Choices available for raising corporate funds

Choices available for raising corporate funds

Companies reach a certain stage where they need to raise funds once equity injections from owners dwindle. There can be several reasons — positive and negative — for raising external funds. Reasons deemed positive include increasing investment to exploit more available opportunities, hiring new staff and purchasing equipment.

Negative reasons include cash flow difficulties indicating that the company’s operating model may need to be reconsidered.

However, it is normal for companies to resort to bank loans to obtain additional capital after reaching a certain size. Having an established banking relationship for many years is often helpful, as most banks are reluctant to lend to relatively new customers. Large corporations have more choice, as they can also turn to the debt or equity markets. However, while both approaches provide a much-needed capital injection to a business, they differ in their impact on the business and the type of security asset they provide to the end investor.

Like other Gulf countries, Saudi Arabia is experiencing a veritable tsunami of IPOs in its main market of Tadawal and Nomu, the parallel exchange.

According to the Kingdom’s Capital Market Authority, the Saudi stock market is now four times larger than the entire Kingdom’s economy, even without taking into account the largest IPO – Saudi Aramco. The CMA revealed that there are 54 other pending registration requests, of which 31 are direct Tadawul registrations. The massive oversubscription of existing and new offerings indicates that the appetite of individual and institutional investors is there. It should be noted that qualified foreign investors are also watching these developments carefully and participating in the ongoing investment frenzy.

Like other Gulf countries, Saudi Arabia is experiencing a veritable tsunami of IPOs in its main market of Tadawal and Nomu, the parallel exchange.

Dr Mohamed Ramady

Investing in shares provides investors with a share of the offering company, as well as voting rights for certain classes of shares, which gives investors the right to be heard at ordinary and extraordinary general meetings. This right is now being used successfully by activist shareholders, particularly in relation to climate change concerns and whether their company is doing more to become ESG (Environmental, Social and Governance) compliant.

Issuing bonds is another option for these companies, or alongside raising equity. The purchase of bonds by investors does not confer ownership rights but is simply debt that a company issues instead of obtaining a traditional bank loan. The relationship between the lender and the borrower is simple – at the end of the life of the bond, ranging from 1 to 30 years for well-established companies, the money invested returns with its return to those who are ready to take this bond risk. .

To make these bond issues more attractive, a credit rating from a rating agency can be obtained to determine the level of risk of default, but this adds to the costs of issuing the bonds. A high yield makes bonds attractive to risk-averse investors, based on the assumption that a company’s life is perpetual and will not go bankrupt or default, rendering the bond worthless. However, there is a market for private and government junk bonds with speculative junk bond investors buying them at a significant discount in the hope that the failing company can be acquired by others and overturn it, or that countries sovereigns begin to make payment on their junk bonds. as happened in some Latin American countries in the 1980s. This type of investment makes it a very different proposition from stock ownership where investors hope to obtain dividends and gains through the increase of the stock price over time. Dividend payments are the responsibility of the company’s board of directors rather than an element of a fixed bond contract, and dividends provide more flexibility for companies that are unsure of their future cash flows.

In Saudi Arabia, investors eagerly await dividend payment announcements, as these notifications affect a company’s stock price. It does not necessarily follow that a poor or no dividend payment is necessarily bad for the company if management sends an explanatory message such as a better use of the money for expansion, potential mergers or the development of new technologies. An example is Microsoft, which paid no dividends until 2003 despite many years of mega-profits, deciding instead to hold onto its profits to develop new technologies to maintain its monopoly position in certain sectors. Interestingly, when Microsoft paid its first dividend, its shares fell as some investors concluded – somewhat erroneously – that only companies that reach maturity pay dividends. While small investors who depend on dividend payouts to supplement their income will not agree to defer dividends, large institutional investors are more understanding.

So which path – debt or equity – should a company take? Debt capital should, in theory, be a cheaper source of finance for a business than equity, as in some countries the tax treatment of debt is more favorable as interest payments are considered a business expense. Dividends are not considered as such. Issuing bonds is also inexpensive compared to the investment management fees for selling stocks, and another factor in favor of bonds is that issuing stocks is a highly regulated activity by stock market regulators. from the country.

Dr. Mohamed Ramady is a former senior banker and professor of finance and economics at King Fahd University of Petroleum and Minerals, Dhahran.

Disclaimer: The opinions expressed by the authors in this section are their own and do not necessarily reflect the views of Arab News

Comments are closed.