1 Is there a principle agent relationship between a debt and

1. Is there a principle agent relationship between a debt and an equity investor?

2. What influences the debt amount a company can have:

a. market risk

b.covenants in the debt instruments

c. all of the above.

3. During the end of a companys Startup Phase what comes first and why:

a. need to look for venture capital

b. will have debt financing access

c. will be ready for their IPO

Solution

1.

No, we do not have Principal Agent Relationship between debt holders and equity holders.

In Principal agent relation, agent is hired to act in the interest of the principal, but there may exist some conflict between debt and share holders as below:-

a . Equity investors do not want to have a company more debt as well as Provide more interest or coupon to debt holders.

b . Equity investors want company to take projects which are more risky than their average risk capability for more profitability whereas debt holders may do not want the same as they have only fixed coupon associated if company takes more profitability or not.

Equity and debt investors have conflict but here debt holders are not hired by Equity holders which gives relationship between Principal and Agent.

2. Debt amount a company can have depends on both of above factors as explained in below:-

a . Market Risk:-

If market risk is high than risk free rate will be more and this will lead investors to put their money in low risk securities than debt or Debt borrowers have to pay more coupon otherwise. Higher coupon rate will make debt instruments more expensive. Ultimately borrowers will take small debt or wait for market risk to decrease along with investors sentiment will be settled with the highly risky market.

Higher risky market (Like 2008 recession), Invetsors avoid to put their money in the securities so this will effect debt amount a borrower can have.

b. Covenants in debt instruments:-

Covenanats effect borrowers by putting some obligations / action to be performed by borrowers, like do not take more debt or do not Pledge collatral associate with their current debt for getting more debt or do not pay dividend etc.

In this way covenants effect borrowers for not taking more debt which could effect their current debt holders.

3.

After the startup phase completion, we have growth and establishment through expansion. This can be done by looking for Venture capital and using that capital or fund for expansion of firm.

Reason:- As the startup goes in another phase of bussiness cycle it becomes necessary to increase the production or service provided to a large group of people for growth otherwise existing customers may not come handy if another bussiness starts up similar to one they are offering with more customer base.

Venture capital provides funds / capital at this stage very quickly and without any interference or any find of reporting. Also the capital provided is not liquid hence for 5-10 years this capital will be with startup for their estabilishment and expansion and venture capital will take share in profit when the startup will be in profit.

Also startup firms do not have to provide any kind of reporting to public or list it with SEC or other exchange commission i.e. Venture capital is also do have low funding cost and reporting cost and effect.

In the IPO Case or debt case. Startup has to register with exchange commission as well as abide with their rules and reporting requirement (Expansive funding) as well as financing will not be as quick and easy as with the Venture Capital.

Thank You!!