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 some angel investors and private equity funds, and may be a good option, as angel investors may be willing to invest a great sum of money. There is also the agent fee of 300,000 common shares, which amounts to 15% of the current shares outstanding. The downside to such a financing option would be the unexpected future cash inflow from the company’s sales, which might impair Granite’s ability to pay dividends.
In the case where Granite misses two consecutive dividend payments, the preferred shareholders would have the authority to take control of the company and exercise voting rights. Some conditions to this financing option apply as well. Granite would not be able to perform a major change in the company should it deem it beneficial, until they redeem all preferred shares, which they could only do five years down the line. As in the case of financing with long-term debt, Granite would lose some control over the company should it decide to deviate from their current strategy. Should an investment opportunity arise, without the consent of the preferred shareholders may hold back the company and dampen their ability to become more profitable.
Initial Public Offering
Granite also has the option of offering an initial public offering, which would imply that the company transfers to being a publicly held company. After the bubble crash of 2001-2003, the market seemed to have recovered well in the past few years. In terms of the apparel and footwear stock, the sector had outperformed the S&P 500 by 28% since the crash, which is considered to be a positive outlook. As well, investors seemed to be moving in the direction of investing in such a sector, another positive aspect of this financing option. However, if Granite were to offer an IPO, they would have to undergo a thorough process of examining all financial records, operations by the investment bank who was willing to underwrite the offer as well as the securities commission, responsible of examining every IPO. The process would take around three to six months.
As well, the company would have to issue an additional six million shares to cover the $50 million investment required. The advantage of a IPO is the ability to acquire the necessary funds easily, which is something to consider if in the future the company would like to expand or had a project that needed indispensable funds than the company had available right away. It seems that the option of IPO is the better fit for the company. This type of financing would allow not giving up too much control. It would also require them to act in the best interest of their shareholders. These shareholders would want to see the stock price increase and make a better return on their investment. Therefore, if the company believes it can act in such a way and make decisions that would attract future investors, the initial public offering seems to be the best option for the company at the moment.