Sebastian Perrier

In choosing between Debt or Equity financing, a good way to analyze the decision is to use the FRICT model. Not that the financing decision is a separate analysis from the investment decision.

1. FLEXIBILITY: debt reduces flexibility because in the future, if you want to raise more money, maybe your only option will be equity because you are highly leveraged. On the other hand, equity provides you with flexibility.
2. RISK (leverage): compare with the industry the levels of leverage vs their P/E ratio. If companies highly profitable and with high P/E ratio are more leveraged than you, maybe you’re under leveraged. Also see your times interest ratio to see if your level of financial risk (leverage) is appropriate to your industry.
3. INCOME (EPS): more debt provides a tax shield and increases profitability and EPS.
4. CONTROL: in terms of debt, the bank usually puts you restrictions which can limit your control. Equity stakeholders may take control if they have more than 50% of the shares.
5. TIMING: whether to finance with debt or equity is also a matter of timing, for example, if at that point in time interest rates are low or maybe the price of your stock is too low to raise funds, etc.