Debt Financing and Financial Flexibility Evidence

Question: Discuss about the Debt Financing and Financial Flexibility Evidence. Answer: Introduction: In the current global business scenario, there are both investors and lenders. These are the two major financing sources, which help an organisation to accumulate cash for running its business operations and ensure future growth (Brealey et al., 2012).Debt financing signifies borrowing money from an external source with an assurance of repaying the amount coupled with an agreed rate of interest. Equity financing, on the other hand, is the process of accumulating capital by selling the enterprise shares. For small or start-up companies, debt financing is the only available option to acquire funds irrespective of the business type or size. Equity financing, on the contrary, is only available to those companies, which are listed in the stock markets. For instance, Spring Singapore has launched $500 million debt venture program with DBS, OCBC and UOB to extend support to the high growth entities of the nation (Gov.sg, 2016). The main purpose of this initiative is to attract the big companies of Singapore to choose the route of debt financing, which offers additional benefits in contrast to the traditional bank loans. In addition, one of the major advantages of debt financing is that the lenders could not affect the running of business operations and the overall decision-making process of the business (Denis, McKeon, 2012). However, in equity financing, the internal shareholders participate in the decision-making process of the organisation and hence, the process of business operations might be altered. Furthermore, the companies enter into relationships at the time of acquiring debts from the lenders, which are completed as the soon as the debts are repaid. Unlike debt financing, the companies are not required to pay monthly instalments coupled with interest to the investors. Instead, the investors invest money into an organisation and own a portion of the companys shares. In the words of Fatica, Hemmelgarn Nicodme (2013), most investors expect a maximum return on investment within three to five years. The major advantage of using equity financing in the context of an organisation is that it does divert the business capital for repaying debt. Moreover, with the help of equity financing, the company owners could share the business risks with the equity shareholders. However, the major drawback of equity financing is that if the business owners distribute the equity stake of 49%, then the risk of business control is increased. Since the equity shareholders own a part of the business, they might restrict the owners to raise capital through additional bank loans. In case, a large investor decides to leave the business, it might affect the financial position of the business in terms of capital accumulation. For instance, the retail and manufacturing sectors rely on debt financing to accumulate funds for their businesses, while the technology sector is more prone to equity financing, since the returns are high to the investors with considerable amount of risk. Therefore, based on the above discussion, it is recommended to the companies to provide priority to debt financing in contrast to equity financing. It has been evaluated that the companies raising funds through equity are highly volatile due to unsteady cash inflows. Thus, majority of the funds need to be acquired through debt for running the business operations through independent decision-making process. References: Brealey, R. A., Myers, S. C., Allen, F., Mohanty, P. (2012).Principles of corporate finance. Tata McGraw-Hill Education. Denis, D. J., McKeon, S. B. (2012). Debt financing and financial flexibility evidence from proactive leverage increases.Review of Financial Studies,25(6), 1897-1929. Fatica, S., Hemmelgarn, T., Nicodme, G. (2013). The debt-equity tax bias: consequences and solutions.Reflets et perspectives de la vie conomique,52(1), 5-18. Gov.sg (2016). Retrieved 9 November 2016, from https://www.gov.sg/~/sgpcmedia/media_releases/spr-spore/press_release/P-20160428-1/attachment/SPRING%20Singapore%20Launches%20$500M%20Venture%20Debt%20Programme%20with%20DBS,%20OCBC%20and%20UOB%20for%20High-Growth%20Enterprises%20_28Apr2016.pdf