Capital raising questions and strategic approaches

Finance

Questions on Capital Raising

Advice on Raising Capital

When businesses wish to expand they are likely to require further capital to support that growth. If the firm does not have sufficient internal capital, they will need to turn to external sources to raise funds, with two main options; debt or equity.

Debt is capital that is raised which will need to be repaid, usually in the form of a loan or the issuance of a corporate bond. The company will then be required to pay interest in the debt, it is usual for the interest payments to be due at regular intervals, such as monthly, quarterly, twice a year or annually, depending on the type of debt instrument used. In some cases, for example loans made to property developers, the interest may be rolled up and payable when the loan is repaid (Howells & Bain, 2007). The lender will make the funds available to the borrower with the aim of making a profit; the profit will come from the interest and fees charged for making the loan. The fees and interest rate will be determined by a number of factors, including the prevailing interest rates and the degree of risk associated with the loan. The potential risk of default is assessed, the higher the risk premium needed by the lender and the more costly the loan, the lower the risk the lower the interest rate (Howells & Bain, 2007).

There are both advantages and disadvantages associated with debt. Debt does not confer any ownership rights on the lenders, and may be popular with the shareholders as it does not dilute shareholding. It can be cost-effective to raise debt, especially compared to raising equity, and when interest rates are low, it maybe argued that debt may be cost-effective, especially if the borrower is able to raise funds on a fixed interest rate loan (Howells & Bain, 2007). However, there are also some disadvantages; debt will require repayment of both the principal and interest payments, which may increase the pressure on the organization and is not required and an equity issue. Where interest payments are made, interest payments are tax deductible. Caveats may be associated with the raising of debt, for example lenders may require security, or require borrowers to make commitments regarding the way in which they will operate, use or dispose of assets or other controls on the organization's activities (Howells & Bain, 2007).

The raising of equity allows the firm to gain an inflow of capital as a result of issuing shares and granting ownership to those who provide the equity. Equity is not a loan, it is an investment, and confers ownership rights on the investors. Where shares issued, each share will contain equal rights in terms of voting, and rights to dividends. Investors will usually make equity investments with the aim of creating profit; this can be achieved through capital growth of the share price, as well as the receipt of dividends. A specific advantage associated with the use of equity is the low costs; dividends are not compulsory on equity investments, and the investment does not need to be repaid, which can be a significant advantage compared to debt. However, raising equity finance can be costly, especially if it is through a share issue. Furthermore, the issuance of shares dilutes ownership, and therefore the rights and potential returns of the existing owners.

One consideration may be the costs associated with both debt and equity, but according to equity arbitrary, it maybe argued that the risk premium associated with the company should be based on the company's activities, and therefore the cost difference between debt and equity should be minimal (Miller, 1988).

Advice on Selecting an Investment Banker

When a company starts to pursue a capital raising strategy there will need to select an investment banker. There are many investment bankers, the first consideration may be to choose an investment banker which is suited to the size of the organization. For example, many of the large investment banks may choose to deal only with large deals will have minimum transaction sizes. Therefore, the first consideration may be the suitability of the bank given the size of the organization. There may also need to be consideration of the degree of attention and expertise that the investment banker direct with the company, even if the minimum is met, large organizations with a large number of clients may have a higher level of expertise that can be directed, but they may also be more focused on large clients. This can only be assessed by talking to the relevant investment bank.

Prior to taking on any investment bank it will be necessary to allow the investment banker to make a pitch. Ross details of the organization's financial position may be given prior to this pitch, but an investment banker should be willing to sign a confidentiality agreement before receiving sensitive financial data, including projections for future performance.

Investment bankers will charge fees for their services, therefore the organization also need to decide the way in which they would like the fees to be structured when choosing investment banker. For example, a fixed set rate fee for services, or a lower fee supplemented by a performance-based fee, the greater the level of performance the higher the fees. The first provides for a degree of security uncertainty, whereas the second may result in higher fees if the investment banker is successful, but may also provide motivations for continued efforts.

It may also be argued that the relationship between feminine investment banker will also have a number of subjective aspects, and while many of the decisions may be made based on logical reasoning, such as what it is the investment bankers can do, fit between the company and investment bankers knowledge and experience, and fees, there may also need to be some consideration regarding the personal relationship which can be developed.