The advantage of a long-term debt financing option, in this case, is the attractive rate of interest Metropolitan Life is willing to offer. However, their offer comes with some conditions:
An upfront free of 200,000 common shares is required.
In terms of operations, the capital budget would not be able to exceed the forecasted budget. No acquisitions could be made without the approval of Metropolitan Life. No change could be made to the current compensation packages of the firm’s executives until 50% of the debt was repaid. Their debt-equity ratio would be constrained to 1.20.
They would not be able to raise any more debt without the insurance company’s approval.
While the interest rate may be an attractive one and may prompt the acceptance of such an offer, it is important to understand that the above conditions may have a negative impact on the company in the long run. Such conditions would limit the amount of control the company would retain. As such, any potential investor would have to be refused unless the insurance company approves of such an investment. The common shares amounting to 200,000 represent 10% of the total shares of the company. However, debt financing does have an interest tax shield benefit attached to it, which may be an important asset to the company. Since the company has no way of determining whether or not the expansion of the business will go due to the increased competition, the tax shield benefit may not overrule the disadvantages of such a financing decision. Their ability to repay the loan would depend greatly on their future success, and the loan may become a burden in such a case.
Preferred Share Offering
Another option the company may consider is a preferred share offering. This type of financing involves allowing a pool of angel investors as well as private equity funds to finance the expansion with the form of preferred shares. The growth of the company has impressed...