Financing Expansion

Sources of Finance

Long term sources of finance used to finance expansion include:

• Reserves/Retained Earnings: Profits that the business has saved over time. This source of finance has the advantage of having no borrowing costs or interest payments, reducing the risk of financial distress. An example is Ryanair using retained earnings to purchase shares in Aer Lingus.
• Share (Equity) Capital: Selling shares in the business to investors, giving them part ownership and voting rights. This provides a large amount of capital without the need for repayment, although it dilutes ownership. An example is Facebook financing the acquisition of WhatsApp primarily using equity.
• Debentures (Debt Capital): Long-term loans from banks or investors, often secured against assets. This enables large-scale borrowing with the obligation to repay with interest. An example is IAG borrowing €1.4 billion from banks to acquire Aer Lingus.
• Grant: Non-repayable funds provided by the government to support business needs like expansion. This is a permanent source of finance with no repayment required, provided conditions are met. Grants can be used to fund capital expenditures such as buildings or machinery.

Factors to consider when choosing how to finance expansion

• Cost: Consider the cost of borrowing (interest rates on debt) versus the potential dilution of ownership and loss of control that comes with issuing equity. Debt can be cheaper in the long term but requires regular interest payments, whereas equity does not require repayments but reduces ownership stakes.
• Security: Evaluate whether the business has sufficient assets to offer as security for debt financing. Secured loans may have lower interest rates but risk losing assets if the business fails to meet payment obligations.
• Tax Implications: Consider the tax benefits or liabilities associated with different finance options. Interest payments on debt are often tax-deductible, which can provide a tax advantage over equity financing.
• Dilution of Ownership (Loss of Control): Issuing equity shares can dilute the current owners' control over the company. Consider how important maintaining control is versus the need for capital and the implications of sharing decision-making power with new shareholders.