Long term Sources of Finance

Prapti Paul Faculty, IBS Gurgaon

LEARNING OBJECTIVES
Explain the features of ordinary shares Focus on the benefits and valuation of rights shares Discuss the pros and cons of debentures and preference shares Highlight the features of term loans

INTRODUCTION
Ordinary shares provide ownership rights to investors. Debentures or bonds provide loan capital to the company, and investors get the status of lenders. Loan capital is also directly available from the financial institutions to the companies.
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Ordinary SharesFeatures
Claim on Income Claim on Assets Right to Control Voting Rights Pre-Emptive Rights Limited Liability

Reporting of Ordinary Shares

Tata Motors' Share Capital as on 31 March 2008

Ordinary SharesPros and Cons

Advantages Permanent Capital Borrowing Base Dividend Payment Discretion Disadvantages Cost Risk Earnings Dilution Ownership Dilution
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Public Issue of Equity

Public issue of equity means raising of share capital directly from the public. As per the existing norms, a company with a track record is free to determine the issue price for its shares

Underwriting of Issues
It is legally obligatory to underwrite a public and a rights issue. In an underwriting, the underwritersgenerally banks, financial institution, brokers, etc.guarantee to buy the shares if the issue is not fully subscribed by the public. The agreement may provide for a firm buying by the underwriters. The company has to pay an underwriting commission to the underwriter for their services.

Private Placement
Private placement involves sale of shares (or other securities) by the company to few selected investors, particularly the institutional investors. Private placement has the following advantages: Size Cost Speed
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Right Issue of Equity Shares

Selling of Ordinary shares to the existing shareholders of the company. Effect on Shareholders Wealth The shareholder has three options: (i)he exercises his rights, (ii)he sells his rights ,or

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(iii)he does not exercise or sell his rights. He will lose under the third option.

Right Shares Pros and Cons

Advantages 1.Control is maintained 2.Less flotation cost 3.Issue more likely to be successful

Disadvantages
1.Shareholders lose if fail to exercise their right 2.If shareholding concentrated in hands of FI
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Preference Shares
Similarity to Ordinary Shares: 1.Non payment of dividends does not force company to insolvency. 2.Dividends are not deductible for tax purposes. 3.In some cases, it has no fixed maturity dates. Similarity to Debentures:

1.Dividend rate is fixed. 2.Do not share in residual earnings. 3.Preference shareholders have claims on income and assets prior to ordinary shareholders. 4.Usually do not have voting rights.

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Preference SharesFeatures
1.Claims on Income and Assets 2.Fixed Dividend 3.Cumulative Dividend 4.Redemption 5.Sinking Fund

6.Call Feature
7.Participation Feature 8.Voting Rights 9.Convertibility
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Preference SharesPros and Cons

Advantages: Risk less leverage advantage Dividend postponability Fixed dividend Limited Voting Rights

Disadvantages: Non-deductibility of Dividends Commitment to pay dividends

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DEBENTURES
A debenture is a long-term promissory note for raising loan capital.

The firm promises to pay interest and principal as stipulated.

The purchasers of debentures are called debenture holders. An alternative form of debenture in India is a bond.

Mostly public sector companies in India issue bonds

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DebenturesFeatures

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Interest Rate Maturity Redemption Sinking Fund Buy-back (call) provisions Indenture Security Yield Claims on Assets and Income

Types of Debentures
1.Non Convertible Debentures 2.Fully Convertible Debentures 3.Partly Convertible Debentures

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DebenturesPros and Cons

Advantages: Less Costly No ownership Dilution Fixed payment of interest Reduced real obligation Disadvantages: Obligatory Payment Financial Risk Cash outflows Restricted Covenants

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Term LoansFeatures
Maturity Direct Negotiations Security Restrictive Covenants 1.Asset related covenants 2.Liability related covenants 3.Cash flow related covenants 4.Control related covenants Convertibility Repayment Schedule
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Thank You!

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