Presented by Parikshit Saha Pankaj Lokesh Randeep Garg Sahil Aggarwal Nishant Adlakha

Capital Structure Menu of Financing Debentures Methods of Offering Term Loans Miscellaneous Sources Raising Venture Capital Raising Capital in International market

DEBT Must be repaid or refinanced Requires regular interest payments. Company must generate cash flow to pay. Debt providers are conservative. They cannot share any upside or profits. Therefore, they want to eliminate all possible loss or downside risks Interest payments are tax deductible. Debt has little or no impact on control of the company

EQUITY Can usually be kept permanently. No payment requirements. May receive dividends, but only out of retained earnings. Equity providers are aggressive. They can accept downside risks because they fully share the upside as well Dividend payments are not tax deductible Equity requires shared control of the company and may impose restrictions.

Cost Nature of Assets Business risk Norms of lenders Control considerations Market conditions

Sources of Finance
Internal Accruals Securities Term Loans Working Capital Advances Miscellaneous Sources

Sources of Finance
Equity Equity Preference Internal Accruals Debt Bonds Term Loans Working Capital Advances Miscellaneous Sources

Internal accruals of a firm consist of depreciation charges and retained earnings. Depreciation represents the allocation of capital expenditure to various periods over which the capital expenditure is expected to benefit the firm.

Advantages:
1. 2.

Internal accruals are readily available. It eliminates issue costs and losses on account of underpricing. The amount that may be available by way of internal accruals may be limited. The opportunity cost of depreciation-generated funds is equal to the weighted average cost of capital of the firm.

Disadvantages:
1.
2.

Equity capital represents ownership capital as equity shareholders collectively own the company. They enjoy the rewards and bear the risks of ownership. However , their liability, unlike the liability of the owner in a proprietary firm and the partners in a partnership concern, is limited to their capital contributions. The book value of an equity share is equal to: Paid-up equity capital + Reserves and surplus

Number of outstanding equity shares The book value of an equity share tends to increase as the ratio of reserves and surplus to paid up equity capital increases.

Advantages:
1. 2.
3.

4.

There is no compulsion to pay dividends. Equity capital has no maturity date and hence the firm has no obligation to redeem. Equity capital provides cushion to lenders, it enhances the credit worthiness of the company. Presently, equity dividends are tax-exempt in the hands of investors.
Sale of equity shares to outsiders dilutes the control of existing owners. Cost is very high, usually the highest. Equity dividends are paid out of profit after tax, whereas interest payments are tax-deductible expenses. Cost of issuing equity shares is generally higher than the cost of issuing other types of securities.

Disadvantages:
1. 2. 3. 4.

1.

The equity investors have a residual claim to the income of the firm. 2. Right to control: Equity shareholders elect the board of directors and have the right to vote on every resolution placed before the company. The board of directors, in turn, selects the management which controls the operations of the firm. Hence equity shareholders exercise an indirect control over the operations of the firm. 3. Pre-emptive right: This right enables existing equity shareholders to maintain their proportional ownership by purchasing the additional equity shares issued by the firm. 4. Right in Liquidation: Equity shareholders have a residual claim over the assets of the firm in the event of liquidation. Claims of all others-debenture holders, secured lenders, unsecured lenders, other creditors are settled prior to the claim of equity shareholders.

Right to income:

i. ii. iii.

Preference capital represents a hybrid form of financing- it partakes some characteristics of equity and some attributes of debentures. It resembles equity in the following ways Preference dividend is payable only out of distributable profits Preference dividend is not an obligatory payment Preference dividend is not a tax-deductible payment.

Cumulative

Cumulative preference shares entitle the shareholders to receive dividends for the previous years in which dividend was not paid.

and

Non-cumulative

shares:

Participating and Non-participating shares:

The holders of participating preference shares get a share in the profits of the company after a certain date of dividends is paid to the equity shareholders of the company.

Redeemable and Non- redeemable Preference shares:

Redeemable preference shares are repayable at par or at premium after a specific period. Non-redeemable preference shares are not repayable except when a company goes into liquidation.

Convertible and Non- convertible Preference shares:

Convertible preference shares can be converted into equity shares at the option of the preference shareholders in accordance with the certain predetermined terms. Non-convertible shares do not carry such an option.

Advantages:
1. 2. 3.

There is no legal obligation to pay preference dividend. Preference capital is regarded as part of net worth. Preference shares do not, under normal circumstances, carry voting rights.
Compared to debt capital, it is more expensive source of financing. Skipping preference dividend can adversely affect the image of the firm in the capital market. Compared to equity shareholders, preference shareholders have a prior claim on the assets and earnings of the firm.

Disadvantages:
1.

2.
3.

Methods of Offering/Raising Finance

Public offering Rights issue Private placement

Public offering
It

involves sale of securities to the members of the public. There are three types of public offering as under: Initial public offering(IPO) Seasoned equity offering Bond offering

 It is the first public offering of equity shares of

a company, which is followed by a listing of its shares on the stock market. The decision to go public is a very important issue. It is a complex decision so carefully taken Benefits over Cost.

 The

company has a certain track record of profitability and a certain minimum net worth. The securities are compulsorily listed on a recognized stock exchange, which means that a certain minimum percent of each class of securities is offered to the public. The promoter group is required to make a certain minimum contribution to the post issue capital. The promoters contribution to the equity is subject to a certain lock-in period.

Hiring the merchant bankers Due diligence and prospectus preparation

Marketing
Subscription and allotment

 Also called Secondary offerings.

As

companies need more finances, they are likely to make further trips to the capital market with seasoned equity offering. The process of this is easy than that of IPO.

It is similar to IPO process, though some differences are there: The prospectus for a bond offering emphasizes a companys stable cash flows, whereas prospectus for an equity offering companys growth. Book building method is not used. It is necessary for a company to appoint one or more debenture trustees before a debenture issue.

rights issue involves selling securities in the primary market by issuing rights to the existing shareholders. When a company issues additional equity capital, it has to be offered in the first instance to the existing shareholders on a pro rata basis.

 It consists of four forms , i.e. forms A,B,C and D. Form A is meant for the acceptance of the rights

and application of additional shares. It has also a column through which a request for additional shares may be made. Form B is to be used if the shareholder wants to renounce the rights in favour of someone else. Form C is meant for application by the renouncee in whose favour the rights have been renounced, by the original allottee. Form D is used to make a request for split forms.

private placement is an issue of securities to a select group of persons not exceeding 49. Private placement means direct sale of securities to a small number of investors. These investors are financial institutions , Banks. This method is very popular because it saves time and cost. Private placement of shares can be of two types: Preferential allotment Qualified institutional placement

Public issue Amount that can be raised

Right issue

Private placement Moderate Negligible Yes Small Neutral

Large High Yes Large Negative

Moderate Negligible No Irrelevant Neutral

Cost of issue
Dilution of control Degree of under pricing Market perception

 Firms obtain long term debt mainly by raising

term loans or issuing debentures. Term loans given by financial institutions and banks have been the primary source of long term debt for private firms and most public firms.

Currency

Restrictive covenants

Security

Interest payment and principal repayment

Submission of loan application. Initial processing of loan application.

Appraisal of the proposed project.

Issue of the letter of sanction. Acceptance of the terms and conditions by the borrowing unit.

Execution of loan agreement.

Creation of security. Disbursement of loan.

Monitoring.

Cash credits/overdrafts. Loans. Purchase/discount of bills.

Predetermined limit for borrowing is specified by bank. Borrower can draw as often as required with in that limit. Borrower enjoy the facility for repaying the amount , partially or fully and when he desire. Interest is charged only for the running balance.

Advances of fixed money to the borrower. Interest charged on the entire loan amount. Payable either on demand or in periodic installments.

Arrangement whereby a bank help its customer to obtain credit from its supplier.

Letter of credit Here bank take responsibility to honour the obligation of its customer if the customer failed to do so.

The information furnished in the application covers the following.. Name and the address of the borrower and his establishments. Detail of the borrowers business. Nature and amount of security offered. Financial statements and financial projections of the firm.

Involve examination of the following factors. Ability, integrity and experience of the borrower in the particular business. General prospects of the borrowers business. Purpose of advance. Requirement of the borrower and its reasonableness. Adequacy of margin. Provision of security. Period of repayment. Repayment capacity.

The amount of the loan or the maximum limit of the advance. The nature of the advance. Period for which the advance will be valid.

Rate of interest applicable to advance. Insurance of the security. Details of the collateral security. Margin to be maintained. Other Restriction and obligations on the part of borrower.

Hypothecation-owner of goods borrows money against the security of movable property.

Pledge-owner of goods deposits the goods with the lender as security for borrowing.

 Deferred credit Under this the supplier

gives time to the buyer to pay for the machinery. But bank guarantee should be furnished by the buyer. whereby the lesser grants the lessee the right to use an asset in return for periodic lease rental payments.

Lease finance Contractual agreement

Intermediate term to long term non cancelable arrangement which vary from three, five or eight years. The lesser recovers through the lease rentals and acceptable rate of return. The lessee is responsible for maintenance, insurance and taxes.

The lease term is less then the economic life of the equipment. Lessee enjoy the right to terminate the contract at short notice without any penalty. The lesser provides the know how and the related services and responsibility of insuring and maintaining the equipment.

Most leases are finance leases not operating leases. Lease finance is available for identifiable performing assets. Lease finance is available in small volume. There is great deal of flexibility in structuring lease finance. Lease of immovable assets is not possible by banks. Lease tenors up to eight years is available.

The hiree purchases the asset and gives it on hire to the hirer. Hirer pays regular installments over specified period of time. With the payment of last installment the asset is transferred from hiree to the hirer. Hiree charges interest on flat basis not on diminishing rate.

Similar to the hire purchase but here the title of the assets is transferred from hiree to the hirer when he pays his first installment. In case of default the hiree can force the buyer to sell the asset and recover his remaining amount.

Provided by the promoters to fill the gap between the promoters contribution required by the financial institution and the equity capital subscribed to by the promoter. These are the deposits from the public with tenor one to three years

 Bill rediscounting scheme Operated by the IDBI. Meant to promote the sale
Suppliers line of credit Administered by ICICI. Under this scheme the bank

of indigenous machinery on deferred payment basis.

directly pays to the machinery manufacturer against usance bills duly accepted or guaranteed by the bank of the purchaser.

 Subsidies

and sales tax deferments and exemptions Provide subsidies to industrial units located in backward areas. Under sales tax deferment scheme the payment of sales tax on the sales of finished goods may be deferred for a period. Commercial paper Issued by firms which enjoys a high credit rating. Maturity period ranges from 90 to 180 days. Sold at discount and redeemed at par.

 Factoring

A factor is a financial institution work as a mediator between the creditor and the debtor. Factoring may be recourse basis or nonrecourse basis. Factor charges a commission which may be 1 to 2 percent of the face value of the debts factored.

 Euromarkets

Foreign Domestic Markets

Export Credit Scheme

1.
2.

Composed of Eurobanks who accept or maintain deposits of foreign currency Dominant currency: US$

caused by restrictive US government policies, especially 1. Reserve requirements on deposits 2. Special charges and taxes 3. Required concessionary loan rates 4. Interest rate ceilings 5. Rules which restrict bank competition.

1. 2.

A chain of deposits Changing control/usage of deposit

3.
a.

Eurocurrency loans
Use London Interbank Offer Rate: LIBOR as basic rate

b. Six month rollovers c. Risk indicator: size of margin between cost and rate charged.

4.

Multicurrency Clauses

a. Clause gives borrower option to switch currency of loan at rollover. b. Reduces exchange rate risk

5. Domestic vs. Eurocurrency Markets

a. Closely linked rates by arbitrage b. Euro rates: tend to lower lending, higher deposit

1.

Recent Substantial Market Growth-due to use of swaps.

Financial instrument which gives 2 parties the right to exchange streams of income over time.

2.

Links to Domestic Bond Market arbitrage has eliminated interest rate differential.

3. Placement underwritten by syndicates of banks

4. Currency Denomination a. Most often US$ b. Cocktails allow a basket of currencies

5.

Eurobond Secondary Market result of rising investor demand

6. Retirement a. sinking fund usually b. some carry call provisions.

7. Ratings a. According to relative risk b. Rating Agencies Moodys, Standard & Poor 8. Rationale For Market Existence a. Eurobonds avoid government regulation b. May fade as market deregulate

E.

Eurobond vs. Eurocurrency Loans

International bond denominated in a currency not native to the country where it is issued. Also called external bond. A Eurodollar bond that is denominated in U.S. dollars and issued in Japan by an Australian company would be an example of a Eurobond.

1. Five Differences a. Eurocurrency loans use variable rates b. Loans have shorter maturities c. Bonds have greater volume d. Loans have greater flexibility e. Loans obtained faster

F.

Note Issuance Facility (NIF)

A syndicate of commercial banks that have agreed to purchase any short to medium-term notes that a borrower is unable to sell in the Eurocurrency market.

1. Low-cost substitute for loan 2. Allows borrowers to issue own notes 3. Placed/distributed by banks

G. NIFs vs. Eurobonds 1. Differences: a. Notes draw down credit as needed b. Notes let owners determine timing c. Notes must be held to maturity

Foreign Domestic Markets

Most firms raise their initial capital in their own domestic market While many can be tempted to skip the intermediate steps to complete an Euroequity issue in global markets, good financial advisors will offer a reality check on this strategy Most firms that have only raised capital in their domestic market are not well enough known to attract foreign investors

Depositary Receipts
Depositary receipts are negotiable certificates issued by a

bank to represent the underlying shares of stock, which are held in trust at a foreign custodian bank
Global Depositary Receipts (GDRs) refers to certificates traded outside the US American Depositary Receipts (ADRs) are certificates traded in the US and denominated in US dollars ADRs are sold, registered, and transferred in the US in the same manner as any share of stock with each ADR representing some multiple of the underlying foreign share

Depositary Receipts
This multiple allows the ADRs to possess a price

per share conventional for the US market ADRs are either sponsored or unsponsored Sponsored ADRs are created at the request of a foreign firm wanting its shares traded in the US; the firm applies to the SEC and a US bank for registration and issuance

Export Credit Schemes

Prominent Export Agencies US EXIM, JEXIM, HERMES, and COFACE Follow certain consensus guidelines for supporting exports under Berne Union Interest Rate is regulated Two Kinds of Export Credit
Buyers Credit
Suppliers Credit

The overseas exporter and the Indian Buyer negotiate a contract An application for the buyers credit facility is made to the export agency of the exporters country along with relevant details The buyers credit facility is approved by the export credit agency f the exporters country A negotiated loan agreement delineating the terms and conditions

The overseas exporter notifies his bank and the export credit agency of a potential export order of an Indian buyer who requires medium term finance The export credit agency communicates to the bank its willingness to provide the facility The terms of the facility are incorporated in the contract between the overseas exporter and the Indian Buyer.