Sources Of Long Term Finance
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Sources Of Long Term Finance

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21 Slides that explain Long Term Finance Options and their relevance(Specially good for Asian Students)

21 Slides that explain Long Term Finance Options and their relevance(Specially good for Asian Students)

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Sources Of Long Term Finance Sources Of Long Term Finance Presentation Transcript

  • SOURCES OF LONG TERM FINANCE
  • Need for long term Finance
    • Long term vs. short term(working capital) funds requirements
    • For modernisation, expansion, diversification; huge quantities reqd., irreversible decision
    • Asset-liability mismatch, interest rate risk, liquidity risk, if LT reqts.met by ST funds
  • Equity Capital
    • Authorised, Issued, Subscribed and Paid up capital
    • Par/face value, Issue Price, Book value and Market Value
    • Rights of equity shareholders
    • - Right to Income :PAT less preferred dividends
    • - Right to Control : voting rights
    • - Pre-emptive Right : for additional issues, rights issue in the same proportion
    • - Right in liquidation : residual claim over assets
  • Pros and cons of equity Capital
    • Advantages
    • No fixed maturity, no obligation to redeem
    • No compulsion to pay dividends
    • Provides leverage capacity
    • Dividends tax exempt for investors
    • Disadvantages
    • Dilution of control of existing owners
    • High Cost: rate of return expected by equityholders higher than debtholders
    • Dividends are not tax deductible: hence cost is higher
    • Issue costs higher: underwriting, brokerage, other issue expenses
    • Higher servicing costs: hold AGMs, post annual reports etc.
  • Internal Accruals
    • Pros
    • Readily available, no talking to outsiders
    • Effectively additional equity capital, however no issue costs of loss due to underpricing
    • No dilution of control
    • No expansion in equity base, hence no dilution of EPS, BV per share etc.
    • Cons
    • Quantum very limited
    • High Opportunity costs: dividends forgone by equity holders
    • Requires careful attention to NPV of projects
    Consists of retained earnings and depreciation charges
  • Preference Capital
    • Is a hybrid form of financing , payment after debt but before equity
    • Equity features :
    • -out of distributable profits
    • -not an obligatory payment
    • -dividends not tax deductible
    • Debt features :
    • -dividend rate is fixed
    • -capital is redeemable
    • -normally no right to vote
    • Can have other features like cumulative, convertible, participating…..
  • Preference Capital
    • Pros
    • No obligation to pay dividend, no bankruptcy or legal action for non payment
    • Financial distress of redemption obligation not very high
    • Part of net worth, hence increases its creditworthiness/ leverage capacity
    • No dilution of control
    • No pledging of assets required
    • Cons
    • Expensive source since dividends not tax deductible
    • Though no legal consequences, liability to pay dividends stands, can spoil company’s image
    • Can acquire voting rights in some cases
    • Have claim prior to equity holders
  • Term Loans
    • Provided by FIs/banks
    • Can be in domestic/foreign currency , liability on FC loans translated to rupees for payment
    • Are typically secured against fixed assets/ hypothecation of movable properties, prime security/ collateral security
    • Definite obligations on interest and principal repayment; interest paid periodically; based on credit risk and pegged to a floor rate
    • Carry restrictive covenants for future financial and operational decisions of the company, its management, future fund raising, projects, periodic reports called for
  • Term Loans
    • Pros
    • Interest on debt is tax deductible
    • Does not result in dilution of control
    • Do not partake in value created by the firm
    • Issue costs of debt is lower
    • Interest cost is normally fixed, protection against high unexpected inflation
    • Has a disciplining effect on management
    • Cons
    • Entails fixed obligation for interest and principal, non payment can even lead to bankruptcy/ legal action
    • Debt contracts impose restrictions on firm’s financial and operational flexibility
    • Increases financial leverage, excess raises cost of equity to the firm
    • If inflation rate dips, cost of debt higher than expected
  • Debentures
    • Like promissory notes , are instruments for raising LT debt
    • More flexible compared to term loans as they offer variety 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 or non 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 credit rating agency
    • Trustee: Need to appoint a trustee to ensure fulfilment of contractual obligations by company
    • DRR : Company needs to create a DRR if maturity more than 18 months
  • Other forms of Finance
    • Leasing: asset leased out in lieu of lease rentals, title not transferred, only economic use of assets given; can be financial lease or operating (service) lease
    • Hire Purchase : ownership transferred to the buyer after all the installments paid up
    • Securitisation: assets involving financial claims pooled and financial instruments created, thus creating cash out of receivables
    • Government Subsidies : central and state govts offer cash subsidies to units in backward areas, classified in three categories
    • Sales tax deferments and exemptions : payment deferred for a fixed period, like interest free loan; or exemptions given for certain no. of years
    • Suppliers credit : available from suppliers of machinery, other fixed assets, terms devised to defer payment, or pay in installments over a period of time
  • Leasing vs. Hire Purchase
    • Leasing
    • Ownership not transferred to lessee
    • Depreciation benefit to lessor
    • Magnitude of funds high, for big ticket items
    • No margin money/down payment required
    • Maintenance of asset by lessor in operating lease
    • Tax benefits of depreciation taken by lessor; lessee gets tax shield on lease rentals
    • Considered off balance sheet mode of financing, as no asset or liability figures in balance sheet
    • Hire-Purchase
    • Ownership transferred to hirer on payment of all instalments
    • Depreciation shield available to hirer
    • Maybe for smaller value capital goods
    • Some down payment reqd
    • Maintenance cost borne by hirer
    • Hirer allowed depreciation claim and finance charge for taxation; seller may claim interest on amount borrowed to acquire asset
    • Asset figures in balance sheet on complete of purchase
  • Raising Long Term Finance
    • Initial Public Offer (IPO)
    • Secondary Public offer
    • Rights Issue
    • Bought out deals
    • Euro Issues
    • Private Placement
    • Preferential allotment
    • Venture Capital/ Private Equity transactions
    • Obtaining a term loan
  • Initial Public Offer
    • Pros
    • Access to larger amount of funds
    • Further growth limited companies not using this route
    • Listing: provides exit route to promoters; ensures marketability of existing shares
    • Encash on value created in the firm
    • Recognition in market
    • Stock prices provide useful indicators to management
    • Sometimes stipulated by private investors in the company
    • Cons
    • Pricing may have to be attractive to lure investors
    • Loss of flexibility
    • Higher accountability
    • More disclosure requirements to be met
    • Visibility in market
    • Cost of making a public issue quite high
  • Steps in an IPO
    • Approval of BOD
    • Shareholders’ approval
    • Appointment of lead manager(s)
    • Due diligence by LM
    • Appointment of intermediaries like registrars, printers, bankers, advertisers
    • Prepare draft prospectus
    • Filing with SEBI
    • Listing applications filed alongwith draft prospectus
    • Agreement with registrars and depositories
    • Appoint underwriters (if reqd.)
    • Make changes in draft prospectus as per SEBI observations, SE suggestions
    • File prospectus with ROC
    • Issue marketing exercise commences
    • Application forms dispatched
    • Issue opened
    • Basis of allotment finalised
    • Allotments made, refunds posted, shares listed on SEs
  • Other aspects of a public issue
    • Eligibility criteria defined : net worth, track record of profitability, issue in same year; secondary issues have no such restrictions
    • Book Building process : process of tendering quantities at prices within a band
    • Issue expenses : underwriting, brokerage commissions, fees to managers to the issue, registrars, printers, advertisers, listing fees, stamp duty
    • Issue pricing : free pricing, disclose basis for issue price
    • Public issue of debt : appointment of debenture trustee, creation of DRR, credit rating reqd., security to be created
  • Rights Issue
      • Issue of capital to existing shareholders
      • Offer made on a pro rata basis
      • Offer document called Letter of Offer
      • Option given to apply for additional shares
      • Rights renunciation : are tradeable, may be sold off in the market
      • Value of a share after rights:
      • (NP 0 +S)/(N+1); N=no. of existing shares required for rights; P 0 =cum rights MP per share; S= subscription price of rights issue
      • Value of a right = (P 0 –S)/(N+1)
      • Comparison with Public issue : with familiar investors, hence likely to be more successful; less floatation costs since no underwriting; but lower pricing to benefit shareholders
  • Private Placement
    • Sale of securities directly to wholesale investors like FIs, banks, MFs, FIIs,PE funds etc.
    • Called private placement in equity/equity related instruments, in unlisted companies and in all cases of debt
    • Called preferential allotment in case of unlisted companies for equity/equity related instruments
    • 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 SEBI for compliance and disclosures
  • Private Placement
    • Pros
    • Less expensive mode
    • Lesser SEBI and other regulations
    • Easier to market the issue to a few investors
    • Entry of wholesale financially sophisticated investors in company’s profile
    • May use this route until IPO decision taken
    • Less administrative maintenance
    • Cons
    • Does not qualify for listing in an unlisted company
    • Restrictive covenants may be imposed by the investors
    • May call for management participation
    • Issue pricing more tight
  • Venture Capital/Private Equity
    • Equity finance to potentially high growth companies
    • Reasonably long to medium term commitment
    • Hands on management approach, active participation in management
    • Considered value add investor
    • VC: primarily high risk high return investment esp. in technology oriented/ knowledge intensive businesses with long development cycles, greenfield ventures
    • Can be in unlisted or listed (PIPES) Companies
    • Exit route to be defined at the time of investment
    • Restrictive clauses on promoters’ holding sell off and other financial/operational issues
    • Detailed memorandum/business plan on company, its financials to be prepared
    • Shareholders agreement to be signed by both parties
    • Valuation of Company key issue
    • Leads to dilution of control by existing promoters
  • Obtaining a Term Loan
    • Submission of loan application : a project report containing complete details of the project given to the FI/Bank
    • Initial processing of loan application : prepare flash report to decide if project worth an appraisal or not
    • Project Appraisal: Detailed appraisal done to decide if project taken or not, in terms of market, technical, financial, managerial appraisal
    • Issue of Letter of Sanction: to the borrower containing amount sanctioned and terms and conditions thereto
    • Acceptance of terms and conditions by the borrowing unit: thru a board meeting and conveyed to the FI/Bank
    • Execution of loan agreement: signed by both parties
    • Disbursement of loan: in tranches based on progress of the project, tie up of means of finance
    • Creation of security: formalities to be completed within a timeframe
    • Monitoring: at implementation and operational stage thru periodic progress reports, site visits etc.