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Long Term Finance: Shares, Debentures and Term Loans

Ordinary SharesFeatures
Claim on Income

Claim on Assets
Right to Control Voting Rights

Pre-Emptive Rights
Limited Liability

Ordinary SharesPros and Cons

Advantages
1.
2. 3.

Permanent Capital Borrowing Base Dividend Payment Discretion


Cost Risk Earnings Dilution Ownership Dilution

Disadvantages
1. 2. 3. 4.

Sweat Equity
The term Sweat Equity means equity shares

issued by a company to its employees or directors at a discount or for consideration other than cash for providing know-how or making available rights in the nature of intellectual property rights or value addition. The purpose of sweat equity is to ensure more loyalty and participation.

Financial Management, Ninth Edition I M Pandey Vikas Publishing House Pvt. Ltd.

Right Issue of Equity Shares


Selling of Ordinary Shares to the existing

shareholders of the company. The price of the share before the ex-rights date is called as right-on or cum-rights while the price after this date is referred to as the ex-rights price. In India along with the letter of right, generally four forms may be sent.

Right Shares Pros and Cons

Advantages
1. 2. 3.

Control is maintained Less flotation cost Issue more likely to be successful

Disadvantages
1. 2.

Shareholders lose if fail to exercise their right If shareholding concentrated in hands of FI

DebenturesFeatures

Interest Rate Maturity Redemption Sinking Fund Buy-back (call) provisions Indenture ( Debenture Trust Deed ) Security Yield Claim on Assets and Income
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Types of Debentures
Non Convertible Debentures

Fully Convertible Debentures


Partly Convertible Debentures

DebenturesPros and Cons

Advantages
1. 2. 3. 4.

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

Disadvantages
1. 2. 3. 4.

Preference Shares

Similarity to Ordinary Shares:


1.

2. 3.

Non payment of dividends does not force company to insolvency. Dividends are not deductible for tax purposes. In some cases it has no fixed maturity dates. Dividend rate is fixed. Do not share in residual earnings. Usually do not have voting rights.

Similarity to Debentures:
1. 2. 3.

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Preference SharesFeatures

Claim on Income and Assets Fixed Dividend Cumulative Dividend Redemption Sinking Fund Call Feature ( buy-back ) Participation Feature Voting Rights Convertibility
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Preference SharesPros and Cons

Advantages
1.

2.
3. 4.

Risk less Leverage advantage Dividend postponability Fixed dividend Limited Voting Rights Non-deductibility of Dividends Commitment to pay dividends

Disadvantages
1. 2.

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Internal Financing
Retained Earnings or Ploughing Back of

Profits The tool of ploughing back of profits can be successfully employed only by those concerns which have stable earnings.

Financial Management, Ninth Edition I M Pandey Vikas Publishing House Pvt. Ltd.

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Pros: 1. A cushion to absorb the shocks of economy. 2. Flexible financial structure 3. Increase in the value of shares 4. Enhanced earning capacity 5. Stimulates industrialization Cons: 1. Over-capitalization 2. Creation of monopolies 3. Misuse of retained earnings 4. Evasion of taxes
Financial Management, Ninth Edition I M Pandey Vikas Publishing House Pvt. Ltd. 14

Loan Financing
A. Short-term :Loans and Credits:
1. Indigenous Bankers 2. Trade Credit

3. Commercial Paper
4. Commercial Banks

5. Public Deposits
6. Factoring

Financial Management, Ninth Edition I M Pandey Vikas Publishing House Pvt. Ltd.

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B. Term Loans from specialized financial institutions: 1. Industrial Finance Corporation of India(IFCI) 2. Industrial Credit and Investment Corporation of India (ICICI ) 3. State Financial Corporations (SFCs) 4. State Industrial Development Corporations (SIDCs) 5. Industrial Development Bank of India (IDBI) 6. Small Industries Development Bank of India (SIDBI)
Financial Management, Ninth Edition I M Pandey Vikas Publishing House Pvt. Ltd. 16

Term LoansFeatures

Maturity Direct Negotiations Security Restrictive Covenants


1.
2. 3. 4.

Asset related covenants Liability related covenants Cash flow related covenants Control related covenants

Convertibility Repayment Schedule

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Some Other Innovative Sources of Finance


1. Venture Capital
2. Seed Capital 3. Bridge Finance

4. Lease Financing
5. Hire Purchase

6. Securitization

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Financial Management, Ninth Edition I M Pandey Vikas Publishing House Pvt. Ltd. 18

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