Correct Answer:
A. Dilution of ownership
Equity financing involves raising capital by selling ownership stakes (shares) in a company. While it offers several advantages, such as no fixed repayment obligation, it also comes with significant drawbacks. Understanding these disadvantages is crucial for businesses when deciding on their capital structure.
- The major disadvantage of equity financing is the dilution of ownership (A). When a company issues new shares to raise capital, it increases the total number of outstanding shares. This means that existing shareholders will own a smaller percentage of the company, which can dilute their control, voting power, and earnings per share.
- Fixed payment requirement (B) is a disadvantage of debt financing, where interest payments are legally binding. Equity financing does not have this obligation.
- High financial risk (C) is more associated with excessive debt financing, which can lead to bankruptcy if payments cannot be met. Equity financing generally reduces a company's financial risk compared to debt.
- Short maturity (D) is not a characteristic of equity financing. Equity shares typically have no maturity date and remain outstanding indefinitely, unlike debt instruments which have defined repayment periods.
Therefore, the dilution of ownership is the primary concern for existing shareholders when a company opts for equity financing.