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

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 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 Shares–Features

• Claim on Income

• Claim on Assets

• Right to Control

• Voting Rights

• Pre-Emptive Rights

• Limited Liability

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 Reporting of Ordinary Shares
• Tata Motors' Share Capital as on 31 March
2008

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 Ordinary Shares–Pros 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

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 Underwriting of Issues

• It is legally obligatory to underwrite a public and a rights issue.

• In an underwriting, the underwriters—generally 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.

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 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

• (iii)he does not exercise or sell his rights.

• He will lose under the third option.
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 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 Shares–Features
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 Shares–Pros 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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 Debentures–Features
• Interest Rate
• Maturity
• Redemption
• Sinking Fund
• Buy-back (call) provisions
• Indenture
• Security
• Yield
• Claims on Assets and Income

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Types of Debentures

1.Non –Convertible Debentures

2.Fully –Convertible Debentures

3.Partly –Convertible Debentures

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 Debentures–Pros 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 Loans–Features
• 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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