48 MULTIPLE PURPOSE RIVER DEVELOPMENT 



to venture capital in an enterprise's financial structure, the greater 

 the risk for any investor who lends it money. This is true because 

 the nature of the bond contract entitles lenders to a prior lien on 

 the earnings of the firm. If a high proportion of the financing is 

 to be achieved by borrowing, there remains a correspondingly 

 smaller residual risk-bearing component in the firm's capitalization 

 to absorb any fluctuations in returns. An additional feature of 

 debt financing is the claim of the lender to the assets of the 

 borrowing enterprise should it fail to meet its interest obligation. 

 This is a form of security, however, which decreases as the ratio 

 of debt to risk capital increases, other factors remaining equal. 

 For example, if financing were arranged so that all capital was 

 raised by borrowing and the enterprise failed to meet its interest 

 costs, the market value of the enterprise's assets would decline. 

 An enterprise's market value is expressed as the capitalized value 

 of its earnings, and if these were insufficient to meet interest 

 obligations, the value of the assets would decline below the amount 

 of the originally borrowed capital. From the lender's standpoint, 

 this is tantamount to loss of a part of his principal. Hence, the 

 security which access to an enterprise's assets affords will be limited 

 unless the proportion of debt to venture capital is kept sufficiently 

 low. Investors, correspondingly, will be reluctant to purchase an 

 unlimited quantity of an enterprise's bonds, and the firm's access 

 to investment funds at the prevailing rate in the bond market 

 will be dependent on the amount of risk-bearing equity capital 

 available to it. 



Equity capital raised in the securities market may be substituted 

 for borrwing to provide the risk component in the financial struc- 

 ture. Here, however, the volume of capital that an enterprise's 

 management is willing to employ may be governed by its own 

 share of the equity capital, for additional amounts of risk-bearing 

 capital will dilute management's control over the policies of the 

 enterprise and reduce the possible rate of return to the equity 

 capital. 



Thus, reluctance of investors to lend except at increasingly 

 greater risk premiums, and reluctance of management to risk 

 dilution of control by employing more equity capital, qualify the 

 assumption of unrestricted access to the capital market at the pre- 

 vailing market rate of interest and willingness to push investment 

 to the point where the promised returns at the margin only equal 

 the interest cost. 



