Innovative Sources of Long Term Finance

1. Innovative Sources of Long Term Finance
Prepared By:
Mohammed Jasir PV
Asst. Professor
MIIMS, Puthanangadi
Contact: 9605 69 32 66

2. Topics
• Sources of long term finance
– Innovative Sources

3. Some Innovative Sources of Finance
1. Venture Capital
2. Seed Capital
3. Bridge Finance
4. Lease Financing
5. Hire Purchase Finance
6. Euro Issues

4. 1. Venture Capital
• Financial investment in a highly risky project with the objective of
earning a high rate of return
• They provide the necessary risk capital to the entrepreneurs so as to
meet the amount required by the financial institutions
• In addition to providing capital, these VCFs (Venture capital firms) take an
active interest in guiding the assisted firm

5. 2. Seed Capital
• Its simply means financing promoter's contribution
• At the time of financing a project, financial institutions always insist
that the promoter should contribute a minimum amount, called
promoter's contribution, towards the project
• But there are number of technically qualified entrepreneurs who lack
financial capability to provide the required amount of contribution
• Then financial institutions providing this special capital
• IDBI has opened schemes to provide such funds to the 'eligible'
entrepreneurs

6. 3. Bridge Finance
• Commercial banks proving short-term loans for the period of delay may
occur when approach for
 Time gap b/w the date of sanctioning of a loan and its disbursement by the financial
institution or banks
 Time gap between the sanctioning of a grant or subsidy and release by the Govt.
 Delay in public issue of shares and its receipt of public subscription.
• Therefore, to avoid delay in implementation of the project, the firms
approach Commercial banks and they proving short-term loans

7. Bridge Finance – In Detail
• There is usually a time gap between the date of sanctioning of a term loan and its
disbursement by the financial institution to the concerned borrowing firm.
• In the same manner, there may be a time gap between the sanctioning of a grant or
subsidy and its actual release by the Government or the institution. The same delay
may occur in case of public issue of shares with regard to receipt of public
subscription.
• Therefore, to avoid delay in implementation of the project, the firms approach
commercial banks for short-term loans for the period for which delay may otherwise
occur. Such a loan is called 'Bridge Finance'.

8. 4. Lease Financing
“A lease is an agreement under which a firm acquires a right to make
use of a capital asset like machinery etc. on payment of an
agreed fee called lease rentals”
Lease financing is based on the observation made by Donald B. Grant:
“Why own a cow when the milk is so cheap?
All you really need is milk and not the cow.”

9. Terminology
 Lessee - The person (or the company) which acquires the right
 He does not get the ownership of the asset
 Lessor - The person (or the company) who gives the right
 He acquires only the right to use the asset
 Lease rentals - Payment of an agreed fee

10. Lease can be defined as the following ways:
1. A contract by which one party (lessor) gives to another (lessee) the use and
possession of equipment for a specified time and for fixed payments
2. The document in which this contract is written
3. A great way companies can conserve capital
4. An easy way vendors can increase sales

11. Lease Financing
• Leasing is an arrangement that provides a firm with the use and control
over assets without buying, the cost of leasing the asset should be
compared with the cost of financing the asset through normal sources of
financing, i.e., debt and equity.
• Since payment of lease rentals is similar to payment of interest on
borrowings and lease financing is equivalent to debt financing, financial
analysts argue that the only appropriate comparison is to compare the
cost of leasing with that of cost of borrowing.
• Hence, lease financing decisions relating to leasing or buying options
primarily involve comparison between the cost of debt-financing and
lease financing.

12. The advantages of leasing
• Use a new piece of machinery
• Preserve precious cash reserves
• Deal with limited capital
• Upgrade assets more frequently (Latest equipment)
• Flexibility of the repayment period
• It gives businesses certainty
• Additional benefits
• It is easy to access because it is secured

13. The advantages of leasing
• To possess and use a new piece of machinery or equipment without huge
investment
• Help to preserve precious cash reserves
• Helps the businesses to deal with limited capital to manage their cash flow
more effectively (smaller, regular payments)
• Leasing also allows businesses to upgrade assets more frequently
• Latest equipment without having to make further capital outlays.

14. Contd.
• It offers the flexibility of the repayment period being matched to the
useful life of the equipment
• It gives businesses certainty (finance agreements cannot be cancelled by
the lenders and repayments are generally fixed)
• Can include additional benefits such as servicing of equipment or
variable monthly payments depending on a business’s needs.
• It is easy to access because it is secured (asset being financed, rather
than on other personal or business assets)

15. Limitation of leasing
• It is not a suitable mode of project financing
• Certain tax benefits/ incentives/subsidies etc. may not be
available to leased equipments
• In this case lessee may lose potential capital gain
• The cost of financing is generally higher than debt financing
• Huge penalty to Lessor by lessee for pre-closing lease agreement
• There is no exclusive law for regulating leasing transaction

16. Limitation of leasing
• It is not a suitable mode of project financing because rental is payable soon
after entering into lease agreement while new project generate cash only
after long gestation period.
• Certain tax benefits/ incentives/subsidies etc. may not be available to leased
equipments
• The value of real assets (land and building) may increase during lease
period. In this case lessee may lose potential capital gain.
• The cost of financing is generally higher than debt financing.

17. Contd.
• A manufacturer(lessee) who want to discontinue business need to pay
huge penalty to lessor for pre-closing lease agreement
• There is no exclusive law for regulating leasing transaction.
• In undeveloped legal systems, lease arrangements can result in inequality
between the parties due to the lessor's economic dominance, which may
lead to the lessee signing an unfavourable contract

18. Types of Leasing
There are two basic kinds of leases:
1. Operating or Service Lease
2. Financial Lease

19. Types of Lease
• Financial lease
• Operating lease
• Sale and lease back
• Leveraged leasing
• Direct leasing
• Other types
(First Amendment Lease, Full Payout Lease, Guideline Lease, Net
Lease, Open-end Lease, Sales-type Lease, Synthetic Lease, Tax
Lease, True Lease)

20. 1) Financial Lease / Capital Lease
• Long-term, non-cancellable lease contracts
• Lessor agrees to transfer the title for the asset at the end of the lease
period at a nominal cost
• At lease it must give an option to the lessee to purchase the asset he has
used at the expiry of the lease
• The lessor recovers 90% of the fair value of the asset as lease rentals and
the lease period is 75% of the economic life of the asset
• Only title deeds remain with the Lessor
• Lessee bear risk, cost, maintenance, insurance and repairs etc

21. 2) Operational / operating lease
• It is opposite to the financial lease in almost all aspects
• For a short period and even otherwise is revocable at a short notice
• Gives the lessee only a limited right to use the asset
• The lessor is responsible for the maintenance of the asset
• The lessee can’t purchase the asset at the end of the lease period
• Eg. Mines, Computers hardware, trucks and automobiles are found
suitable for operating lease because the rate of obsolescence is very
high in this kind of assets.

22. Differences between financial lease and operating lease
Financial leasing Operational leasing
Long term Short term
Expenses such as taxes,
insurance are paid by the lessee
All expenses are paid by the
lessor
It covers the entire economic life
of the asset
Not covers the entire economic
life of the asset
Lessee cannot terminate Lessee can end the lease
anytime before expiration date
of lease
Financial lease is enough to fully
amortize the asset
Which is not the case under
operating lease

23. Differences between financial lease and operating lease
1. While financial lease is a long term arrangement between the lessee (user
of the asset) and the owner of the asset, whereas operating lease is a
relatively short term arrangement between the lessee and the owner of
asset.
2. Under financial lease all expenses such as taxes, insurance are paid by the
lessee while under operating lease all expenses are paid by the owner of
the asset.

24. Contd..
3. The lease term under financial lease covers the entire economic life of the
asset which is not the case under operating lease.
4. Under financial lease the lessee cannot terminate or end the lease unless
otherwise provided in the contract which is not the case with operating
lease where lessee can end the lease anytime before expiration date of
lease.
5. While the rent which is paid by the lessee under financial lease is enough to
fully amortize the asset, which is not the case under operating lease.

25. 3) Sale and Lease Back
• It is a sub-part of finance lease
• The owner of an asset sells the asset to a party (the buyer), who in turn leases
back the same asset to the owner in consideration of lease rentals
• Under this arrangement, the assets are not physically exchanged but it all
happens in records only
• This is nothing but a paper transaction
• This is suitable assets which are not subjected depreciation but appreciation,
Eg. Land
• The advantage of this method is that the lessee can satisfy himself completely
regarding the quality of the asset and after possession of the asset convert the
sale into a lease arrangement

26. 4) Leveraged leasing
• A third party is involved between lessor and lessee
• The lessor borrows a part of the purchase cost (say 80%) of the asset
from the third party i.e., lender and the asset so purchased is held as
security against the loan
• The lender is paid off from the lease rentals directly by the lessee and
the surplus after meeting the claims of the lender goes to the lessor
• The lessor (Owner) is entitled to depreciation allowance with the asset

27. 5) Direct leasing
• A firm acquires the right to use an asset from the manufacture directly
• The ownership of the asset leased out remains with manufacturer itself
• The major types of direct lessor include manufacturers, finance companies,
independent lease companies, special purpose leasing companies etc

28. • Under primary and secondary lease, the lease rentals are changed
in such a manner that the lesser recovers the cost of the asset and
acceptable profit during the initial period of the lease
• Then a secondary lease is provided at nominal rentals
• In simple words, the rentals charged in the primary period are
much more than that of the secondary period
• Also known as front-ended and back-ended lease
Primary and Secondary Lease
(Front-ended and Back-ended Lease)

29. Problems of leasing in India
1. Unhealthy Competition
2. Lack of Quality Process
3. Tax Consideration
4. Stamp Duty
5. Delayed Payment and Bad Debts

30. 5. Hire purchase
• HP is an alternative to leasing
• HP is a transaction where goods are purchased and sold on the condition
that payment is made in instalments
• Advance payment (20%)
• The buyer gets only possession of goods
• He does not get ownership at first payment
• He gets ownership only after the payment of the last instalment
• If the buyer fails to pay any instalment, the seller can repossess the goods
• Each instalment includes interest also

31. Concept and Meaning of Hire Purchase
• Hire purchase is a type of instalment credit under which the hire purchaser,
called the hirer, agrees to take the goods on hire at a stated rental, which is
inclusive of the repayment of principal as well as interest, with an option to
purchase.
• Under this transaction, the hire purchaser acquires the property (goods)
immediately on signing the hire purchase agreement but the ownership or
title of the same is transferred only when the last instalment is paid

32. Features of Hire Purchase
1. Immediate possession-under HP
2. Hire Charges
3. Property in goods / Ownership
4. Down payment
5. Repossession
6. Return of goods
7. Depreciation

33. Features of Hire Purchase
1. Immediate possession-under HP, the buyer takes immediate
possession of goods by paying only a portion of its price.
2. Hire Charges- Each instalment is treated as hire charges.
3. Property in goods - ownership is passed to the hirer only after paying
last or specified number of instalments
4. Down payment- hirer has to pay 20 to 25% of asset price to the vendor
as down payment.

34. Contd.
5. Repossession- Hire vendor, if default in payment of instalment made by
hirer, can reposes the goods and he can resell the goods.
6. Return of goods- hirer is free to return the goods without being required
to pay further instalment falling due after the return.
7. Depreciation- depreciation and investment allowances can be claimed by
the hirer even though he is not an exact owner.

35. Rights and Obligations of hirer
Rights of the hirer
• To buy the goods at any time
• To return the goods to the owner
• contract to a third person
Obligations of hirer
• To pay hire installments
• To take reasonable care of the goods
• To inform the owner where goods
will be kept

36. Rights of the hirer
The hirer usually has the following rights:
1. To buy the goods at any time by giving notice to the owner and paying the
balance of the HP price less a rebate
2. To return the goods to the owner — this is subject to the payment of a
penalty
3. With the consent of the owner, to assign both the benefit and the burden of
the contract to a third person. Where the owner wrongfully repossesses the
goods, either to recover the goods plus damages for loss of quiet possession
or to damages representing the value of the goods lost.

37. Owner’s rights
The owner usually has the right to terminate agreement where hirer defaults
in paying the installments or breaches any of the other terms in agreement
This entitles the owner:
1. To forfeit the deposit
2. To retain the installments already paid and recover the balance due
3. To repossess the goods
4. To claim damages for any loss suffered

38. Leasing Versus Hire Purchase

39. Differences between Lease and Hire purchase
1. Ownership
2. Method of Financing
3. Depreciation
4. Tax benefits
5. Salvage value
6. Deposit
7. Nature of deal
8. Extent of Finance
9. Maintenance
10. Reporting

40. Differences between lease and Hire purchase
1. Ownership- in lease, ownership rests with the lessor throughout and the hirer
of the goods not becomes owner till the payment of specified installments.
2. Method of financing- leasing is a method of financing business assets whereas
HP is financing both business and non-business assets.
3. Depreciation- in leasing, depreciation and investment allowances cannot be
claimed by the lessee, in HP, depreciation can be claimed by the hirer
4. Tax benefits- the entire lease rental (some types of lease) is tax deductible
expense. Only the interest component of the HP installment is tax deductible
5. Salvage value- the lessee, not being the owner of the asset, doesn’t enjoy the
salvage value of the asset. The hirer, in HP, being the owner of the asset, enjoys
salvage value of the asset.

41. Contd.
6. Deposit- lessee is not required to make any deposit whereas 20% deposit is
required in HP.
7. Nature of deal - with lease we rent and with HP we buy the goods
8. Extent of Finance- in lease financing is 100 % financing since it is not required a
down payment, whereas HP requires 20 to 25% down payment.
9. Maintenance- cost of maintenance hired assets is carry by hirer and the leased
asset (other than financial lease) is carry by the lessor.
10. Reporting- HP assets is a balance sheet item in the books of hirer where as
leased assets are shown as off- balance sheet item (shown as Foot note to BS)

42. Advantages of HP
1. Spread the cost of finance
2. Interest-free credit
3. Higher acceptance rates
4. Sales
5. Debt solutions

43. Advantages of HP
1. Spread the cost of finance – A hire purchase agreement allows a consumer to
make monthly repayments over a pre-specified period of time
2. Interest-free credit – Some merchants offer customers the opportunity to pay
for goods and services on interest free credit
3. Higher acceptance rates – The rate of acceptance on hire purchase
agreements is higher than other forms of unsecured borrowing
4. Sales – A hire purchase agreement allows a consumer to purchase sale items
when they aren’t in a position to pay in cash
5. Debt solutions - Consumers that buy on credit can pursue a debt solution,
such as debt engagement plan, should they experience money problems
further down the line

44. 6. Euro Issues
• Euro issue is a method of raising funds required by a company in foreign
exchange
• It provides greater flexibility to the issuers for raising finance and allows
room for controlling their cost of capital
• The term 'Euro issue' means an issue made abroad through instruments
denominated in foreign currency and listed on an European stock
exchange, the subscription for which may come from any part of the
world
• The idea behind Euro issues is that any one capital market can absorb
only a limited amount of company's stock at any given time and cost

45. Thank You