Question

Suppose there is a startup Alpha founded last year in a very promising industry with a lot of growth opportunities. (1) This year Alpha considers raising more funds for expanding its business and innovations, it could either choose to raise funds by issuing equities to some venture capitals or choose to issue some debts. Which way do you think is a better choice? Why? (2) Suppose this year Alpha also earns considerable profit, what are the two ways to deal with the profit? Which way is better in this case, and why?

Answer 1

1.It can be seen that Alpha is a startup company and Alpha is trying to innovate itself and trying to take risk in order to extend itself into gaining of larger market share so it can be seen that this company does not need the debt capital because debt capital will be having a whole lot of debt covenants and fixed payment associated with them so they will be having a risk of financial in solvency attached with them also and the risk of fixed payment also so debt capital is not an appropriate choice for this company as this company should be trying to issue the shares to the venture capitalist in order to gain capital in form of equity capital and it should be trying to take risk in order to expand itself because venture capitalist will generally be assisting these young entrepreneurs and young startup companies as they are also into risk-taking business as they seek a higher rate of return.

2. If this company has earned a considerable amount of profit, then this company will be having two choices either to reinvest the profit or it can also redistribute the profits, so in this case it can be said that the company has made enough profit and it is showing that the company is having a growth trajectory on the upside since it is a young firm and this needs to acquire large market share so I would be advocating that this company should be trying to reinvest its capital back into the business in order to gain a higher market share rather than redistributing it profits to the shareholders.