long term sources of financ
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SOURCES OF LONG TERM
FINANCE
SOURCES OF LONG TERM
FINANCE
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Finance is the life blood of abusiness
Sources of finance:
Short term sources
Long term sources
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Purpose of long term finance:
To finance fixed assets
To finance the permanent part of
working capital
To finance the growth and expansion of a
business
Uncertainit
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Factors determining long term
sources of finance:
Nature of business
Nature of goods produced
Technology used
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Share capitalShare capital
Meaning of Share Capital:
Share capital denotes the amount of capital
raised by the issue of shares, by a company.
It is collected through the issue of shares and
remains with the company till its liquidation.
shareholder are the owners of the company
The total share capital is divided into small
parts and each part is called a share. Share is the smallest part of the total capital of
a company
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Featuresof Share CapitalFeaturesof Share Capital
Owned capital
Remains with the company
Dependable sources
Raises creditworthiness
Substantial funds
Available for Expansion and
Diversification
Amendment
No charge
Opportunity to participate
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EQUITY CAPITAL
TERMS:
Authorized, Issued, Subscribed & Paid up
Capital.
Par/ face Value, Issue Price, Book Value,
Market Value.
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Represents ownership capital
Enjoys the rewards and bear the risks
Some Terms
Authorized capital is the amount of capital that acompany can potentially issue, as per its memorandum.
The amount offered by the company to the investors iscalled the Issued Capital.
The part of issued capital which has been subscribed toby the investors represents the Subscribed Capital.
The actual amount paid up by the investors is called thePaid-up Capital.
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Par Value
Face value of the share
The stated value on a stock certificate is called
thepar value.
The par of equity shares is generally Rs. 10, or
Rs. 100.
Issue Price
The issue price is the price at which the equity
share is issued. Generally par and issue price are same for new
companies
When issue price exceeds the par value, the
difference is referred as share premium
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Contributed Surplus Usually refers to amounts of
directly contributed equity capital in excess ofthe par value
For example, suppose 1,000 shares of common stock
having a par value of Rs.1 each are sold to investorsfor Rs. 8 per share. The contributed surplus would be
(8 1) 1,000 = Rs. 7,000
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Book Value-Paid up capital+Reserves and Surplus
No of Equity Shares
Market Price is the price at which the share is
traded in the stock market
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Rights Of Equity Share Holders:
Right to Income = Profit After Tax
Income of the shareholder is called Dividend
as recommended by the Board Unchallengeable
Right to Control Elect the board
Lack effective control
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Pre emptive Right on pro rata basis
Right in Liquidation
Residual claim over assets of the firm
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EQUITY CAPITALEQUITY CAPITAL
Advantages
No fixed maturity, no obligation toredeem
No compulsion to pay dividends
Provides leverage capacity
Dividends tax exempt forinvestors
Disadvantages
Dilution of control
High Cost
Dividends are not taxdeductible: hence cost is higher
Issue costs higher:
Higher servicing costs
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PREFERENCE CAPITAL
Hybrid form of Financing (Equity + Loan)
Equity Features:out of distributable profits
dividends not tax deductible
Priority over Equity shares in case of
bankruptcy
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Debenture features:
dividend rate is fixed
capital is redeemable
normally no right to vote
Preference dividend is paid out distributableprofit Not a Tax-deductible payment
Dividend rate is fixed
Not an obligatory payment Preference over equity shareholders
No voting power
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Features of Preference SharesFeatures of Preference Shares
Cumulation of dividends
Callability company may buyback whole/part at a certain price
Convertible into equity
Redeemability
No voting power Exception:
Dividend in arrear for 2/more years incase ofcumulative preference shares
Dividend not paid for an aggregate period of 3/moreyears in preceding 6 years
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Types of Preference SharesTypes of Preference Shares
Cumulative or Non-cumulative
Redeemable and Non- Redeemable
Participating Preference Share or non-
participating preference shares
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PREFERENCE CAPITALPREFERENCE CAPITAL
Advantages
No obligation to pay dividend, nobankruptcy or legal action for non
payment
Financial distress of redemption
obligation not very high
Part of net worth, hence increasesits creditworthiness
No dilution of control
No pledging of assets required
Disadvantages
Expensive source since dividendsnot tax deductible
Though no legal consequences,liability to pay dividends stands,
can spoil companys image
Can acquire voting rightsin some cases
Have claim prior to
equity holders
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Retained Earnings Depreciation
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INTERNAL ACCRUALSINTERNAL ACCRUALS
Advantages
Readily available
Effective additional equity capital
No dilution of control
Disadvantages
Quantum very limited
High Opportunity costs: dividendsforgone by equity holders
Requires careful attention toNPV of projects
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TERM LOANS
Maturities
Security
Provided by Foreign Institutes/ Bank
Repayment schedule
Restrictive Covenants
Convertibility
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Many industrial development banks, cooperative banksand commercial banks grant medium term loans for a
period of three to five years.
The period of repayment of short term loan is extended at
intervals and in some cases loan is given directly for a long
period.
A term loan is a monetary loan that is repaid in regular
payments over a set period of time. Term loans usually last
between one and ten years.
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A term loan usually involves an unfixed interest rate.
Term loans can be given on an individual basis but areoften used for small business loans. The ability to repay
over a long period of time is attractive for new or
expanding enterprises, as the assumption is that they
will increase their profit over time. E.g.- Some student loans are essentially term loans.
These Loans are often offered to college students as a
means of paying tuition and living expenses. Part of the
loan may be subsidized, so that interest does not accrue
while the student remains in school. Students are alsotypically given a six month grace period following
graduation before beginning repayments.
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One thing to consider when getting a term loan is whether the
A fixed interest rate means that the percentage of interest will never
increase, regardless of the financial market.
Floating interest rates will fluctuate with the market, which can be
good or bad for you depending on what happens with the global and
national economy.
Interest Rate
Fixed Floating
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MeritsMerits
It is a flexible source of finance as loans can be repaid
when the need is met. Finance is available for a definite period, hence it is not
a permanent burden.
Banks keep the financial operations of their clients
secret. Less time and cost is involved as compared to issue of
shares, debentures etc.
Banks do not interfere in the internal affairs of the
borrowing concern, hence the management retains thecontrol of the company.
Loans can be paid-back in easy installments.
In case of small-scale industries and industries in
villages and backward areas, the interest charged is low.
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DemeritsDemerits
Banks require personal guarantee or pledge of assets
and business cannot raise further loans on these assets.
In case the short term loans are extended again and
again, there is always uncertainty about this continuity.
Too many formalities are to be fulfilled for getting term
loans from banks. These formalities make theborrowings from banks time consuming and
inconvenient.
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DEBENTURES
Interest
Security Maturity & Redemption
Options
Convertibility
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DebenturesDebentures
Like promissory notes, are instruments for raising LTdebt
More flexible compared to term loans as they offervariety of choices as regards maturity, interest rate,security, repayment and other special features
Interest rate can be fixed/floating/deep discount
Convertibility : Can be FCDs, NCDs, PCDs
Warrants : Can have warrants attached, detachable ornon detachable, detachable traded separately
Option : Can be with call or put option
Redemption: Bullet payment or redeemed in instalments
Security: Secured or unsecured
Credit rating: Need to have a credit rating by a creditrating agency
Trustee: Need to appoint a trustee to ensure fulfilment ofcontractual obligations by company
DRR: Company needs to create a DRR if maturity more
than 18 months
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Few types of Debenture
Nonconvertible debentures
Fully convertible debentures
Partlyconvertible debentures
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Debentures ContdDebentures Contd
Advantages
Low cost
No ownership dilution
Fixed payment of interest
Reduced real obligation
Disadvantages
Obligatory payments
Financial Risk
Cash outflow
Restricted Covenants:
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Comparison of Various sources of Long term Financing
Cost Dilution of
Control
Risk Restraint on
managerial
freedom
Equity
Capital
High Yes Nil No
Retained
Earning
High No Nil No
PreferenceCapital
High No Negligible No
Term Loans Low No High Moderate
Debentures Low No High Some
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Initial Public Offering
Decision to go Public
Benefits
Cost
Eligibility
Book Building process
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Right Issue
Issue of capital to existing shareholders
Offer made on pro rata basis Right shares are tradable, may be sold in
open market.
Comparison with Public issue: familiar
investors, hence likely to be more
successful
Less floatation costs
Lower pricing to benefit shareholders
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Private Placement
Sale of securities directly to wholesale investorslike FIs, banks, MFs, FIIs, PE funds etc.(QIPs)
Called private placement in equity/equityrelated instruments, in unlisted companies and inall cases of debt
Called preferential allotment in case of unlistedcompanies for equity/equity relatedinstruments
Different from reservations made for such QIBs
out of a public issue Subject to SEBI regulations on pricing, lock in
period, open offer to be made to public
QIB placement guidelines recently issued by SEBIfor compliance and disclosures
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Obtaining a term loan
Submission of loan application
Initial processing of loan application
P
roject Appraisal Issue of Letter of Sanction
Acceptance of terms and conditions bythe borrowing unit
Execution of loan agreement
Disbursement of loan
Creation of security
Monitoring
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VENTURE CAPITAL
venture capital is a source of fund for newenterprise as well as growth of existing
enterprise but basically meant for new enterprise
and new projects of existing enterprises.
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Venture capital has a number of advantages
over other forms of finance, such as:y It injects long term equity finance which provides a solid capital
base for future growth.
y The venture capitalist is a business partner, sharing both the risks
and rewards. Venture capitalists are rewarded by business success
and the capital gain.
y The venture capitalist is able to provide practical advice and
assistance to the company based on past experience with other
companies which were in similar situations.
y The venture capitalist also has a network of contacts in many areas.
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Venture capitalists have differing operating
approaches.:-
These differences may relate to
1. location of the business,
2. the size of the investment,3. the stage of the company,
4. industry specialization,
5.structure of the investment and
6. involvement of the venture capitalists in thecompanies activities.
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How to get venture capital..?
Enterprise have to reach with a Business plan..
Some imp. Points in business plan.
1. Background of the company
2. The product or service
3. Market analysis
4. Marketing
5. The management team
6. Financial projections7. Amount and use of finance required and exit oppurtunities.
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Factors while choosing source of long-term finance..
1. Control
2. Size of the company
3. Time period
4. Risk
5. Growth and Stability
6. Cost of capital
7. Return on Investment
8. Cash flow position
9. Floatation Cost
Factors while choosing source of long-term finance..
1. Control
2. Size of the company
3. Time period
4. Risk
5. Growth and Stability
6. Cost of capital
7. Return on Investment
8. Cash flow position
9. Floatation Cost