The Case for Bond Issuance

• Company profit is measurable through balance sheets and cash flow. Management may recognize opportunities that can't be met because the cash flow of the company can't generate the large amount of investment to make that product. For example, the cost of brewing a local ale may be able to be supported in a garage. To take the ale into a regional or country market may take the building of a large facility. For that reason, debt is incurred. Management knows that the cost of interest and debt payments can be paid in a number of years and that the cash flow from beer sales is fairly predictable. While the profit margin is reduced to pay for the borrowing and building the net profit, the total number of dollars remaining after all expenses is considerably higher. Thus the incentive to enlarge a business by debt.
  The downside of the transaction is that the plan doesn't work. The very leveraging of the company to increase profitability may threaten the entire enterprise if the cash flow can't cover debt service, or principal and interest payments.
  
  

The Case for Equity

• Increased equity investment is the participation of additional parties to contribute equity and be the owners of a company. This entitles them to share in the proportionate profits the company may earn.
  Unlike the example above--in which additional debt leverages the company shareholders' potential earnings--the equity shareholders give up a proportionate share of current earnings for the potential to use the newly raised capital to earn additional revenues in the future.
  
  

The Pros and Cons for Debt and Equity Issuance

• Typically, the choice to raise money is not simply a debt or equity choice. Convertible preferred stock is often used to structure a financing by issuing preferred debt with a small interest payment, which converts at the borrower's choice into equity. The ability to borrow depends on the nature of the borrowing as well. Guarantees that include collateral of property or readily marketable inventory can reduce the burden of personal guarantees. Often, a company will raise equity in order to reduce borrowings and then build up a manageable debt position as company growth continues.