FINANCING SOURCES FOR

INDIAN COMPANIES
 Sources of Finance
1. Equity Shares
2. Preference shares
3. Retained earnings
4. Bonds or securitized Instruments
5. Term loans/Bank loans
6. GDR and ADR
7. External Commercial Borrowings
8. Foreign Currency Convertible Bonds
9. Lease Finance
EQUITY SHARES (COMMON STOCK)

• OWNERSHIP CAPITAL
• PAR OR NO PAR STOCK
• BOOK VALUE
• ISSUE PRICE
• MARKET VALUE
 RIGHTS OF EQUITY SHAREHOLDERS

• RIGHT TO VOTE AND RIGHT TO

CONTROL
• RIGHT TO DIVIDEND
• PRE EMPTIVE RIGHT
• RIGHT TO LIQUIDATE INVESTMENT
• RIGHT TO RESIDUAL CLAIM ON
ASSETS
• RIGHT TO RECEIVE ANNUAL REPORTS
AND OTHER RETURNS
• RIGHT TO BE HEARD IN CASE OF
MERGERS AND ACQUISITIONS
 MERITS OF EQUITY CAPITAL FOR A
COMPANY
• LESS RISKY CAPITAL
• NO MATURITY DATE
• PROVIDES A CUSHION AGAINST LOSS
TO CREDITORS
• DIVIDENDS FULLY TAX FREE IN THE
HANDS OF THE INVESTORS
• REWARDS FOR GOOD PERFORMANCE
IN THE FORM OF HIGH PREMIUM
• POSSIBILITY OF MOBILISATION OF
LARGE AMOUNT OF CAPITAL
 PROBLEMS ASSOCIATED WITH EQUITY
CAPITAL

• POSSIBILITY OF DILUTION OF CONTOL

• HIGH COST OF FUND DUE NO TAX
DEDUCTIBILITY
• HIGHER COST OF ISSUE IN
COMPARISON TO DEBT CAPITAL
• CONSTANT VIGIL BY THE MARKET
• POSSIBILITY OF HIGH SPECULATION
IN AN IMPERFECT CAPITAL MARKET
• PAYMENT OF DIVIDEND DISTRIBUTION
TAX
• POSSIBILITY OF NEGLECT OF THE
MINORITY SHAREHOLDERS
• FUNDING IS DIRECTLY RELATED TO
THE CAPITAL MARKET CONDITIONS
 FACTORS FOR FIRMS TO CONSIDER ON
EQUITY FINANCING

• ISSUE EXPENSES

• SERVICING COSTS

• DIVIDEND OBLIGATION

• OBLIGATION TO REDEEM THE

INVESTMENT
• TAX DEDUCTIBILITY OF DIVIDEND

• EFFECT ON CONTROL AND FREEDOM

OF ACTION

• PRICING OF THE ISSUE

• UNCERTAINTY OF PUBLIC ISSUE

FACTORS FOR THE POTENTIAL INVESTORS
TO CONSIDER IN EQUITY INVESTMENT

• LEVEL OF RETURNS
• RISKINESS OF RETURNS
• POSSIBILITY OF APPRECIATION OF
MARKET PRICE
• EASE OF LIQUIDATING THE
INVESTMENT
• CAPITAL GAIN AND PERSONAL TAX
• DEGREE OF CONTROL
• INDUSTRY PROSPECTS
• FIRM’S PAST RECORDS
• COMPOSITION OF THE BOARD
MEMBERS
 Preference Shares
• Hybrid security (debt +equity)
• Accountants treat it as equity
• Par value,
• Fixed rate of dividend-no bankruptcy if the
company defaults in paymnet
• Rate of dividend normally higher than the fixed
rate of interest on bonds
• Dividend only when the company earns income,
Usually cumulated-less risky for a company
• Ordinarily no voting right
• Cumulative vrs. Non cumulative
• Redeemable preference shares(permanent
preference shares)
• Participating preference shares
• Convertible preference shares.
• Adjustable rate preference shares
• Dividend not exempted from tax
• Preference shares also traded in the stock
market but traded within a narrow range
 RETAINED EARNINGS

THE LARGEST SOURCE OF FUNDING FOR THE

CORPORATE SECTOR IN INDIA

AVAILABLE ONLY TO THE EXISTING AND WELL

ESTABLISHED COMPANIES

THERE IS CLOSE AND POSITIVE RELATIONSHIP

BETWEEN CAPITAL MARKET,PERFORMANCE OF
THE CORPORATE SECTOR AND THE EXTENT OF
FINANCING THROUGH THE RETAINED EARNING
 ADVANTAGES OF FINANCING
THROUGH RETAINED EARNING
• NO POSSIBILITY OF DILUTION OF
CONTROL
• PROVIDES A HEDGE AGAINST
VOLATILITY OF THE FINANCIAL
MARKET
• IMPROVES THE CREDIT RATING OF
THE COMPANY
• INTERNAL FINANCING IN PROFITABLE
PROJECTS IMROVES THE FUTURE
DIVIDENDS OF THE SHAREHOLDERS

• NO FLOATATION COST
 ARGUMENTS AGAINST TOO MUCH USE OF
INTERNAL FINANCE

• RETAINED EARNINGS COME AT THE

EXPENSE OF THE EQUITY
SHAREHOLDERS
• RETAINED EARNING FINANCING
HIDES THE UNSTABLE EARNINGS OF
THE FIRM
• OPPORTUNITY COSTS OF RETAINED
EARNING ARE MUCH HIGHER
• TOO MUCH RETAINED EARNINGS MAY
LEAD TO
*EXPAND THE BUSINESS
BEYOND PROFITABLE
SIZE
*DIVERSIFY INTO NEW AREA AT
HIGHER RISK
*ACQUIRE OTHER FIRMS WITH
LOWER NPV
 CORPORATE BONDS AND OTHER
SECURITISED DEBT INSTRUMENTS
FEATURES
• FACE VALUE AND ISSUE PRICE
• COUPON RATE
• MATURITY
• TRUST INDENTURE
• SECURITY
• CONVERTIBILITY
• CREDIT RATING
• CALL AND PUT OPTIONS
• CLAIM ON INCOME AND ASSETS
• REDEMPTIONS
RISKS ASSOCIATED WITH CORPORATE
BONDS
• INTEREST RATE RISK
• INFLATION RISK LEADING TO REDUCTION
OF PRESENT VALUE OF THE BOND DUE TO
LOWER VALUE OF FUTURE CASH FLOW
• COUNTRY AND POLITICAL RISK
• DEFULT RISK/BANKRUPTY RISK
• FOREX FLUCTUATION RISK
 ADVANTAGES WITH BOND FINANCE

• INTEREST PAYMENTS ARE TAX

DEDUCTIBLES(LOW COST FUND
• DEBT HOLDERS DONOT SHARE IN
THE VALUE CREATED BY THE
COMPANY DUE TO FINANCIAL
LEVERAGE
• BOND HOLDERS DONOT VOTE
• ISSUE COSTS OF BONDS LOWER
THAN EQUITY
• BONDS CAN BE
REENGINEERED/CUSTOMISED TO
MEET THE REQUIREMENTS OF THE
FIRM
• DISCIPLINING THE
MANAGEMENT(MORE
ACCOUNTABILITY)
 PROBLEMS WITH DEBT FINANCE

• GREATER USE INCREASES FIRM’S

FINANCIAL RISK
• INCREASES IN FINANCIAL LEVERAGE
INCREASES THE COST OF EQUITY
• CONTAINS RESTRICTIVE COVENANTS(
REDUCES FIRM’S ABILITY TO ENGAGE
IN VALUE MAXIMISING ACTIVITIES
• REAL COST OF DEBT WILL BE HIGHER
IF THE RATE OF INFLATION TURNS
OUT TO BE LOWER
• CREDIT RATING IS A MUST FOR DEBT
ISSUE
• SECONDARY MARKET (LIQUIDITY)
FOR CORPORATE DEBT IS NOT VERY
ACTIVE IN INDIA( MOSTLY CONFINED
TO WHOLESALE MARKET)
FACTORS TO BE CONSIDERED BY THE FIRM
WHILE ISSUING BONDS

• SHOULD THE COMPANY BORROW

SHORT TERM OR LONG TERM?
• WHAT WOULD BE THE INTEREST
COST AND OTHER ISSUING COSTS?
• SHOULD THE DEBT BE FIXED OR
FLOATING RATE?
• SHOULD THE FIRM BORROW IN
RUPEE OR IN SOME OTHER
CURRENCY?
• WHAT PROMISE WOULD YOU MAKE TO THE
LENDERS?
• WHAT ARE THE EXPECTATIONS OF THE
BOND HOLDERS?
• SHOULD YOU ISSUE STRAIGHT OR
CONVERTIBLE BOND?
• WILL IT BE SENIOR BOND OR SUBORDINATE
BOND?
• WHAT TYPE OF SECURITY COVER YOU ARE
WILLING TO OFFER TO THE BOND
HOLDERS?
TERM FINANCING BY BANKS AND FINANCIAL
INSTITUTIONS

FEATURES
» LOAN AMOUNT( NO FACE
VALUE,MAXIMUM AMOUNT
LIMITED)
» MATURITY PERIOD
» COUPON RATE-FIXED OR
FLOATING
» NEGOTIATED LOAN
» NON SECURITISED DEBT
» SECURITY
» PROJECT FINANCE OR ASSET
BASED FINANCE
» COVENANTS
 COVENANTS OR RESTRICTIVE CONDITIONS

• ASSET BASED COVENANTS-MAINTENANCE,BAN

ON CREATION OF ADDITIONAL CHARGE,BAN ON
SALE OR SHIFTING OF ASSETS
• LIABILITY RELATED COVENANTS-RESTRICTIONS
ON TAKING FRESH LOANS,RESTRICTIONS ON
DEBT-EQUITY RATIO,PROHIBITION ON DISPOSAL
OF PROMOTERS HOLDINGS
• CASH FLOW RELATED COVENANTS-
RESTRICTIONS ON PROJECTS AND NEW
EXPANSIONS,LIMITATIONS ON DIVIDEND
POLICY,CEILING ON MANAGERIAL SALARY AND
PERKS
• CONTROL RELATED COVENANTS-BROADBASING
BOARD OF DIRECTORS,NOMINEE
DIRECTORS,APPOINTMENT OF SUITABLE
PROFESSIONAL STAFF
• OTHER COVENANTS-SUBMISSION OF
RETURNS,MINIMUM NET WORTH AND WORKING
CAPITAL,CREATION OF SINKING FUND FOR
REDEMPTION OF DEBENTURES