CFM11010 - Understanding corporate finance: raising finance: overview

How companies raise finance

A company can raise money in a variety of ways. The most obvious means are:

  • issuing shares; or
  • borrowing.

Advantages and disadvantages of issuing shares

Raising finance by issuing shares has the advantage that a company is not normally compelled to make payments to shareholders. The reward for investing by way of shares comes in the form of dividends and any increase in the value of the shares. The company will only have to pay dividends if there are distributable profits and cash available and a dividend is declared by the board and/or voted by the shareholders.

However, it may have drawbacks for both the shareholders and the company. The company has to be legally entitled to issue shares, in accordance with its articles of association. Further issues of share capital may require a resolution passed by a general meeting of the shareholders. Unless taken up by the existing shareholders the issue of additional shares dilutes the interests of the existing shareholders who may be unwilling to lose their control of the company.

There are many different kinds of shares (CFM11020) which offer the company the chance to raise money on different terms.

Cash raised through the issue of ordinary shares is permanent funding, and cannot be ‘repaid’ unless the company

  • redeems the shares
  • purchases its own shares, either in the market or privately
  • effects a reduction of capital.

Preference shares may be easier to redeem, and typically leave the original shareholders a greater degree of control of the company, but the rewards they offer may be unattractive to new investors.

Advantages and disadvantages of borrowing

A company that borrows will have to repay the borrowing, and will also have to pay for the use of the money, usually in the form of interest or discount. This will affect its cash flow. A company just starting up or that is short of realisable cash may prefer to issue equity to raise finance.

The advantage of borrowing is its flexibility. If the company no longer needs the funds it can usually repay the debt. It can increase its borrowing without meeting complicated Companies Acts requirements, although there may be regulatory or market restrictions on the amount a company can borrow (CFM11040). Unlike dividends, the cost of the borrowing will normally be tax deductible.

Alternative means of raising finance

There are alternatives which usually equate, in economic substance, to borrowing funds at interest. For instance, the company might utilise assets it holds as a means of raising finance without paying interest as in Islamic Finance.

Shares or securities might be sold subject to an agreement to repurchase at a predetermined price in the future. Such ‘repo’ transactions are a common way of raising finance, most notably in the financial sector.

Securitisation structures {#} are another example, assets may be transferred (in fact or substance) to a special purpose vehicle (SPV), typically not legally controlled by the company needing funds and not exposed to that company in the event of its insolvency, which then issues debt, usually with recourse limited to the income steam arising from the assets.

Or, rather than borrowing money to buy an asset outright, a company may lease the asset. The lease might be accounted for as it the company had acquired the asset with borrowed funds, reflecting the economic substance of the arrangement.