Why debt funding might be preferable to raising capital via equity

Why debt funding might be preferable to raising capital via equity.

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Adding debt to a company, often referred to as leveraging, can improve its internal rate of return (IRR) by potentially increasing the returns on its investment projects.

Here’s how it works:

1. Lower Cost of Capital:
   1. Debt is generally cheaper than equity due to tax advantages (interest is tax-deductible).
   2. By incorporating debt, a company can lower its overall cost of capital, enhancing project returns.
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2. Amplifying Returns:
   1. When a company earns a return on its investments that's higher than the interest rate on its debt, the excess returns boost the overall profitability.
   2. Essentially, the company can earn more with borrowed money than it costs to service that debt.
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3. Leverage Effect:
   1. ‍ By using debt, a company can undertake more or larger projects without diluting ownership through issuing new equity.
   2. This leverage can lead to higher IRR if the projects are successful.

However, it's important to note that while adding debt can increase IRR, it also comes with risks.

Too much debt increases financial risk and can lead to solvency issues, especially if the company faces downturns or the investments don't perform as expected.

So, it's a balance of optimising returns while managing risk.

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Please get in touch with us if you'd like to discuss what debt funding options you might qualify for and what market rate and term options are available.