Business Financing and the Capital Structure - Assignment Example

In their effort to expand and increase their outputs, firms can adopt various methods of raising capital. These include the use of debts and equity among others. Debts include loan from banks while equity entails looking for investors.

Advantages of debt financing

One of the notable merits of using debts is that the bank or the institutions that provide the loan do not control the business. Secondly, the interest accruing on the loan is tax deductible. Thirdly, once the money is paid back the business ownership ends. Fourthly, business owners are aware of the principal and the interest. Thus they are in a position to make budgets.

Disadvantages of debt financing

One of the notable demerits is that the loan must be repaid within a fixed time. Secondly, if a business experiences cash flow problems due to heavily relying on debts, it will face difficulties in paying back the loan (Daniel, 2014). Thirdly, when sales decrease during hard times, debt financing can negatively affect a firm. Fourthly, due to the high costs of repaying the loan, a firm expansion process may be difficult. Fifthly, the assets owned by the business can be used as collateral by the lending institutions.

Advantages of equity financing

One of the major advantages of using equity as a source of capital is that it is less risky. Secondly, by involving investors in a business, its credibility improves. Thirdly, a firm will not need to use all its profit into repaying loans. Fourthly, a business will have more cash on its hand to expand its operations. Fifthly, if the business fails, it is not compulsory to pay back the investments. Lastly, since the majority of the investors do not expect returns on their investment immediately, the business can maximally use the funds at the initial stages.

Disadvantages of equity financing

First, the rate of return may be higher than that used to repay bank loans. Secondly, investors are interested in the business and may control the business an aspect that business owners may not be ready to give up (Daniel, 2014). Thirdly, business owners must consult the investors before making any major decision. Fourthly, it takes time for the management before getting the right investors.

Based on the many advantages of equity financing, I would advise my client to use equity as the source of capital. It is effective not only by the huge amount of funds that the business is likely to get but also due to improved business credibility.

During the selection of an investment banker, I would advise my client to first communicate with them, and note who they will contact as well as their relationship with the banker. Secondly, the investment must understand the client business segment as well as significant information about the industry (Rosenbaum and Joshua, 2009). Thirdly, the investment banker must create a solid relationship with the venture capitalists who are involved within the business segment. Fourthly, the management must ensure that the motives of the banker are in line with those of the firm. For example, if the firm wants a large number of funds, it must choose an aggressive banker (Fleuriet, 2008). Fifthly, the client must not just choose a banker but a partner also. In this way, the banker will professionally represent the firm.

By investing in a stock, one becomes partly an owner of the company. On the other hand, investing in a bond once becomes a creditor. As a part owner, nothing is guaranteed since the division depends on whether the business makes a profit. As a bondholder on the other hand, an investor expects fixed interest as his or her money back. Diversification of the portfolio ensures that as the stock market continues to bounce up and down, not the entire portfolio loses value. For example, if the prices of stocks go down resulting in low returns, other investment vehicles such as mutual funds, cash, and real estate may provide high returns to the investors.  If a company in the telecommunication industry for example has $100 million to invest it can invest $15 million in the oil industry, $25 million in the retail industry, and $30 million in transportation among other industries.