Debt or Equity?

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Debt_and_EquityAre You Confused About Debt & Equity?

It has recently been announced that Santos (a major Australian oil services company) is soon to raise over $500 million (denominated in Euro) from European investors by means of  a financial  instrument that is effectively a bond (in that it pays regular interest payments), but has been classified as equity by ratings agencies.

This brings up the question of what is debt and what is equity?  This is important because interest payments on debt are tax deductible whereas dividend payments on equity are not.  In fact, there have been many attempts to dress up equity as debt by calculating interest payments based on profits earned.  Many years ago, the ATO determined that if something looks like equity then it is no matter how the so called “interest” has been calculated and that, in these cases, the “interest” is not tax deductible.??  Assuming that a business is profitable, it obviously benefits shareholders if as much debt as possible can be raised because the return on debt (interest) is usually much lower than the expected return on equity and, of course, interest is tax deductible which is a further benefit to shareholders.  On the other hand, interest has to be paid whether profits are being made or not and it has to be refinanced (or repaid) when it matures which, as the GFC and it’s aftermath has shown, is not as simple as it sounds. ??For most Australian SMEs it is impossible to tap the corporate bond market and, if they need debt, they are generally forced to borrow from the banks who not only require security but also ongoing performance measured by various ratios and, when you most need it, they are unwilling to help.

Raising debt and/or equity is a complex issue and determining the right balance and the best sources depends on a proper risk assessment taking into account, the relevant economic outlook which could be global, national, local or a combination of all of them, the relevant industry, the volatility of expected profits and other factors.

Do you understand your debt and equity position? Do you keep abreast of these issues? Would you like our help? Please call on +61 2 9258 1972 or go to our Contact page.

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