02-Dec-13

1
Overview of Financing Choices
Debt vs. Equity
2
Fixed Claim
High Priority on Cash Flows
Tax Deductibility of Interest
Fixed Maturity
No Management Control
Residual Claim
Lowest Priority on Cash
Flows
Dividends not Tax Deductible
Infinite Life
Management Control
Debt
Hybrid Securities
(features of Debt & Equity)
Equity
02-Dec-13
2
Debt Finance
Debt Financing Options
Debt Capital may consists of:
Debentures/bonds issued to the public or placed
privately with Institutional Investors,
Loans from Banks / Financial Institutions
4
02-Dec-13
3
Debentures
Debentures/ Bonds: Most corporates issue bonds with maturities
ranging from 5 - 15 years, though some companies have also
raised funds for 50 100 years.
Basic Types:
Non-Convertible Debenture (NCD): A straight debenture, which
gets redeemed at maturity.
Fully Convertible Debenture (FCD): Gets converted into equity
shares at a pre-decided conversion price and time.
Partly Convertible Debenture (PCD): Has 2 parts- Convertible +
Non-Convertible.
P&G issued 400,960 PCD of Rs 200/- each :
Convertible portion of face value Rs. 65/- to be converted into 1
equity share of Rs 10 at a premium of Rs 55 at the end of 18
months, and
Non-convertible portion (Rs 135/-) carries coupon of 12%, and
maturity period of 8 years.
5
Innovations in Debentures - Maturity
Companies may alter the maturity by making the bond callable,
puttable or extendable.
Callable Bonds: The borrowing firm has the right to buy (call) the
bond at any time before its maturity.
Used when the interest rates fall subsequent to issue of bonds by
the firm.
Puttable Bonds: Investors have the right to sell (put) the bonds
back to the Issuer firm at any time before maturity.
Used when the interest rates increase subsequent to issue of
bonds by the firm.
Bonds with Call & Put facility.
Extendable Bonds: Investors have the right to extend the maturity
of the bonds.
6
02-Dec-13
4
Innovation in Bond Market 7
Innovations in Debentures - Coupon
Usually, the interest payable on the bonds is fixed Fixed-rate
bonds.
Deepdiscount Bond: Bonds are issued at a very low value (at
deep discount) as compared to its face value and do not carry any
interest.
E.g.:IDBI issued DDBs at Rs 5,600/- for Face Value of Rs 2 Lacs and maturity
period of 25 years.
Protect investors from re-investment risk, notional (imputed)
interest is being reinvested at the bonds yield.
DDBs however, entail balloon repayments, hence may cause
liquidity problems at maturity.
Floating-rate Bond: Due to higher inflation and greater interest
rate volatility, both firms and issuers become reluctant to lock in a
coupon rate for a longer period.
Innovations in Debentures - Coupon
Consequently, interest rate on long-term bonds, are linked
(indexed) to some benchmark rate such as LIBOR, T-bill rate, or
prime rate, and adjusted periodically.(E.g.: LIBOR+2%).
E.g.: SBI issued FRBs having Face Value of Rs 1,000/- at Banks
Max. Termdeposit rate + 3%.
Variations of Floating rate bonds:
Inverse Floaters: Coupon rate moves in the inverse direction to
the benchmark rate. E.g.: interest rate may be 14% - LIBOR, so if
LIBOR increases, interest rate on the bond would reduce.
Caps & Floors: Caps prevent interest rates from moving above a
specified maximum rate, while floors prevent them from falling
belowa minimumrate.
Step-up & Step-in Floating rate Bond:The spread over the
indexed interest rate increases or decreases over time instead of
remaining fixed over the bonds life.
02-Dec-13
5
9
Innovations in Debentures - Security
Although lenders have prior claims over the equity investors on the
firms assets in the event of bankruptcy or liquidation, not all
lenders are equal.
Secured Debentures: Occupy maximum priority as specific assets
are pledged as security on the debt.
In case of default, these assets provide the basis for claims
made by secured debt holders.
Further, these assets cannot be disposed-off without the
consent of Secured bondholders.
Unsecured Debentures: No asset backing, backed by earnings
power of the firmonly.
10
Warrants
Warrants: entitles the investor to purchase a fixed number of equity
shares at a pre-determined price, during a specified period.
Deepak Fertilizers issued PCDs with warrants attached:
Instrument Details:
Each PCD had a Face Value of PCDs is Rs 100/- with detachable warrants.
Part A (FCD): Rs 20/- to be converted into 1 equity share (Rs. 10/-
+ 10/-) at the end of 3
rd
year
Part B (FCD): Rs 30/- to be converted into 1 equity share (Rs.
10/- + 20/-) at the end of 4
th
year
Part C (NCD): Rs 50/- with a maturity period of 7 years carrying
coupon of14%
Plus Detachable Warrant: which will entitle the investor to buy 1
equity share of Rs 10/- at a price not exceeding Rs 50/- between 3
rd
to 5
th
year. To be separately listed and traded on stock exchange.
02-Dec-13
6
11
Other Innovations in Debentures
Currencies
Dual Currency Bonds:Coupon payment is in one currency and
principal repayment is in another currency.
Eurobonds: (Eurodollar/ Euroyen):
Foreign Currency Convertible Bonds(FCCBs)
12
Loans from Financial Institutions / Bank
Terms loans are long-term debts from FIs & Banks.
Maturity period: usually 6-10 years (FIs) or 3-5 years
(Banks), with a moratorium period of 1-2 years.
Security: Assets acquired using Term loan provide the
primary security. Additionally, cos other current &
future assets may provide secondary or collateral
security.
Convertibility: Loans may be converted into Equity on
failure to repay.
Repayment Schedule: Usually in equal instalments after
the moratorium period.
02-Dec-13
7
13
Loans from Financial Institutions / Bank
Restrictive covenants(conditions):
Asset related:
Maintain min asset base;
Not to sell assets without lenders approval,
No additional charge.
Liability related:
No additional loans without lenders approval;
D/E to be maintained;
No dilution in equity by promoters.
Cash flow related:
Restrictions on cash dividends;
Restrictions on Capital expenditures
Restrictions on salaries, perks etc.
Control related:
Appointment of Nominee Director (to safe guard the interests of FIs;
to have knowledge of the operations of the firm and contribute to
management policies)
14
Lease Finance
Lease is contract between the owner of the asset (Lessor)
and the user (Lessee) of the asset, wherein the Lessor
gives the right to use the asset to the Lessee for a
consideration called Lease Rentals over an agreed period
of time called the Lease period or tenure.
At the end of the lease period, the leased asset reverts back
to the Lessor, unless the lease is renewed for another term.
Leasing separates the Ownership and Usage of the asset
as two separate economic activities.
02-Dec-13
8
15
Leasing, Hire Purchase,Instalment Sale
Leasing: Lessor avails the benefit of Depreciation,
while the Lease Rentals are tax-deductible for the
Lessee. Ownership remains with the Lessor.
Hire Purchase: The ownership passes when the hirer
pays the Capital + Interest i.e. on the payment of the
last Instalment. The Hirer (user) takes the benefit of
Depreciation and tax-deductibility of the Interest
component of the Hire charges.
Instalment Sale: The legal ownership passes as soon
as the 1
st
instalment is paid. The balance amount is
treated as a secured loan and Interest portion is
Tax-deductible
Equity Finance
02-Dec-13
9
Equity Financing Options
For Private (Unlisted) Firms:
Owners Equity: Most enterprises start off as small
businesses with one or few individuals providing the seed
capital.
Owners equity/Equity capital residual claims on cash
flows
These cash flows are not tax deductible
Holders of equity maintain management control of the
firm.
Venture Capital / Private Equity
For Public (Listed) Firms:
Equity Shares: Traditional way to raise equity capital is
to issue fresh equity thru an IPO.
ADR/GDRs
17
Venture Capital
Concept: Investment in the form of Equity, Quasi-Equity and/ or
conditional loan made in new, unlisted, high-risk or high-tech
firms, started by technically/professionally qualified.
Venture Capitalist, the entity which provides such finance:
Expects the enterprise to have A VERY HIGH GROWTH RATE
Provides SUPPORT to management and business skills
Expects mediumto long termCAPITAL GAINS
DOES NOT expect COLLATERAL to cover the capital
provided.
Venture Capital is money provided by a firm of professionals who
invest alongside management in rapidly growing companies; viz.:
Sun, Intel, Microsoft, Mastek, SatyamInfoway, Rediff, .
02-Dec-13
10
Venture Capital
Venture Capital derives its value from the brand equity, professional
image, constructive criticism, domain knowledge, industry contacts
they bring to table.
A Venture Capital Fund (VCF) strives to provide entrepreneurs with the
support they need to create up-scalable business with sustainable
growth, while providing their contributors with outstanding returns on
investment, for the higher risks they assume.
Venture Capital Fund generally:
Finance new and rapidly growing companies
Typically knowledge-based,sustainable, up scaleable companies.
Purchase equity / quasi-equity securities
Assist in the development of new products or services
Add value to the company through active participation
Take higher risks with the expectation of higher rewards
Have a long-term orientation
Types of Venture Funds
Incubators: An incubator is a hardcore technocrat who works with an
entrepreneur to develop a business idea, and prepares a Company for
subsequent rounds of growth & funding. eVentures, Infinity are examples of
incubators in India.
Angel Investors: An angel is an experienced industry-bred individual with high
net worth who typically:
invests only in his chosen field of technology
takes active participation in day-to-day running of the Company
invests small sums in the range of USD 1 - 3 million
not insist on detailed business plans
sanction the investment in up to a month
help company for "second round" of funding
E.g.: The IndUS Entrepreneurs (TiE) is a classic group of angels like: Vinod Dham,
Sailesh Mehta, Kanwal Rekhi, Prabhu Goel, Suhas Patil, Prakash Agarwal, K.B.
Chandrashekhar. In India there is a lack of home grown angels except a few like
Saurabh Srivastava & Atul Choksey (ex-Asian Paints).
02-Dec-13
11
Types of Venture Funds
Venture Capitalists (VCs): VCs are organisations raising funds from
numerous investors & hiring experienced professional mangers to
deploy the same. They typically:
Invest at second stage
invest over a spectrumover industry/ies
have hand-holding mentor approach
insist on detailed business plans
invest into proven ideas/businesses
provide brand value to investee
invest between USD 2 5 million
Private Equity Players: They are established investment bankers.
Typically:
invest into proven/established businesses
have financial partners approach
invest between USD 5 100 million
Industry wise Cumulative Investment by SEBI Registered Venture
Capital Funds (VCF) & Foreign Capital Investors (FVCI)
(Particulars as on June 30, 2012) (Rs. in Crore)
*excludes Rs.9460 crore of FVCI investments through VCFs
Sectors VCF FVCI Total*
Information Technology 611 3947 4467
Telecommunication 1187 6786 7525
Pharmaceuticals 519 774 1182
Biotechnology 170 140 272
Media/Entertainment 893 762 1094
Services Sector 2054 2480 3668
Industrial Products 1126 1196 2001
Real estate 9541 2364 10632
Others 13137 22829 30214
TOTAL 29238 41277 61056