5. Long-Term Financing Decisions

• Venture capitalists are individuals or firms that provide startup capital for new untested business ventures.
• Angel investors are private investors who inject capital into startups in exchange for ownership equity.
• Crowdfunding is a means of raising capital for a project from a large number of people.
• Target capital structures are the selected mix of debt and equity that a firm strives to maintain.
• Business life cycle is a measure of the stages of a business from inception to growth and through its entire existence.
• Equity capital is a perpetuity, which means that it has no maturity date. While debt must eventually be paid off, equity remains invested with the firm indefinitely. There are two main sources of equity capital: preferred stock and common stock.
• Angel investors, coming in at a much earlier stage of the business and offering slightly less funding but demanding so much less control, offer a more benign route to funding for entrepreneurs seeking to advance their startup with less interference and a minimal loss of control.
• Optimal capital structure is the ideal mix of debt and equity that maximizes the value of a firm.
• What financial theory can do, however, is help to locate and identify key factors which directly impact upon the value maximization of a firm. Some of these key factors are listed as follows:

  • Debt/leveraging has a valuation impact.

  • In equilibrium, there is a net tax advantage to corporate debt financing.

  • A decrease in investment tax shields leads to an increase in debt financing.

  • A decrease in marginal bankruptcy costs leads to an increase in debt financing.

  • As corporate tax rates rise, firms substitute equity with greater debt financing
• Debt financing occurs when a firm raises money for capital expenditures by selling bonds to individuals or institutional investors. Leverage is the use of debt as part of the capital structure of a firm. Debt financing is also known as leverage.
• An aggressive or highly-leveraged firm has high fixed costs, and thus, often a high break-even point, while a conservative or non-leveraged firm has low fixed costs, resulting in a relatively low break-even point. Leverage in business finance terminology is defined as the utilization of outside capital.
• Return Over Investment (ROI) is measured by the amount invested and the income derived from it.

  ROI = Gross Profit\Cash Investment
• Another common form of debt financing takes place through the issuance of bonds. Government debt is the most common form of debt; nations issue debt to receive funds in order to meet obligations until tax revenues are collected and the funds to operate are available. Both government debt and corporate debt are also issued on international markets.
• Government debt is known as sovereign debt. Sovereign debt, often called external debt, is guaranteed by a particular government. In order to raise funds, governments issue bonds in a currency that is not that government’s own currency, and these bonds are sold to foreign investors. It is this sale to international investors rather than domestic investors that makes this debt external. The currency selected for sovereign debt is usually a strong currency, and its value is generally higher than that of other currencies.
• Bonds are instruments of debt. They must be paid back at some point in the future— this can be as far as thirty years into the future or as near as one year into the future— with repayment including the original investment plus interest all at once (in the case of shorter issues) or along the way (in the case of the longer issues). These bonds are called sovereign bonds and the money collected via the sale of these bonds can be used in any manner the issuing government chooses.
• Many bond issues exist in the corporate bond market and are used for corporate debt financing. Most corporate bonds sell with par values of $1,000, €1,000, or ¥100,000. Most have a single maturity date with maturities ranging from 10—40 years. Utility bonds often have longer terms such as 40 years, and most industrials usually mature in 25—30 years. The majority pay interest on a semiannual basis.
• Per value is the return of the initial investment at maturity.
• A corporate bond indenture is the legal agreement specifying the terms of the contract between the lender and borrower. Corporate bonds can either be debts that are secured or unsecured. Secured debt means that there is some form of collateral or asset against which a lender may stake a claim if all is lost, while the unsecured creditor has no such recourse and will only have the option to take whatever is available during an insolvency resolution.
• Some secured corporate bonds include mortgage bonds, which are issued for investing in specific fixed assets, property, or plants. The very same assets are pledged as security against that debt. These are the bonds that many utilities issue for the building of power plants.
• Collateral trust bonds pledge financial assets (e.g., notes, stocks, paper) owned by a firm as collateral against the debt. They are also known as equipment trust certificates when they are issued for investment in fixed assets, specifically the purchase of equipment. Usually in this case, the equipment has substantial resale value and is used to secure the debt obligation.
• Unsecured corporate bond issues such as debentures are known as “unsecured” debt obligations of a company, however, in the event of financial reversals, the holders have the claim of a general creditor against the assets of a firm.
• Other types of unsecured corporate debt financing include subordinated debentures. These are bonds that place their holders in a subordinate position relative to a firm’s other creditors. Interest and principal on these bonds can only be paid after satisfying the issuer’s senior debt obligations.
• Income bonds pay interest only if a firm has sufficient income.
• Variable interest rate bonds have the interest rate that can fluctuate based on economic conditions.
• A lease is defined as a contractual agreement or relationship between the owner of an asset, equipment, or property (lessor) and the person or firm who is granted use of that asset, equipment, or property (lessee) for a specified period of time at an agreed-upon price. Generally, a lease is for a long period, whereas a rental is generally a shorter-term agreement. The lessee must make periodic payments to the lessor for use of the property, with the principal benefit of long-term leasing as a tax reduction to the lessee.