The Exceptional Service Grading Company requires a capital infusion of $500,000. It is currently a closely held corporation with less than 25 shareholders. Although the shareholders are not all related to each other, they all know each other, and they view the business as a family business. The financial statements should be familiar to you because you performed a basic financial analysis of the company in Unit 1 of this course.

Several alternatives are available to the company, consisting of the following:

• Obtain private debt financing
• Seek out a private investor(s) who would be willing to share ownership (private transfer of partial ownership)
• Seek out offers for a private buy-out (private transfer of entire ownership)
• Issue public debt (corporate bonds)
• Issue public common stock (public equity offering)

Briefly discuss each alternative and include implications to the company's capital structure and cost of capital, if any. Considering the size of the investment ($500,000 infusion), provide a conclusion on how it might impact the financial statement reviewed in Unit 1. No calculations are required.

For a capital infusion of $ 500,000, following will be the consequences among these different alternative forms of financing:

1. Private Debt Financing: Private debt is incurred by individuals or businesses in numerous forms such as credit card, bond, business or personal loan. There is however a great risk attached to Private Debt. Private debt has a great cost of capital in the form of higher interest rates and collateral to back the debt financing. The borrower runs a big risk of losing assets if the firm is unable to repay the debt in due period. The business will also have to make periodical interest payments, failing which the whole contract can cause a lot of tension which might result in the owners selling off their assets in the future, or worst case scenario - going bankrupt. Depending on how much equity is held in total by the 25 shareholders, the company should carefully strike a coordinated private debt financing, if it has run out of other sources of finance.
2. Private Investors: Private Investors are a good alternative for new companies which need capital to start on with their business. To seek out a private investor is not the same as taking a loan as the investors know well that they run the risk of not receiving the business failing. But as an impact to the capital structure of any company, private investors may lead to dilution in the share of earnings, thereby limiting your upside potential. In addition to that, there is also a possibility of losing a proportion of control of the business in favor of the deal struck with any private investor.
3. Private Buyout: A buyout is any transaction after which the buyer, through transfer from original shareholdings, is transferred the control of company. That is, they obtain a control of more than or equal to 51% of the total voting shares of the company. This form of financing will most certainly dilute the control of the original 25 shareholders. The capital structure in the case of a private buyout can change to a great extent as the new investor might acquire the majority of controlling interest. In other words, it can be seen as a form of equity in which there is a abnormal shift in control.
4. Public Debt: Debt is basically the bonds that are issued to finance a business. The cost of debt is generally lower than the cost of equity. But on the other hand, issuing too much debt can increase financial expense such as the periodical interests to be paid. More debt implies increased chances of defaulting on the debt payments. That is because if a company has great amount of debt (and debt is considered to be riskier than equity) then the debt-holders might demand greater return because of increased risks in business (Greater the risk, greater the reward principle), which in turn would mean a higher interest rate.
5. Public Equity: Cost of equity compared to the cost of debt is generally higher. This is because equity comes with greater risk. Debt-holders are paid interests firm and then preference shareholders could be paid dividend. It is from the residual earnings of the company that a company decides to retain or pay dividends. It is for this reason that equity investors demand greater returns (because greater risk, compared to others). But public equity could also dilute the share of control in the company.

Impact on Financial Statements, assuming profit is the same:

1. Private Debt Financing: Increase in Non-Operating Expenses (Finance/Interest Costs) and Increase in Non-Current or Current Liabilities (For Example, Loan, Long Term/Short Term). Decrease in Taxes. Increase in Shareholder Earnings (Depending on Leverage).
2. Private Investors: Decrease in Dividend Per Share. Increase in Equity under Balance Sheet (Shareholders Funds).
3. Private Buyout: Decrease in Dividend Per Share. Increase in Equity under Balance Sheet (Shareholders Funds).
4. Public Debt: Increase in Non-Operating Expenses (Finance/Interest Costs) and Increase in Non-Current Liabilities (For Example, Debentures). Decrease in Taxes. Increase in Shareholder Earnings (Depending on Leverage).
5. Public Equity: Increase in Equity under Balance Sheet (Shareholders Funds). Decrease in Earnings Per Share (If constant Profit, otherwise Increase in EPS depending on the increase in profit).