Equity capital is also a ownership capital. Equity shareholders enjoys the profit of the firm on one hand and bears the risk on the other hand. i) ii) iii) iv) Authorized capital: It is the maximum capital which an organization can issue. Issued capital: It is that part of authorized capital which is actually issued by the company. Subscribed capital: It is that capital which is subscribed by the public when it was issued. Called up and paid up capital: It is the equity capital which is actually paid by the investor. = Paid up equity capital + reserves and surplus / No. of equity shares. Face value: It is the normal price of the shares to be issued by the company. Issue price: It is the price at which the company issues the shares, usually its more than face value. Market price: When shares are traded in secondary market the prevailing price is a market price. Features of equity shares: i) ii) iii) iv) v) Residual claim on income:- After paying interest, tax, preference dividend, the remaining profit can be distributed to equity share holder. Residual claim on asset: While repaying capital also equity shareholders stands last. Right to control : the firm Voting rights are available to equity share holders Pre-emptive rights: This rights of equity shareholders makes the company to offer additional equity shares to existing equity holders before it is offered to general public. Limit liability arises in case of equity capital. It is a permanent source – no maturity period No compulsion to pay dividend It provides cushion to lenders Dividend on equity capital is tax exempted in the hands of investors.
Book value: It is the value of the equity shares, as shown in the balance sheet.
vi) a) b) c) d)
Limitations: i) ii) Dilutes the control Floatation (issue cost) cost is very high
Dividend on equity is not allowed as deduction for tax purpose, more over there will be a additional tax on dividend declared.
Issue of equity shares: Firm can raise finance by issuing equity shares in different forms like: a) b) c) d) e) By going for IPO By going for subsequent issue By right issue By private placement By preferential allotment A) Initial public offer of equity shares (IPO):If the firm is issuing the shares for the first time, it is referred to as initial public offer. Initial public offer will be followed by listing of the equity shares in the stock exchange. Benefits of going public:
Access to capital Respectability Investors recognition Liquidity to promoters Signals from markets Dilution of control Loss of flexibility Disclosure Accountability Public pressure Costs associated with issue Approval of board of directors Appointment of lead managers (merchant banker) Appointment of other intermediaries like co-managers, underwriters, registrar, bankers, brokers etc. Filing of prospectus with SEBI Filing of prospectus with Registrar of companies. Printing and dispatch of prospectus Statutory announcement of the issue Promotion of the issue Collection of application by lead manager
Cost of going public (limitations):-
Steps involved in IPO
Processing of application by lead manager Allotment of shares Listing of the shares in stock exchange. B) Subsequent issue/ public issue by listed companies:
A company whose shares are already listed in stock exchanges may think of generating some more finance by issuing equity shares. this is referred to as subsequent issue. The company need to fulfill certain conditions before going for subsequent issue of equity shares like: a) b) Company should be listed in stock exchange for atleast 3 years. Company need to have a track record of payment of dividend for atleast 3 years immediately proceeding the year of issue.
Procedure for issue of equity shares of a limited company is similar to that of an IPO. The company is having a freehand in fixing the prices of subsequent issue. The general practice in India is that 6 months average closing price is taken as issue price. C) Right issue: Right issue involves selling equity/securities in the primary market to existing shareholders. This can be done after meeting some requirements specified by SEBI. When company issues additional capital, it has to be first offered to existing shareholders. The shareholders however may forfeit this right partially or fully to enable the company to issue additional capital to public. Characteristics of right issue:1) 2) 3) 4) 5) 6) 7) Number of rights that a shareholders gets is equal to the number of shares held by him. The number of rights required to subscribe an additional shares is determined by issued company. Price per share is determined by the company. Existing shareholders can exercise right and can apply for the share. Shareholders who renounce their rights are not entitled for additional shares. Rights can be sold Rights can be exercised only during a fixed period (usually 1 month) Desired funds Number of new shares = --------------------------------Subscription / offer price Existing shares Number of rights required to get an additional shares = ---------------------New shares
Price of the share after right issue = Existing shares x current M.P. + new shares x subscription price = -------------------------------------------------------------------------------------Total shares (existing + new shares) Merits of right issue: 1) 2) i) ii) iii) Less expensive as compared to direct public issue Management of applications and allotment is less cumbersome. Can be used by only existing company Cannot be used for large issues Wider ownership bare cannot be achieved. D) Private placements It involves allotment of shares (or other securities) by a company to few selected sophisticated investors like mutual funds, insurance companies, banks etc. Private placement of equity:- Usually unlisted companies who are not ready for IPOs can go for this. Price can be freely determined by company as it is not regulated by SEBI. Private placement of debt:- Companies can directly place their debentures, bonds etc. In Indian context private placement of debt of listed companies and equity of unlisted companies are popular. Advantages of private performance: 1) 2) 3) Helpful in rising small size of funds Less expensive as compared to other methods Takes less time as compared to other type of issues. E) Preferential allotment: It is an issue of equity by a listed company to selected investors at a price which may or may not be related to prevailing market price. It is not a public issue of shares. This kind of preferential allotment is made mainly to promoter or their friends and relative. The company should pass special resolution to do preferential allotment. In case if the government is having a state in the company., the central government permission is necessary. Pricing:- price of preferential allotment must not be lower than 6 months average closing price. Pricing regulations of preferential allotment to FII’s are more stringent.
Lock in period:- The shares allotted under preferential allotment process will attract a lock in period. If it is allotted a promoter, the lock in period will be 3 years and to others, it is 1 year.
3 PREFERENCE SHARE CAPITAL: It is an unique type of long tem financing which combines some of the characteristics of equity shares as well as debentures. It is similar to equity capital because:a) b) c) a) b) c) d) Dividend to equity capital because: Not obligatory to pay dividend Irredeemable type does not have any maturity. It carries fixed dividend It is ranked higher than equity on the basis of claim It does not have any voting rights normally It does not have any share in residual earnings.
It is similar to debenture because:
Features of preference shares:
1) 2) 3) 4) 5) 6) 7) 8) 9)
Prior claim on income/ asset:- Prior claim arises as compared to equity shares. Cumulative dividend:- Dividends get accumulated and must be paid before paying dividend to equity shareholders. Redeemability:- At the end of maturity period the preference shares need to be redeemed. Fixed divided:- Preference shares carries fixed of dividend. Convertibility:- Preference shares can be converted into equity shares at the end of maturity period. Voting rights:- Generally preference shareholders does not possess voting rights, but if dividend on preference shares is not paid for 2 or more consecutive years than preference shareholders gets voting rights. Participation feature:- Preference shares holders may enjoy participation in additional profits of the organization. Sinking fund:- Sinking fund may be created by issuing company to retire preference shares. Call feature:- If preference shares carried call option, company can buy back the preference shares before its maturity.
Types of preference shares:
Redeemable and irredeemable preference shares:-
Redeemable is one which can be redeemed/ re-purchased by the company after the maturity period of shares on the other hand the shares which cannot be retired by the company is termed as irredeemable preference shares. ii) Convertible and non convertible preference shares If the preference shares can be converted into equity shares at the end of maturity period it is termed as convertible preference shares. If the company does not convert preference shares into equity shares it is called as non-convertible preference shares. iii) Participative and non-participative preference shares If preference shareholders enjoys additional dividend in case of extra profit or if they enjoys additional capital in case of liquidation of the company. It is termed as participative preference shares. If such participation is not available it is termed as nonparticipative preference shares. iv) Cumulative and non cumulative preference shares: Unpaid dividend of one year it gets accumulated to next period it is termed as cumulative preference shares. If dividend does not get accumulated it is termed as noncumulative preference shares.
Advantages of preference shares: a) Risk less source of finance: Dividend payment is not compulsory in case of preference shares and claims of promoters does not get dilated, it is considered as risk less source of finance. b) profit. c) d) i) Limited voting rights is available to preference shares Redemption of preference shares can be delayed without any significant penalty No tax advantage: Stable dividend: The company need not have to pay any extra dividends even when there is a extra
Limitations of preference shares: Payment of dividend on preference shares is not allowed as deduction for tax purpose. ii) Cumulative dividend: The company has to pay all the accumulated dividend on preference shares before dividend is payable to equity shareholders.
Debentures / bond is a debt instrument indicating that a company has borrowed certain sum of money and promises to repay if future under clearly defined terms. Debenture holders are the long term creditors of the organization and are eligible to get stipulated amount of interest and re-payment on the maturity. Features: a) b) c) d) Interest:- Debentures carries a fixed rate of interest, which is a contractual payment by the company. Interest is allowed as deduction for tax purpose. Maturity:- debentures have fixed maturity usually 7 – 10 years. They are redeemable after the maturity period. Redemption:- After the maturity debentures are redeemed. They may be redeemed at par or at premium. Sinking fund:- A sinking fund si created by the company for the purpose of redemption of the bond. Every year a fixed sum is transferred to the fund and that money will be used to redeem the debentures. Buy back/ call provision:- Company may exercise call option, there by can redeem the debentures before the maturity wherever buy back is done the company has to redeem at a premium. Trust:- When the debentures is issued by the company a trust is created. It includes trustees drawn from company’s directors, investors, bankers etc. it is the duty of the trust to protect the interest of the investors. Security: Debentures are either secured or unsecured. If it is secured the debenture holders can exercise lien on company’s assets. Yield:- Debentures are listed in the stock exchange there will be a market value of debentures. Yield on the debenture is related with its market value. Claims on asset and income:- Before payment of dividend to shareholders interest on debentures are paid same way. Before payment of capital to shareholders, capital be paid to debenture holders, therefore debentures holders are having preferential claim over shareholders. Compulsory credit rating:- The company issuing debentures need to take compulsory credit rating from approved agencies. Non convertible debentures: There are the debentures, which will not converted in to equity shares by the company. Fully convertible debentures:- These are the debentures which will be fully converted into equity shares as per the terms of issue. The conversion will be made at the end of stipulated period.
g) h) i)
Types of debentures: i) ii)
Partly convertible debentures: Here only a part of debenture will be converted into equity shares at the end of the period and remaining part will be redeemed by the company. Innovative debt instruments 1) Zero interest debentures/bonds (ZIB):Zero interest bonds, do not carry any explicit interest. They are sold at discount, the difference between face value and acquisition price is the return/ gain on the bond. For eg:- Rs. 100 face value bond may be issued at Rs. 50 for period of 6 years. The investor pays Rs. 50 on the bond at the time of issue and gets RS. 100 on maturity. Face value/ market value Acquisition price = ---------------------------------(1 + K)n 2) Deep discount bonds: It is similar to ZIB. In case of deep discount bond, it carries a marginal rate of interest and issued at discount and redeemed as par.
Example :- Rs. 100 face value bond issued at Rs. 70, 6 years and redeemed at Rs. 100 over 6 years period it carries a interest of 3 years. Organization like IDBI, SIDBI have issued this type of debentures. 3) Secured premium notes: It is a secured debenture which is redeemable at premium in different installments. It carries no interest in lock-in period. TISCO has issued in 1992. Example:- Rs. 100 face value instrument is issued at par, for 3 years there will be no interest from 4th year onwards till the 8th year it will be redeemed at RS. 35 per annual. 4) Floating rate bonds: Interest rate on these bonds are not fixed. Interest is linked to market rate of interest. Interest is payable on the benchmark rates like bank rate, maximum interest on term deposits etc. Advantages of debentures: a) Less costly : as compared to equity shares b) Tax deduction :- Interest payable on debentures is allowed as deduction for tax purpose. c) No ownership dilution:- As the debenture holders does not carry any interest payment. d) Fixed interest:- Interest rate does not increases with increase in profits of organizatin.
Reduced real obligation:- Although interest payable is fixed, with the change in inflation rate, the real obligation the part of the company reduces.
Limitations of debentures: i) Obligatory payment:- If the company fails to pay the interest on debentures the investors can ask for the declaring company as bankrupt. Interest payment on debenture is obligatory. Financial risk associated with debenture is higher than shares. Cash out flow on maturity is very high. The investors may put various restrictions/ covenants while investing in the debentures.
ii) iii) iv)
There are different ways in which the equity holders can mismanage the funds belonging to debenture holders. This leads to default risk to debentures. This possibility arises in the following circumstances.
Excess dividend payment to equity shareholders. By issuing more debentures diluting the claim. Asset substitution where by funds may be used for higher risk projects. Under investment of funds.
Therefore debt holders should try to protect their interest. Supplier of debt may include several covenants (conditions) in the debt agreements to protect their interest. Covenants are meant to protect the interest of debentures against dilution of claim, asset depletion, asset substitution and under-investment. Broad categories of covenants: 1) Positive covenants: These covenants indicates what the firm should do in order to protect the interest of the investors. Example: a) b) c) d) 2) Submission of periodical returns Maintaining minimum working capital Maintaining sinking fund Maintaining minimum networth etc.
There covenants restricts certain actions by borrowing firm without prior permission of lender.
Not to issue additional debt and dilute the claim Not to diversity the activity
Not to dispose or lease out the asset Not to declare the dividend to shareholders beyond a given percentage.