Understanding corporate finance: raising finance: overview
How companies raise finance
A company can raise money in a variety of ways. The main ones are:
- issuing shares
- exploiting assets.
Advantages and disadvantages of issuing shares
Raising finance by issuing shares may be a relatively cheap alternative. The reward for investing by way of shares comes in the form of dividends and any increase in the value of the shares. The company will only have to pay dividends if there are distributable profits and cash available and a dividend is declared by the board and/or voted by the shareholders.
However, it may have drawbacks for both the shareholders and the company. The company has to be legally entitled to issue shares, in accordance with its articles of association. Further issues of share capital require a resolution passed by a general meeting of the shareholders. Unless taken up by the existing shareholders the issue of additional shares dilutes the interests of the existing shareholders who may be unwilling to lose their control of the company.
There are many different kinds of shares (CFM11020) which offer the company the chance to raise money on different terms.
Cash raised through the issue of ordinary shares is permanent funding, and cannot be ‘repaid’ unless the company
- redeems the shares
- purchases its own shares, either in the market or privately.
Preference shares may be easier to redeem, and leave the original shareholders in control of the company, but the rewards they offer may be unattractive to new investors.
Advantages and disadvantages of borrowing
A company that borrows will have to repay the borrowing, and will also have to pay for the use of the money, usually in the form of interest or discount. This will affect its cash flow. A company just starting up or that is short of realisable cash may prefer to issue equity to raise finance.
The advantage of borrowing is its flexibility. If the company no longer needs the funds it can usually repay the debt. It can increase its borrowing without meeting complicated Companies Acts requirements, although there may be regulatory or market restrictions on the amount a company can borrow (CFM11040). Unlike dividends, the cost of the borrowing will normally be tax deductible.
Raising money from disposing of assets
A company could raise money by selling assets. It might also use the debtor assets it holds to raise further finance.
If an asset is sold the company loses the ownership of the asset, though not necessarily the use of the asset which it may retain through a lease or rental agreement. If, on the other hand, the company can make existing assets produce more money while not selling them, the company could get more funding without losing its assets. CFM11140 (making debt saleable/securitisation) has more details.