Debt Finance
Debt finance is a source of finance, which is borrowed with an legal obligation to repay at maturity date. Debt finance usually bears an obligation to pay interest. However, debt finance can also be issued at zero interest rate.
Cost of finance
Debt finance is cheaper source of finance than convertible loan notes. However, it is more expensive than preference share capital and equity finance. Debt finance holders have legal protection and can enforce payments in the event of default. Therefore, they agree at lower returns for low risk.
Risk
Debt finance is less risky for investors. However, it is more risky for business owner/managers. Non payment of interest or principle amount can force the business into liquidation/dissolution by the creditors (Debt finance holders).
Control
Debt finance does not result in transfer/dilution of control. Debt finance holders have no voting rights. Therefore, debt finance holders cannot influence strategic, investment and financial decisions.
Access
Debt finance is accessible to both listed and unlisted businesses (private limited companies, partnerships and sole proprietors).
Debt finance is available in variety of forms such as bank loan (secured and unsecured), loan notes (also known as debentures and bonds), convertible loan notes, zero coupon bonds, deep discount bonds, redeemable preference shares etc.
Tax benefits
Interest paid to debt finance holders is tax deductible expense for tax purpose. It reduces the cost of finance even lower by the percentage of tax rate applicable to business.
Irredeemable Preference Share Capital
Preference share capital have prior rights in respect of dividend and claim on surplus assets in the event of winding up. Preference shareholders (redeemable or irredeemable) are the owner of the company according to company law. However, only irredeemable preference shareholders are considered as the owner for financial decision making.
Cost of finance
Irredeemable preference share capital is more expensive than debt finance (including redeemable preferences share capital). However, it cheaper than equity finance. Irredeemable preference shareholders may agree at lower returns for prior right in dividends and claim on surplus assets.
Risk
Preference shareholders are owner of the company. They are not required to pay until liquidation of the company. They cannot enforce dividend payments. However, if dividend is declared then they have receive dividend earlier than equity finance holders.
Control
Preference shareholders have no voting rights unless decision under consideration involves changes in rights of preference shareholders with respect to par value, percentage of dividend payable etc. Therefore, preference shareholders cannot influence the strategic, investment, financial decisions taken by managers. It means preference shareholders cannot appoint and remove managers in AGM.
Access
Preference holder capital (redeemable and irredeemable) can only be issued by publicly listed companies.
Tax benefit
Preference shareholders are owners of the company according to company law and paid dividends. Dividends are not tax deductible expense.
Equity Finance
Equity finance holders have residual claim on dividends and surplus assets of the company in the event of liquidation. They are considered owners from both legal and financial viewpoint.
Cost of finance
Equity finance is most expensive source of finance. Return required by equity finance holders depends on perception of risk (financial and business risk) profile of the company. Equity finance holders usually require higher return than debt finance holders to compensate themselves for additional risk (financial and business risk) faced by equity holders due to investment in the company.
Level of return required by equity shareholders is reflected in the market share price of publicly listed companies.
Private limited companies can also have market share price, if listed on AIM (Alternative Investment Market)
Risk
Equity finance more risky for equity finance holders. However, equity finance is less risky for business owners. Equity finance is not legally required to pay dividends and repay principle amount invested until winding up.Therefore, it does not bears the risk of forced liquidation as risk associated with debt finance.
Control
Equity finance result in transfer/dilution of control to the extent of equity finance raised. However, if equity finance is raised through right issue and it is 100% subscribed then it will result in transfer of control.
Access
Equity finance can be issued by both private and publicly listed companies.
Tax benefit
Equity shareholders are owners of the company according to company law. Equity shareholders are paid dividend rather than interest as compensation. Dividend payments are not tax deductible.
