SOURCES OF LONG TERM FINANCE & RAISING LONG TERM FINANCE

FINANCIAL MANAGEMENT

1. A Presentation On Sources of Long Term Finance & Raising Long Term Finance Prepared by :~ Madhuri Bhatt ( 04 ) Ankita Chaniyara (08 ) Bhumika Fuletra ( 15 ) Kailash Naghera ( 33 ) Palak Sukhanandi ( 52 ) Mamta Zankat ( 60 )

2. Presentation Flow Sources of long term finance Raising long term finance Equity Capital Internal Accruals Preference Capital Term Loans Debentures Venture capital Initial public offer Secondary public offer Right issue Private placement Preferential allotment Dilution Obtaining a term loan

3. Introduction It is rightly said that finance is the life-blood of business. No business can be carried on without source of finance. There are several sources of finance and as such the finance has to be raised from the right kind of source.

4. Long Term Source of Finance Long term sources of finance are those that are needed over a longer period of time –generally over a year. Long term finance may be needed to fund expansion projects It’s types are:- Share, Debenture, Venture Capital, Government Grant, Bank Loan.

5. Need For Long Term Finance Long term vs. short term funds requirements For modernization, expansion, diversification, huge quantities required. Asset- liability mismatch, interest rate risk, liquidity risk.

6. Sources of Long Term Finance

7. Equity Capital Equity Shares also known as ordinary shares, which means, other than preference shares. Equity shareholders are the real owners of the company. They have a control over the management of the company. Equity shareholders are eligible to get dividend if the company earns profit. Equity share capital cannot be redeemed during the lifetime of the company. The liability of the equity shareholders is the value of unpaid value of shares .

8. Some Terms Authorized capital Issued capital Subscribed capital Paid –up capital Par value Issue price Book value Market value

9. Rights & Position of Equity Share Holders Right to Income Right to Control Pre- Emptive Right Right in Liquidation

10. Advantages of Equity Capital Permanent sources of finance Voting rights No fixed dividend Less cost of capital Retained earnings

11. Dis Advantages of Equity Capital Irredeemable Obstacles in management Leads to speculation Limited income to investor No trading on equity

12. Internal accruals It 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.

13. Advantages Readily available, no talking to outsiders Effectively additional equity capital, however no issue costs of loss due to under-pricing No dilution of control The stock market generally views an equity with skepticism, but retained earning doesn’t

14. Quantum very limited High opportunity costs: dividends forgone by equity holders Disadvantages

15. Preference Capital The parts of corporate securities are called as preference shares. It is the shares, which have preferential right to get dividend and get back the initial investment at the time ofwinding up of the company. Preference shareholders are eligible to get fixed rate of dividend and they do not have voting rights.

16. Advantages Fixed dividend Cumulative dividends Redemption Participation Convertibility

17. Disadvantages Expensive sources of finance No voting right Fixed dividend only Permanent burden Taxation

18. Term Loan Term loan is a loan made by bank/financial institution to a business having an initial maturity of more than one year.

19. Features of Term Loans Currency Security Interest payment and principal repayment Restrictive covenants

20. Advantages Interest on debt is tax deductible Does not result in dilution of control Do not partake in value created by the firm Issue costs of debt is lower Interest cost is normally fixed, protection against high unexpected inflation Has a disciplining effect on management

21. Disadvantages Entitles fixed obligation for interest and principal, non payment can even lead to bankruptcy/ legal action. Debt contracts impose restrictions on firm’s financial and operational flexibility. If inflation rate dips, cost of debt higher than expected.

22. Debenture A Debenture is a document issued by the company. It is a certificate issued by the company under its seal acknowledging a debt. According to the Companies Act 1956, “debenture includes debenture stock, bonds and any other securities of a company whether constituting a charge of the assets of the company or not.”

23. Features Trustee Security Interest rate Maturity and redemption Call and put feature convertibility

24. Advantages Long-term sources Fixed rate of interest Trade on equity Income tax deduction Protection

25. Disadvantages Fixed rate of interest No voting rights Creditors of the company High risk Restrictions of further issues

26. Raising Long Term Finance What is long term financing? Financial requirement of the business differs from firm to firm and the nature of the requirements on the basis of terms or period of financial requirement, it may be long term and short-term financial requirements.

27. Securities Issued To Raise The Long Term Finance Venture capital Initial public offer Secondary public offer Rights issue Private placement Preferential allotment Dilution Obtaining a term loan

28. Venture capital What Is Capital ? Most important factor of production. No economic entity can function without capital. Requires at every step for set up, expansion, growth, modernization, diversification.

29. Question of Concern What is Venture Capital??? It is type of private equity capital typically provided by professional, outside investor to buss. Growth…. ?

30. Initial Public Offer Initial Public Offer (IPO) 1 st public offering of equity shares Followed by a listing of shares on the stock market Decision to go public

31. Benefits of Going Public Access to capital Respectability Investor recognition Window of opportunity Liquidity Benefit of diversification Signals from the market

32. Costs of Going Public Adverse Selection Dilution Loss Of Flexibility Disclosures Accountability Public Pressure Costs

33. Eligibility for an IPO A company can make 100% retail issues provided it satisfies all the following conditions It has a net tangible asset of at least Rs 3 crore in each of the preceding three years. It has a track record of distributable profit for at least three out of immediately proceeding 5 years. It has a net worth of at least Rs1 crore in each of the preceding 3 financial years. The issue size (offer through offer document + firm allotment + promoters contribution through offer document) does not exceed five times the pre-issue net worth

34. Principal steps in an IPO Approval of the MD Approval of the share holders Appointment of a merchant banker as LM The LM carries out due diligence to check Appointment of various intermediaries  The LM draws up the issue budget The LM prepares the draft prospectus The LM files the draft prospectus with SEBI, SEBI places the same on its website

35. Conti. Listing application to the stock exchanges, the draft prospectus is also hosted on the websites of the LM and the underwriters. Tripartite agreement with the registrar and all the depositories The LM makes the underwriting arrangements, if the issue is proposed to be underwritten.  

36. Conti . Within 21 days, SEBI makes observations Stock exchanges suggest changes Company carries out modifications Company files the prospectus with the ROC Market the issue by press meetings, brokers’ meetings, investors’ meetings and so on

37. Conti . ‘ Announcement advertisement’ – 10 days prior to the opening the issue. conform to Form 2A – abridged prospectus Dispatch of the application forms to all stock exchanges, SEBI collection centers, brokers

38. Conti. Underwriters and investor associations. Accompanied by the abridged prospectus open for min of 3 days and max of 21 days After the issue is closed, the basis of allotment is finalized The LM ensures that the demat credit or dispatch of share certificates and refund orders to the allottees is completed within 2 working days after the basis of allotment is finalized and the shares are listed within 7 days of the finalization of the basis of allotment.

39. Role Of The Lead Manager of The Issue Structure the issue Submit the prospectus with the SEBI Arrange underwriting Finalize the prospectus Coordinate the efforts of brokers, bankers, advertising agencies, printers, and others

40. Conti . Develop the strategy for marketing the issue Monitor the issue during the subscription period Help in finalizing the basis of allotment Assist in securing the stock exchange listing

41. Cost of Public Issue Underwriting expenses Brokerage Fees to the managers to the issue Fees for the registrars to the issue Printing expenses Postage expenses Advertising and publicity expenses Listing fees Stamp duty

42. Issue Pricing SEBI ( DIP ) Guidelines Every company can freely price its shares Disclose the basis for the issue price in terms of following Adjusted EPS (for past 3 years) P/E ratio in relation to issue price Return on net worth Minimum return on total net worth after the issue needed to maintain EPS Net asset value

43. Under-pricing of IPOs Winner’s Curse Bait for Future Offerings Informational Asymmetry Regulatory Constraints Political Goals

44. Secondary public offer:  Secondary public offer Similar procedure to that of an IPO Subject to fewer regulations than an IPO

45. Key Provisions For Secondary Public Offer Aggregate size of the issue does not exceed 5 times the pre-issue net worth Promoters’ contribution To the extent of 20% of the proposed issue OR At least 20% holding in the post-issue equity capital

46. Conti . Excess contribution subject to preferential allotment guidelines – locked in for 1 year period Non-applicability of promoters’ contribution and lock-in of excess contribution – if listed for minimum of 3 years

47. Public Offer of Debts No distinction between an IPO and secondary public offers Mechanics for secondary offer are much the same as an IPO Some differences Retail route vs. book building Security Credit rating Debenture redemption reserve Debenture trustees Stable cash flows vs. growth prospects 

48. Rights Issue Issue of a capital to the existing shareholders Pro rata basis, This is required under Section 81 of the Companies Act 1956. The shareholders however, may by special resolution forfeit this right, partially or fully, to enable a company to issue additional capital to the public

49. Characteristics of a Rights Issue No. of rights shares to be issued The rights entitlement Subscription price Rights are negotiable, holders can sell them Can be exercised only during a fixed period usually 30-60 days

50. Procedure for a Rights Issue Letter of Offer + composite application form Form A ,Form B, Form C ,Form D The composite application form must be mailed to the company within a stipulated period, which is usually about 30 days.

51. Conditions Exercise rights in full – can apply for additional shares Renounce rights, wholly or partially – can’t apply for additional Shares available due to non-exercise of rights – allotted to shareholders who have applied for additional shares Balance shares left after meeting requests of additional shares – disposed of at the ruling market price or the issue price, whichever is higher

52. Consequences of a Rights Issue Market value per share Value of a right Earnings per share Wealth of shareholders : - ( Right offering provided to the share holders are free to exercise their right or sell )

53. Continue. Value of a share NP 0 + S N + 1 Value of a Right N(P 0 – S) N + 1 Where , N - no. of existing shares required for a rights share, P 0 - cum-rights market price per share, S - subscription price  

54. Setting the subscription price Theoretically subscription price is irrelevant practically If S > P 0 Market value after issue < S Existing shareholders – do not like the idea Non- shareholders – no interest , suffer a loss If S = P 0 Existing shareholders – not appealing Non-shareholders – no opportunity of gain Therefore S has to be set lower than P 0

55. Following points to be considered while setting S Probability of the success of the offering No. of rights shares to be issued to raise a given amount of additional capital Expectations of investors The fluctuation of the share The size of the rights issue Pattern of share holding

56. Comparison Between A Rights Issue And A Public Issue Familiarity and success Floatation costs of a rights issue Price dilution of earnings per share  

57. Private placement Private placement Sale securities to a sophisticated investors. Securities sale to only few institutions like mutual funds, venture capital Private placement of Equity Unlisted company get funds from sophisticated investors. Free to choose qty. & price. Private placement to Debt Listing was not compulsory Credit rating was not mandatory

58. Conti . In a private placement, funds are raised in the primary market by issuing securities privately To some investors without resorting to underwriting (insurance against risk by a guarantor). The investors in this case may by financial institutions, commercial banks, other companies, shareholders of promoting companies, and friends and associates of the promoters.

59. Private placement of Equity Private placement to Debt Unlisted company get funds from sophisticated investors. Free to choose qty. & price. Listing was not compulsory Credit rating was not mandatory

60. The Key Features of New Regulatory Dispensation In Late 2003 Regulations special resolution pricing open offer Lock-in period The discloser required for the private placed debenture similar to public offered debentures Debt securities shall be compulsorily listed Debt securities shall be issued & traded in Demat form Preferential allotment is made to promoters, venture capitalist, suppliers. Preferential allotment is not related to a public issue

61. Preferential Allotment An issue of equity or equity related instruments by a listed company to pre-identified investors who may or may not be the existing shareholders of the company at a pre-determined price is referred to as a preferential allotment. Made to promoters, strategic investors, venture capitalist, financial institutions and suppliers Rationale- to secure equity participation of those that the company considers desirable, but who may otherwise find it very costly or impractical to buy large chunk of shares in the market

62. Regulations Special resolution Pricing Open offer- Lock-in-period

63. Dilution Dilution is an option we can think it in terms of proportionate ownership or market value or book value or earning per share. Dilution on proportionate ownership. Dilution of value : book value v/s market value

64. Term loan Term loan procedure Submission of Loan Application Initial Processing of Application Appraisal of the proposed project Issue of the letter of sanction Acceptance of term and conditions by the borrowing unit Execution of Loan agreement Disbursement of loan Creation of security Monitoring

65. Project Appraisal Market appraisal Technical appraisal Financial appraisal Economic appraisal Managerial appraisal : Resourcefulness Understanding Coommitment