DEBT AND EQUITY
American superconductor is a company in America that is charged with the responsibility of providing energy technologically by ensuring that best solutions are offered about high temperature superconductor wires and the programmable power electronic converter. The American superconductor is one of the most known energy providing companies, which focuses on wind energy activities in its operations through the delivery of turbine designs and electronics. Any company aiming to expand the business activities being carried out, the important thing to consider is the financial resources available. The business can avail funds for its daily operations by making sure that the available financing resources are utilized to the maximum. The different financing resources is discussed where the business owners can get funds to support their business activities. Debt and equity are the current source of financing resources which can be relied upon by the business owners.
In simple words, Debt financing involves borrowing funds by the business owners to meet their short term and long term needs which will then be repaid in due process with an interest. On the other hand, equity financing can be termed as a mean of raising funds for the company whereby the common stock or the preferred stock of the company are made public to individuals or investors in order to raise funds for the company. Under these financing criteria, the company calculates the number of stock held by the company and there after makes an advert to invite people to buy the stocks. The shareholders who purchases the company stock becomes members in the company stock in that they owns interest of the company. They are entitled to earn interest during the operation of the company (Keynes, 1936).
Most business owners prefer equity financing as a source of funds for running their business in that no interest is required to be repaid back after getting the amount. In most situations, equity financing can be through family members and friends. Confusion a rises whereby business owners are lend money by friends and family members to start up a business. In such a scenario, it is termed as debt financing since the lend money must be repaid back with an interest. The reasons why people prefer equity financing just like the American superconductors includes:
The little amount from your personal saving can be used when starting the business with the support of that of your investors. Equity financing saves the business owners from borrowing funds from other financial institutions whereby it has to repay the money back with interest.
In equity financing, the people who lends you money in most of the situations are friends and close relatives that know you better. In the event where you are unable to continue with the business due to financial constraints, they are likely to understand your position as an individual. Some of them may end up forgoing their cash for the sake of the business. This contrary with debt financing whereby the financing institution may end up forcing you to repay the borrowing money within the time agreed.
Equity financing also offers the business owner an opportunity to acquire different skills and other valuable help. Debt financing firms rarely provide this kind of assistance in that they only focus on lending out money. The investors will be of great importance to the business owner especially at an early stage of the business due to the high risks involved.
On the other hand, equity financing has drawbacks which discourage business owners from getting funds through the system. They tend to prefer debt financing as compared to equity with the following facts (Graham, 1934).
In debt financing, membership does not get lost in the process but in equity financing, the lender may not have ownership in the business interest as agreed. Debt financiers have interest ownership until all the lend money is repaid back with the agreed interest.
Hurst (1970) confirms that, in equity financing, in the event of lending cash to the business owner, shareholders have a right to claim on future profit made by the business un like in debt financing. Here the lender is only interested in the principle amount of the loan and the interest. American superconductors being a large firm, it is advisable to use debt financing as a source of funds. This will give it an opportunity to access large amount of funds from the lending institutions as unlike in equity financing. The decision made to finance their business activities by use of equity financing if not advisable.
The agreed interest rate to be paid by the company can be deducted from the companies’ tax return thereby saving the company from incurring a lot of expenses. Equity financing somehow is complicated in the process of financing as compared to debt financing. In debt financing, there are less rules and regulations that must be fulfilled before getting the loan therefore, business owners may not be obligated to conform to state rules. There are tax deductions for debt financing in that the companies tax returns can be taxed instead of taxing the company’s total earnings for the agreed period of time. I don’t agree with the decision made by American superconductors to shit to equity financing as a source of funds since the amount to be accessed by the company will be limited. Therefore, the best option is to use debt financing since the size of the company needs large amount of cash to run their activities.
According to accounting standards, equity is the amount that shareholders claim from the company after the company pays all the liabilities to the debtors. The shareholders can only get a positive share if the cost of assets exceeds the value of the liabilities. The remaining amount is termed as the interest which is then divided among the shareholders according to their contributions.
Hurst, J. M. (1970). The Profit Magic of Stock Transaction Timing. Englewood Cliffs, N.J: Prentice-Hall.
Keynes, John M. (1936). “12”. The General Theory of Employment, Interest and Money. London: MacMillan.