Businesses that need to raise capital to fund their ventures have two main financing methods available, namely debt financing and equity financing. The majority of businesses use a mixture of equity and debt financing, however, there are several distinct benefits to each. The most notable benefit is that there are no repayment obligations with equity financing and that this option provides additional cash flow that businesses can use to expand. In contrast, debt financing allows businesses to avoid sacrificing part of their ownership.
Often, debt is an appealing way to finance an acquisition, because it tends to cost less for businesses to issue, in comparison to equity. This is because investors expect a higher return percentage from equity investments. There are tax advantages associated with issuing debt, thanks to the tax-deductible interest payments on offer. Also, a business can gain extra leverage with this approach, to increase its return percentage from equity.
Issuing debt can be advantageous in another key respect for businesses, namely that their ownership is not diluted because no extra shares are issued. Then again, there are several key drawbacks to debt financing. If businesses issue large levels of debt, their credit rating will suffer. This will make it more difficult for them to borrow cash in the future, and increase their debt costs. Moreover, debt issuance might be restricted by covenants from lenders that set limitations on debt levels businesses can shoulder. This could prevent certain businesses from borrowing enough capital to make sizable acquisitions.
Although equity costs more, this form of financing remains popular for acquisitions, thanks to the opportunities it gives to investors. Also, it allows businesses to avoid shouldering additional financial burdens. Equity investors can get a decent return on their money, while businesses get more cash flow to invest in expanding their operations. Some of the advantages of equity are:
-No requirement to repay a principal sum of money
-No compulsory interest payments
-No associated undesirable clauses. Equity financing for acquisitions does not affect the credit ratings of businesses, so they can raise debts in the future if necessary.
Notwithstanding, an equity offering can have a number of drawbacks. The return on equity and earnings per share of a listed business might suffer once stock is issued, as it loses leverage. Furthermore, if the share price of a listed business becomes more volatile, this might create uncertainty about the valuation of the acquisition. In turn, this might increase the quantity of time required to finalize the transaction or scupper it together.
Nonetheless, public businesses prefer to use equity financing to pay for acquisitions, while debt also has a key role to play — due to the cost savings it offers and the leverage benefits. Moreover, if you run a private equity business, a big sovereign fund, or a private business and have surplus funds available, it often makes sense to complete acquisitions as all-equity transactions.
Lots of startup businesses will opt for equity financing, whereas established, debt-free businesses with healthy credit scores might prefer conventional debt financing solutions — such as loans for small businesses. The best method for you depends on your risk tolerance, need for control, and business ambitions. Always take the time to research what lenders can offer you, and how innovative they can be to meet your requirements.
MergersCorp M&A International is an experienced M&A corporate advisory firm with a global reach. The company has concluded dozens of mergers and acquisitions in over 40 countries around the world. The company has experts in a variety of industries to advise clients when they want to buy or sell a company.
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