for business expansion, What would you do?
Should you go to bank
or should you look for an investor? Debt vs. Equity Financing Things to Consider Before Expanding Your Business New Marketing
Pushing Your Brand
Better Business Management
Money, Money, Money… DEBT FINANCING borrowing money from external sources to run or expand the business An important source of this type of financing is the bank, but many private companies, and even friends and relatives offer such financing. Control
Easy Administration Repayment
Restricted Cash Flow
Risk Outlook DEBT FINANCING It's less risky
You tap into the investor's network, which may add more credibility to your business.
Investors take a long-term view.
You won't have to channel profits into loan repayment.
More cash on hand
No requirement to pay back the investment if the business fails. EQUITY FINANCING Advantages Disadvantages Threat of Takeover Sara Lehn, chief financial officer of Merit Enterprise Corp., was reviewing her presentation one last time before her upcoming meeting with the board of directors.
Merit’s business had been brisk for the last two years, and the company’s CEO was pushing for a dramatic expansion of Merit’s production capacity. Executing the CEO’s plans would require $4 billion in capital in addition to $2 billion in excess cash that the firm had built up. Sara’s immediate task was to brief the board on
options for raising the needed $4 billion. ILLUSTRATIVE Unlike most companies its size, Merit had maintained its status as a private
company, financing its growth by reinvesting profits and, when necessary, borrowing
from banks. Whether Merit could follow that same strategy to raise the $4 billion
necessary to expand at the pace envisioned by the firm’s CEO was uncertain, though
it seemed unlikely to Sara. She had identified two options for the board to consider ILLUSTRATIVE Option 1: Merit could approach JPMorgan Chase, a bank that had served Merit well for many years with seasonal credit lines as well as medium-term loans. Lehn believed that JPMorgan was unlikely to make a $4 billion loan to Merit on its own, but it could probably gather a group of banks together to make a loan of this magnitude. However, the banks would undoubtedly demand that Merit limit further borrowing and provide JPMorgan with periodic financial disclosures so that they could
monitor Merit’s financial condition as it expanded its operations ILLUSTRATIVE Option 2: Merit could convert to public ownership, issuing stock to the public
in the primary market. With Merit’s excellent financial performance in recent years, Sara thought that its stock could command a high price in the market and that many investors would want to participate in any stock offering that Merit conducted. ILLUSTRATIVE Becoming a public company would also allow Merit, for the first time, to offer employees compensation in the form of stock or stock options, thereby creating
stronger incentives for employees to help the firm succeed. On the other hand, Sara knew that public companies faced extensive disclosure requirements and other regulations that Merit had never had to confront as a private firm. Furthermore, with
stock trading in the secondary market, who knew what kind of individuals or institutions
might wind up holding a large chunk of Merit stock? ILLUSTRATIVE Which option do you think Sara should recommend to the board and why? ILLUSTRATIVE CASE CASE CASE CASE CASE CASE