If debt is cheaper than equity why do companies approach the equity markets?

Answer 1

Equity is always cheaper and better than the debt.
Thats why companies are after equity.

In a debt, you necessarily have to pay interest every year at contracted rate, whether you incur profit or not.
A debt carries the burden of repayment on maturity and the risk on debt may occur any time, if business sees downturns.
High leverage is not good for any organization.
In case of insolvency, the debt will have to be paid if secured, to the extent of realizable value of the security.
Debt will get priority over the equity in the event of insolvency.


However, in the case of equity you are under no such obligations.
Equity represents owners. having more equity adds to company's financial strength.
No fixed rate for payment of dividend. No risk of repayment
Dividend is payable only if profit is made, then again only when decided by the Board. Plough back is possible.
In the case of insolvency, the stake of equity holders comes as last.
In distress, it can even be decided to reduce the extent of liability under equity thru sub-division or consolidation.
When there is excess profit, bonus shares can be issued or dividend can be paid.

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Answer 2

What you're really asking here is about WACC. Google that if you don't know what that means...Now, to answer your question...

Companies need (actually, prefer might be a better word) to approach the equity market first. Doing so, gets them on the radar screen...which gives them better and cheaper access to debt equity. When the company is gushing profits all over, they can reduce their profits by borrowing money and paying interest expense - which reduces taxable income. Then, they take the proceeds from the debt to buy back stock, which jacks up the stock prices, lowers WACC, and gets a better return for the shareholders.

Answer 3

U r question has the answer yaar. Just think Debt is a liability to a company and in some or other forms they must be repaid. But Equity is like a short term liability. After few years or more as per agreement , it will be converted into shares. a Debt holder is always a Debt holder , but an Equity holder is a share holder after few years and so Equity will be a liability for few years and then later it will become as assets. This is the main reason that companies afford more for Equities than Debts.

Answer 4

Not all companies can get debt financing. Most of the time creditors will require some sort of collateral, which companies can't always post.
You tend to see the effects of this if you look at financing structures across industries. Biotechs have little in the way of tangible assets, which means no collateral. They therefore rely on equity financing. Airlines, on the other hand, have billions in tangible assets, so it makes sense for them to go with the cheaper debt option. Note, however, that airlines being financed with debt makes them much more sensitive to economic cycles because they must make payments on their debt.
This is just one contrasting example, if you do some digging you will find more. The general rule is that debt financing is for companies with high levels of tangible assets, and equity financing is for riskier enterprises which often have few tangible assets - investors are much more willing to assume risk than banks.
Hope this helps.

Answer 5

Equity will give you more flexibility. If the company isn't doing well, they are not obligated to pay dividends. With debt, the payments are mandatory and fixed, so limited cash flow could be more of a problem with debt.

Answer 6

You can raise capital at a premium based on the credentials of your company besides utilising the vibrancy of the capital market to promote your company as a wider investor company is exposed to your company.
When you raise debt, the investor is expectant of a fixed guaranteed return and the investors are usually large investors and smaller in number.

Answer 7

Debt is not cheaper than equity.