ALTERNATIVE

SOURCES OF
FINANCE

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 Alternative sources of finance
n bonds,
n leasing,
n franchising,
n factoring and forfeiting,
n venture capital

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 Bonds
n Bond – debt instrument issued by a business which
obligates it to make periodic interest payments to the
holder of the bond, as well as to repay the principal of
the bond at the maturity day;
n The issuer obtains funds by placement of bonds in the
capital market, i.e. they are sold to the economic
subjects that invest their funds to purchase these
securities.
n The process of the issue is similar to that one of the
shares.

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 Characteristics of bonds
n Nominal value (face value ang., par value am.) – due sum lended
by the creditor to its issuer, it is given on the bond
n Quotation – the present market price, given as a percentage of its
nominal value
n Interest payment – a coupon rate
n Bond duration – measure of sensitivity of the price of a fixed-
income investment to a change in interest rates
n Yield upon investment – rate of return of really invested funds
n Yield to maturity (YTM) – an internal rate of return of the bond

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 Bond as a security has to contain:
n name and seat of issuer,
n name of bond and ISIN,
n nominal value,
n determination of return,
n declaration of the issuer that he owes the principal to the
bondholder,
n obligation of the issuer to repay the principal and pay return,
determination of these payments and place of payment,
n registered bonds – name of their first holder,
n date of issue, signature of authorized person,
n information about official approval of issue.

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 Factors important for investors
n Price of bond – in secondary market may be
significantly different than the nominal value
(bond return, average rate of return of
comparable investment opportunities, life of
bond, relation market supply-demand)
n Risk of bond – depends on how is the issue
secured and on creditworthiness of the issuer
(not secured and secured bonds)

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 Factors important for investors
(continued)
n Return of bond – depending on determination of the coupon rate –
different types of bonds
n Date and form of payment – maturity 5 – 30 years; can be repaid
by one balloon payment, by periodical payments;
- some bonds may have a call feature – allows the firm to call or
retire the bond earlier than on maturity date
n Bond liquidity – ability to trade bonds efficiently without causing
any major changes in their price with minimum cost

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 Classification of bonds
Bonds can be categorized according to several criteria.
The most often used – according to the type of issuing
company:
n treasury bonds – issued by the government to cover
state budget deficit,
n municipal bonds – issued by local governments to
cover local budget deficit or to finance large projects,
n bank mortgage bonds – issued by commercial banks to
re-finance mortgage loans,
n corporate bonds – issued by private companies as an
alternative external source of finance.

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 Classification of bonds (continued)
Classification according to the form of interest payments:
n fixed coupon rates – when issued, bond has stated coupon rate,
which, multiplied by the bond´s nominal value, yields the annual
interest payment
n floating rate bond – interest rate can be adjusted up or down
depending on the pre-stated indicator
n hybrid rate bond – combines fixed and floating returns
n extraordinary return – extraordinary motivation type used in
addition to the above forms
n zero-coupon bond – pays no interest for the life of the contract;
investor earns a return by purchasing the bond at one price and
either selling it in a secondary market at a different price, or simply
holding it to maturity and receiving nominal value

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 Bonds - pros
n large loans depending on the capital market
situation,
n obtaining funds from many anonymous
investors,
n the principal is paid once at the bond´s maturity
date,
n possibility to repay the loan earlier without a
special agreement

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 Bonds - cons
n official approval of the issue, complicated legal
regulations, publicity necessary,
n initial issue costs higher than obtaining another
type of loan,
n additional costs for issue administration,
n appropriate for larger companies, smaller
businesses are not able to place the bonds in
the market

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 Leasing
n Lease – a rental agreement that extends for a year or more and
involves a series of fixed payments
n Leasing – similar to borrowing funds in order to purchase an asset
n It is an agreement between 2 parties – the user (the lessee), the
owner (the lessor). The lessor of an asset grants the lessee the right
to its exclusive possession and use for a specific period and under
specified conditions, in return for specified periodic rental or lease
payments. The lessee acquires the use but not ownership, he binds
himself to make periodic lease payments at stipulated intervals for a
stated period. So, the lessor actually owns and is contracting out the
services of the asset, retains title to and consequently ownership of,
that asset.

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 Lease rate factor
[1st payment + other payments + residual value] : purchase price > 1 !!!

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 Types of leases
According to the length of the lease period:
n operating lease – short-term, the contract period much shorter than
the economic life of an asset, is cancellable, after a set period an
asset is returned to the lessor, rewards and risks of ownership stay
with the owner
n financial lease – long-term relation between the lessor and the
lessee; although legal ownership remains with the lessor, it virtually
transfers all the rewards and risks to the lessee; covers a significant
part of the economic life of the asset; generally cannot be cancelled;
transfers ownership to the lessee by the end of the lease period;
allows the lessee to purchase the asset at a price lower than the fair
market value of the asset when the lease expires

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 Types of leases (continued)
Other types:
n direct leasing – the lessor purchases the property directly from the
manufacturer and leases that property to the lessee
n sale and leaseback agreement – a business sells an asset to a
lessor and simultaneously enters into a lease contract to lease it
back in order to raise finance and continues to use the asset
n leveraged lease – has 3 parties involved: lessee, lessor, lender
(supplies funds to the lessor to acquire an asset)
n employee leasing – leasing company (professional employer
organization) is the official employer, assumes responsibility for
work, overseeing all HR-related functions

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 Leasing - pros
n no need to have the entire amount of purchase price available at the
beginning,
n the lease payments periodically become the part of the costs and
reduce profit as well the tax base and tax payable as they are tax-
deductible,
n the lessee repays the lease payments from the revenues of the
financed assets after their launching (in case of manufacturing
assets),
n contract is flexible, less restrictive and not so time consuming as
most loans,
n maintenance of leased assets is often performed by the lessor

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 Leasing - cons
n higher costs due to high profits of leasing
companies and all costs associated with leasing,
n the sum of lease payments is higher than the
purchase price of the leased asset,
n usually it is required to pay the increased first
payment or initial fees that can negatively affect
business liquidity,
n the lessee is usually not allowed to sell, rent or
return the leased asset, contract is not
cancellable

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 Venture capital
n VC – long-term capital provided to SMEs
wishing to grow without ready access to
stock markets with higher level of potential
returns as well as higher level of risk;
normally long-term finance
n Equity finance!!!

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 Venture capital – types
n Start-up capital – for businesses at a concept stage
n Growth capital – for young, expanding businesses
n Buy-out or buy-in capital – to fund the acquisitions
n Share purchase capital – to fund the purchase of
shares in a business in order to buy-out part of the
ownership of an existing business
n Recovery capital – rescue finance used to turn around
a business after a period of poor performance

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 Venture capital process
n Step 1: Obtaining the funds
n Step 2: Evaluating investment opportunities and
making a selection
n Step 3: Structuring the terms of the investment
n Step 4: Implementing the deal and monitoring
progress
n Step 5: Achieving returns and exiting from the
investment

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 Business Angels
n BA – often wealthy individuals who have been
successful in business, they are usually willing to
invest £10,000 - £100,000 in a start-up business
or a business that is at an early stage of
development through a shareholding. In addition
to providing finance, a BA can offer a wealth of
business experience.
n SBAN – the Slovak Business Angels Network
n EBAN – the European Business Angels Network

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 Franchising
n Franchising – a method of expanding business
on less capital than would otherwise be needed.
n A franchisee pays a franchisor for the right to
operate a local business, under the franchisor´s
trade name. The franchisor will charge the
franchisee an initial franchise fee and regular
payments (usually a percentage of the
franchisee´s turnover).

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 Franchising – pros
Advantages to the franchisor:
n the capital outlay needed to expand the business is
reduced substantially,
n the image of the business is improved
Advantages to the franchisee:
n he obtains ownership of a business for an agreed period,
n he is able to avoid some mistakes because the
franchisor has already learned from its own past
mistakes and developed a scheme that works

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 Factoring
n Factoring – a method of raising short-term
finance; a factor will manage the sales ledger of
the business and will be prepared to advance
sums to the business based on the amount of
trade debtors outstanding;
n means the selling of receivables to a financial
institution so funds can be received earlier than
the normal credit period;
n the business can receive between 80-90%
funding f the invoice amount

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 Factoring (continued)
Factoring fee:
n the discount (the interest for the period from selling the account
receivable to its maturity),
n the price of services provided to the client (debt management),
n the risk margin (the price for the assumption of the credit risk)
The factor may purchase:
n one account receivable,
n all client´s accounts receivable,
n accounts receivable within the pre-determined limit (in the absolute
amount or as a percentage of the accounts receivable)

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 Types of factoring
n notified/non-notified factoring –
- notified - the debtor is informed that the debt has been
purchased and requested to pay the factor directly
- non-notified - the debtor is not informed
n export/import factoring –
- export – domestic companies (exporters) use the
factor´s services in their country for international
business
- import – the use by foreign companies of factor´s
services in domestic country

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 Factoring - pros
n improved CF through reduction of outstanding
debts,
n savings through discounts when purchasing,
n up to 100% protection against credit losses,
n savings through debt management,
n ongoing credit rating of debtors,
n savings on credit insurance,
n improved balance sheet structure.

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 Forfeiting
n Forfeiting – similar to factoring, a method of trade
finance allowing exporters to obtain cash by selling their
medium term foreign accounts receivable at a discount
n Forfeiter – a specialized finance firm or a bank
department performing non-recourse export financing,
virtually eliminates the risk of non-payment
n Unlike factors, forfeiters typically work with the exporter
who sells capital goods commodities, or large projects
and needs to offer periods of credit from 180 days to up
to 7 years

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 Forfeiting – pros and cons
n Advantages:
- eliminates the risk of non-payment by foreign buyers,
- strong capabilities in emerging and developing markets
n Disadvantages:
- cost can be higher than commercial bank financing,
- limited to medium-term and high amount transactions

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 Commercial papers
n a short-term unsecured „promissory“ note
backed by the promise of the issuer to
redeem the note at maturity,
n sold on a discount basis like treasury bills;
slightly higher return
n limited secondary market of commercial
papers
n not issued by Slovak companies

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