Bus 1001 Healthy Potion Case Study

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Evaluation of Debt and Equity Funding

The most fundamental decision a company faces regarding financing is whether it will obtain funds by debt financing [borrowing money] or equity financing [selling ownership shares in the company]. Each alternative poses distinct advantages and disadvantages. One central benefit of debt financing is the total ownership and control that owners retain without having to answer to external influences (Klein 2010). However Price (1994) claims, if vendors fail to make their payments they risk the businesses capital and management as well as their personal assets. Nevertheless, many firms borrow funds to cover shorter-term needs, ‘such as a line of credit to smooth out cash flows or a term note to cover asset acquisitions’ (Gellman 2010 cited in Klein 2010). Hence in this case, Price’s viewpoint lacks sufficient grounding. Another characteristic of debt financing described by Kestenbaum (2007) is its recognition as being ‘the cheapest way to borrow money’ and a relatively easy procedure to follow which should not take long (cited in Young 2007, p. 20). Robb (2002) challenges this, proposing that debt financing is more risky than equity financing as debts must be repaid at specific points in time, whether the company is performing well or not. In this way, for young companies to borrow funds from external sources, there is significant emphasis placed on the demand of cash flow (Palermo 2014). Nonetheless, if a debt is paid on time it can enhance the business’s credit rating and make it easier to obtain various types of future financing (Hamilton 1990). Another great incentive to debt borrowing is the deductibility of interest and non-taxable income by corporations which lower the actual cost of the loan (Bovée and Thill 2015).

Equity financing is the alternative option for securing funds that involves selling shares of ownership in a company. Such funds may come from friends and family of the business owner, wealthy ‘angel’ investors, or venture capitalists (Klein 2010). One main advantage to equity financing is that there is no obligation to repay the funds and no risk of personal assets (Price 1994). Instead, shareholders look to reclaim their investment out of future profits. In this sense, what King (2014) sees as a big dilemma of equity financing is the control investors potentially have over a business’ revenue and day-to-day operations (cited by Palermo 2014). Although accurate, the involvement of high-profile investors is generally beneficial as they provide invaluable assistance to a firm in the form of management expertise, business contacts and access to other sources of capital (Schäfer, Werwatz and Zimmermann 2004). As King (2014) also points out, with equity financing, ‘investors sink or swim alongside the business owners’. Another characteristic of equity financing is that it does not divert funds from the business to pay down debts (Robb 2002). Hence, with greater access to up-front capital, vendors are able to finance the projects necessary to achieve strategic growth objectives; rather than channel cash flows into loan repayments (DCA Partners 2012). Yet some sales of equity, such as initial public offerings, can be very complex and expensive to administer. ‘[It] can take months of management time and attention, cost several million dollars, and expose the company to rigorous scrutiny’ (Bovée and Thill 2015, p. 471).

Fund Raising Plan

The biggest decision between debt and equity financing will ultimately come down to a business’ structure. According to Tsuruoka (2004), businesses are advised to use a combination of debt and equity financing; as together, they work well to reduce the downsides of each. ‘Using one type of financing limits the addition of future capital and affects the growth of a business’, adds Price (1994). In Healthy Potion’s case, a plan that the entity can undertake to initially raise its funds is to opt for debt financing rather than equity financing. This is because with the entity starting out as a relatively new business in the industry, it is perceived to be inexperienced, have low cash flow and no strategic value (cited in SMH 2011). As such, there is limited amounts of investors [if any] willing to purchase the company’s shares and it is thereby required to borrow funds. Yet relying solely on debt financing is highly ineffective and many experts suggest it should only be used in the initial stages of development (Tsuruoka 2004). Thus, once HP begins steadily growing and generating substantial profits, it can then progress to equity financing. With the help of investors providing large capital funding and invaluable business expertise, this will enable HP to gain better access to both cash flow and capital which can be diverted to maintain efficiency, achieve diversification strategies as well as expand its capabilities.

Conclusion

In conclusion, it is clear that by conducting Porter’s Five Forces and a SWOT analysis, management functions are able to formulate business development addressing the weaknesses and threats of HP. Such examples include vertical integration, acquiring patent rights and expanding globally. Yet to put the strategies into effect, the blend of both equity and debt financing must be exercised; as jointly they neutralise any drawbacks and provide higher cash flow, capital and profits that expand the business.

Reference List

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Armstrong, G., Adam, S., Denize, S. and Kotler, P. 2015, Principles of Marketing, 6th ed., Pearson Education Australia, Melbourne.

Bovée, C. and Thill, J. 2015, Business in Action, 7th ed., Pearson Education Australia, Melbourne.

Cahill, D. 1997, Target marketing and segmentation: valid and useful tools for marketing, North Union Associates, Ohio, viewed 17 April 2015, http://search.proquest.com.ezproxy2.library.usyd.edu.au/pqcentral/docview/212077933/C69463264DEF43DAPQ/1?accountid=14757>

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Ding, L. and Mahbubani, J. 2013, The two-stage decision model of vertical integration, Emerald Group Publishing Limited,