Assets financing

To start a business, one needs to acquire assets. Financing activities to acquire assets involve obtaining funds from owners and creditors (i.e., banks). When owners fund the activities of a corporation, they become shareholders of the corporation. Shareholders have a claim... 

Common stockholders have a right to the residual assets of a company in the event of dissolution or liquidation but only after all the creditors and then any liabihties to the preferred stockholders have been paid. The larger the proportion of debt financing in a company, the smaller the amount the common stockholders are likely to receive if the company is liqiiidated. 

The advantage of using common stock to finance assets is that it does not incur nxed interest charges. Furthermore, there is no maturity date, as there is with all loans and most preference issues. Common stock can often be issued more easily than debt can be financed. However, the flotation costs of common stock can be quite high, especially when stock values are depressed, so that large discounts for the stock are needed to induce purchase. 

A financial analyst looking at a company from a potential common stockholders point of view is hkely to classify preferred stock as debt. In contrast, bondholders and general creditors are likely to regard preferred stock as additional eqmty. Since preferred stock is a hybrid type of security, it may be issued by a company whose management is divided over the question of whether to use equity or debt to finance additional assets. However, preferred stock does have the disadvantage that the dividends are not allowed as a tax-deductible expense. 

Sometimes, fixed assets are purchased via short-term loans, which can lead to hquidity problems. For the most part, fixed assets should be financed from long-term or permanent capital such as stocks or bonds. The proven abihty of management to handle working capital efficiently will put a company in a better position to obtain such longterm capital when required, because the confidence of bankers and stockholders will have been obtained. 

Equity financing comes 100% from the owners. They are in business to take risks but must realize a higher retuni to make up for this higher risk. Several ways are open to get equity funds. An asset may be sold, common or preferred stock may be sold, or retained earnings may be accumulated. Whatever the source, management must make sure the project is feasible, will pay the debt, and will make a profit. 

Issue of debentures. These will normally carry a fixed rate of interest and have a predetermined date of redemption, possibly at a premium. The holders of debentures will usually require security perhaps by means of a fixed charge over specific assets (or all the assets), and will have a right of prior payment in the event of a liquidation. Debenture holders can also sometimes exercise their rights on the occurrence of certain events. Widespread security given to one class of lender can militate against the provision of shortterm finance from other lenders who require collateral. 

A method of raising money to finance projects whereby the money is loaned on the security of the profitability of the project itself and not on the other assets of the company. 

The change in the NPV using debt financing of assets is known as the principle of leverage. A similar result can often be obtained by leasing equipment because the lease payments are completely deductible as expenses for income tax purposes. 

Sources of finance for company acquisitions as mentioned above can be from reserves or maybe taken a senior or subordinated debt. Alternatively a bond may be issued with various characteristics offering an annuity, a balloon payment or a combination of the two. A variety of convertible structures have been utilized for this purpose as asset sales and the use of the target s balance sheet. There has also been a place for royalty transactions where the future-value of product cash flows are securitized to provide capital in the near term to achieve a company acquisition. 

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