UNIVERSITY OF NAIROBI

OPEN AND DISTANCE LEARNING - NYERI EXTRA MURAL CENTRE

MASTER OF ARTS IN PROJECT PLANNING AND MANAGEMENT

PROECT FINANCING (LDP 602)

TERM PAPER

EXPLAIN THE PROCESS AND MEANS OF RAISING EQUITY

CAPITAL FOR THE PROJECT COMPANY

NAME : KIAI ALEX MAINA

REG NO : L50/22173/2019

SUBMITTED TO : MOSES MURATHIMI

DATE : 7th APRIL, 2019

ABSTRACT

This paper discusses the process and means of raising equity capital for the project company.
It will touch on the various sources with both advantages and disadvantages of each.

This paper discusses the breakthrough success of digital marketing in recent years. It will
touch on areas such as how it originated, how it has progressed, and the several advantages it
provides to advertisers. Specific emphasis will be placed on the campaigns of Gatorade,
Coca-Cola, Dunkin Donuts and Free People.

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Table of Contents
1.0 INTRODUCTION...........................................................................................................................4

2.0 EQUITY FINANCING...................................................................................................................4

2.01 Advantages of Equity Financing................................................................................................6

2.02 Disadvantages of Equity Financing...........................................................................................7

3.0 DEBT FINANCING........................................................................................................................8

3.01 Advantages of debt financing....................................................................................................8

3.02 Disadvantages of debt financing................................................................................................8

3.1. Bank Debt...................................................................................................................................9

3.11 Advantages of Bank Debt Financing.......................................................................................10

3.12 Disadvantages of Bank Debt Financing...................................................................................10

4.0 HYBRID SECURITIES................................................................................................................14

4.1. Convertible Debt.......................................................................................................................14

4.2. Preferred Stock.........................................................................................................................14

4.3. Option-Linked Bonds...............................................................................................................15

4.31 Advantages..........................................................................................................................15

4.32 Disadvantages......................................................................................................................16

5.0 CONCLUSION.............................................................................................................................17

6.0 REFERENCES..................................................................................................................................17

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1.0 INTRODUCTION
Capital can be defined as any form of wealth that is employed to produce more wealth for a
business entity. There are three types of capital in a business entity which are; fixed capital,
working capital, growth capital, equity capital (risk capital) (Maina, 2014). Capital may also
be said to mean “the amount by which the assets of a business exceed its liabilities” while
share capital is the “minimum value of the net assets which must be raised initially and so far
as possible retained in the business” (KeithAbbot, 2002).

The financing options available to a company can differ depending on the size of the
company. A small business is going to have fewer choices about how to raise funds than a
bigger business. A corporate institution can raise capital to finance itself through investors or
financial institutions (KeithAbbot, 2002). The capital is raised through various ways and
areas which may include: capital markets which includes new share issues and rights issues;
loan stock; retained earnings; bank borrowing; government sources; business expansion
scheme funds; venture capital; and franchising. It’s however generally agreed that these
means and ways are broadly grouped into two basic ways to raise capital: equity and debt.

2.0 EQUITY FINANCING

This is the process of raising capital through the sale of shares in an enterprise. Equity
financing essentially refers to the sale of an ownership interest to raise funds for business
purposes. Private firms have fewer choices available than do publicly traded firms, because
they cannot issue securities to raise equity. Consequently, they have to depend either on the
owner or a private entity, usually a venture capitalist, to bring in the equity needed to keep
the business operating and expanding. Publicly traded firms have access to capital markets,
giving them a wider array of choices. Equity financing spans a wide range of activities in
scale and scope, from a few thousand dollars raised by an entrepreneur from friends and
family, to giant initial public offerings (IPOs) running into the billions by household names
such as Google and Facebook. (Investopedia, 2014).

A Kenyan example would be the Safaricom’s IPO, in 2008 which was overwhelmingly
subscribed after attracting some 800,000 new investors bringing with them over 220 billion
against the Sh.50 billion the telecom firm was seeking through the offer. (Kamau, 2014)
Following the IPO, the public got 25 percent of the issued ordinary share capital of
Safaricom, while the government got 35 percent and Vodafone Kenya’s shareholding

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remaining unchanged at 40 percent. (VictorJuma, 2013). There have been other several
successful IPOS in Kenya for instance Kengen Initial Public Offering (IPO) attracted an
estimated 280,000 applicants committing over Sh 26 billion investment capital the figure
represented an oversubscription of Sh18.2 billion.

Equity investors get ownership in the company but do not have a guaranteed return. Issuing
stock is the most obvious way to raise funds using equity. Retained earnings (when the
company uses its own earning to finance projects) are also an equity investment. With
retained earnings, the company takes money that could have been returned to shareholders
and uses it to fund capital projects. Effectively, it is using the shareholders money to fund
these projects that increases the value of a corporate entity’s equity holdings.

Equity financing involves not just the sale of common equity, but also the sale of other equity
or quasi-equity instruments such as preferred stock, convertible preferred stock and equity
units that include common shares and warrants (Pinto, 1994).

If a company has grown large enough to consider going public, it may consider selling
common equity to institutional and retail investors. Later on, if it needs additional capital, the
company may go in for secondary equity financings such as a rights offering or an offering of
equity units that includes warrants as a “sweetener.”For instance in 2014 Kenya’s Uchumi
Supermarkets set the price of its three for eight rights issue at 9 shillings ($0.01008) per share
this was done with the intention to raise 896 million shillings (Mwaniki, 2015).
Consequently, the Uchumi supermarket rights issue was oversubscribed by 83 percent
equivalent to Sh.1.6 billion against a target of Sh.896 million. Thus the rights issue was a
means by which Uchumi was able to raise funds.

The equity-financing process is governed by regulation imposed by a local or national

securities authority in most jurisdictions. An equity financing is therefore generally
accompanied by an offering memorandum or prospectus, which contains a great deal of
information that should help the investor make an informed decision about the merits of the
financing. Such information includes the company's activities, details on its officers and
directors, use of financing proceeds, risk factors, financial statements and so on.

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2.01 Advantages of Equity Financing

DIVIDEND

An investor is entitled to receive a dividend from the company. It is one of the two main
sources of return on his investment.

CAPITAL GAIN

The other source of return on investment apart from dividend is the capital gains. Gains
which arise due to rise in market price of the share.

LIMITED LIABILITY

Liability of shareholder or investor is limited to the extent of the investment made. If the
company goes into losses, the share of loss over and above the capital investment would not
be borne by the investor.

EXERCISE CONTROL

By investing in the company, the shareholder gets ownership in the company and thereby he
can exercise control. In official terms, he gets voting rights in the company.

CLAIM OVER ASSETS AND INCOME

An investor of equity share is the owner of the company and so is the owner of the assets of
that company. He enjoys a share of the incomes of the company. He will receive some part of
that income in cash in the form of dividend and remaining capital is reinvested in the
company.

RIGHTS SHARES

Whenever companies require further capital for expansion etc, they tend to issue ‘rights
shares’. By issuing such shares, ownership and control of existing shareholders are preserved
and the investor receives investment priority over other general investors. Right Shares are
issued at a price lower than current market price of the equity share. So, existing investor can
take that advantage or otherwise can renounce right in some one’s favor to get value of right.

BONUS SHARES

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At times, companies decide to issue bonus shares to its shareholders. It is also a type of
dividend. Bonus shares are free shares given to existing shareholders and many times they are
given in lieu of dividends.

LIQUIDITY

The shares of the company which is listed on stock exchanges have the benefit of any time
liquidity. The shares can very easily transfer ownership.

STOCK SPLIT

Stock split means splitting a share into parts. How should an investor be benefited by this?
By splitting of share, the per-share price reduces in the market which eventually increases the
readability of share. At the end, stock split results in higher volumes with a number of
investors leading to high liquidity of the share.

2.02 Disadvantages of Equity Financing

DIVIDEND

The dividend which a shareholder receives is neither fixed nor controllable by investor. The
management of the company decides how much dividend should be given. If there is a loss,
there is no question of dividend. If there is a profit, unless Board of Directors propose
dividend, investors will not receive dividend.

HIGH RISK

Equity share investment is a risky investment as compared to any other investment like debts
etc. The money is invested based on the faith an investor has in the company. There is no
collateral security attached with it.
FLUCTUATION IN MARKET PRICE

The market price of any equity share has a wide variation. It is always very difficult to book
profits from the market. On the contrary, there are equal chances of losses.

LIMITED CONTROL

An equity investor is a small investor in the company, therefore, it is hardly possible to

impact the decision of the company using the voting rights.

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RESIDUAL CLAIM

An equity shareholder has a residual claim over both the assets and the income. Income
which is available to equity shareholders is after the payment of all other stakeholders’
viz. debentureholders etc.

3.0 DEBT FINANCING

A clear alternative to using equity, which is a residual claim, is to borrow money. This option
both creates a fixed obligation to make cash flow payments and provides the lender with prior
claims if the firm is in financial trouble.

Debt financing is borrowing; investors get a promise of fixed future payments, but do not
have any ownership. Borrowing can be done through a financial intermediary, such as a bank,
or directly by issuing bonds.

3.01 Advantages of debt financing

Maintaining ownership - unlike equity financing, debt financing gives you complete
control over your business. As the business owner, you do not have to answer to
investors.

Tax deductions - unlike private loans, interest fees and charges on a business loan are
tax deductible. This is a big incentive for debt financing. Learn more about tax
deductions for your business.

Retaining profits - your only obligation to your lender is making repayments within
agreed time frames. You do not have to share your business profits.

3.02 Disadvantages of debt financing

Accessibility - banks are conservative when lending money. New businesses may find
it difficult to secure debt finance.

Repayments - you need to be sure your business can generate enough cash to service
the debt (i.e. repayments plus interest). Remember, if your business fails you are still
obliged to repay your debts.

Credit rating - failing to make repayments on time will affect your credit rating,
which may affect your chances of securing future loans.

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 Cash flow - committing to regular repayments can affect your cash flow. Start-up
businesses often experience cash flow shortages that make regular payments difficult.

Bankruptcy - unless you have a guaranteed way of paying back your loan, any
business that uses debt financing is risking potential bankruptcy. This is particularly
serious if you have pledged your personal assets to secure a loan.

3.1. Bank Debt

Historically, the primary source of borrowed money for all private firms and many publicly
traded firms have been banks, with the interest rates on the debt based on the perceived risk
of the borrower. Bank debt provides the borrower with several advantages. First, it can be
used for borrowing relatively small amounts of money; in contrast, bond issues thrive on
economies of scale, with larger issues having lower costs.

Second, if the company is neither well known nor widely followed, bank debt provides a
convenient mechanism to convey information to the lender that will help in both pricing and
evaluating the loan; in other words, a borrower can provide internal information about
projects and the firm to the lending bank. The presence of hundreds of investors in bond
issues makes this both costly and not feasible if bonds are issued as the primary vehicle for
debt. Finally, to issue bonds, firms have to submit to being rated by ratings agencies and
provide sufficient information to make this rating. Besides being a source of both long-term
and short-term borrowing for firms, banks also often offer them a flexible option to meet
unanticipated or seasonal financing needs. This option is a line of credit, which the firm can
draw on only if it needs financing.

Debt financing ventures have been undertaken by many companies. While some have been
successful others have not. Recently the Mumias Sugar Company Kenya’s largest sugar
manufacture has been on the verge of collapse due to the Sh.10.2 billion debt, Mumias went
on default on June 2014 with the seven banks contemplating placing it under receivership, the
seven lenders are collectively owed sh.6.5 billion by Mumias. Suppliers and other creditors
are demanding Sh.1.5 billion, while the taxman wants 2.2 billion. This is an example of an
unsuccessful debt financing venture (Gibendi, 2015).

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3.11 Advantages of Bank Debt Financing

Keep Control of the Company

A bank loans money to a business based on the value of the business and its perceived ability
to service the loan by making payments on time and in full. Unlike with equity finance where
the business issues shares, banks do not take any ownership position in businesses. Bank
personnel also do not get involved in any aspect of running a business to which a bank grants
a loan. This means you ghet to retain full management and control of your business with no
external interference.

Bank Loan is Temporary

Once a business borrower has paid off a loan, there is no more obligation to or involvement
with the bank lender unless the borrower wishes to take out a subsequent loan. Compare this
with equity finance, where the company may be paying out dividends to shareholders for as
along as the business exists.

Interest is Tax Deductible

The interest on business bank loans is tax-deductible. In addition, especially with fixed-rate
loans, in which the interest rate does not change during the course of a loan, loan servicing
payments remain the same throughout the life of the loan. This makes it easy for businesses
to budget and plan for monthly loan payments. Even if the loan is an adjustable-rate loan,
business owners can use a simple spreadsheet to compute future payments in the event of a
change in rates.

3.12 Disadvantages of Bank Debt Financing

Tough to Qualify

One of the greatest disadvantages to bank loans is that they are very difficult to obtain unless
a small business has a substantial track record or valuable collateral such as real estate. Banks
are careful to lend only to businesses that can clearly repay their loans, and they also make
sure that they are able to cover losses in the event of default. Business borrowers can be
required to provide personal guarantees, which means the borrower's personal assets can be
seized in the event the business fails and is unable to repay all or part of a loan.

High Interest Rates

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Interest rates for small-business loans from banks can be quite high, and the amount of bank
funding for which a business qualifies is often not sufficient to completely meet its needs.
The high interest rate for the funding a business does receive often stunts its expansion,
because the business needs to not only service the loan but also deal with additional funding
to cover funds not provided by the bank. Loans guaranteed by the U.S. Small Business
Administration offer better terms than other loans, but the requirements to qualify for these
subsidized bank loans are very strict.

3.2. Bonds

For larger, publicly traded firms, an alternative to bank debt is to issue bonds. Generally
speaking, bond issues have several advantages for these firms. The first is that bonds usually
carry more favourable financing terms than equivalent bank debt, largely because risk is
shared by a larger number of financial market investors. The second is that bond issues might
provide a chance for the issuer to add on special features that could not be added on to bank
debt.

3.3. Leases

A firm often borrows money to finance the acquisition of an asset needed for its operations.
An alternative approach that might accomplish the same goal is to lease the asset. In a lease,
the firm commits to making fixed payments to the owner of the asset for the rights to use the
asset. These fixed payments are either fully or partially tax deductible, depending on how the
lease is categorized for accounting purposes. Failure to make lease payments initially results
in the loss of the leased asset but can also result in bankruptcy, though the claims of the
lessors (owners of the leased assets) may sometimes be subordinated to the claims of other
lenders to the firm. A lease agreement is usually categorized as either an operating lease or a
capital lease. For operating leases, the term of the lease agreement is shorter than the life of
the asset, and the present value of lease payments is generally much lower than the actual
price of the asset. At the end of the life of the lease, the asset reverts back to the lessor, who
will either offer to sell it to the lessee or lease it to somebody else. The lessee usually has the
right to cancel the lease and return the asset to the lessor. A capital lease generally lasts for
the life of the asset, with the present value of lease payments covering the price of the asset.
A capital lease generally cannot be cancelled, and the lease can be renewed at the end of its
life at a reduced rate or the asset acquired by the lessee at a favourable price.

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3.31 Advantages
Lease financing has following advantages

a. To Lessor:
The advantages of lease financing from the point of view of lessor are summarized below

Assured Regular Income:

Lessor gets lease rental by leasing an asset during the period of lease which is an assured and
regular income.

Preservation of Ownership:
In case of finance lease, the lessor transfers all the risk and rewards incidental to ownership to
the lessee without the transfer of ownership of asset hence the ownership lies with the lessor.

Benefit of Tax:
As ownership lies with the lessor, tax benefit is enjoyed by the lessor by way of depreciation
in respect of leased asset.

High Profitability:
The business of leasing is highly profitable since the rate of return based on lease rental, is
much higher than the interest payable on financing the asset.

High Potentiality of Growth:

The demand for leasing is steadily increasing because it is one of the cost efficient forms of
financing. Economic growth can be maintained even during the period of depression. Thus,
the growth potentiality of leasing is much higher as compared to other forms of business.

Recovery of Investment:
In case of finance lease, the lessor can recover the total investment through lease rentals.

b. To Lessee:
The advantages of lease financing from the point of view of lessee are discussed below:

Use of Capital Goods:

A business will not have to spend a lot of money for acquiring an asset but it can use an asset
by paying small monthly or yearly rentals.

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 Tax Benefits:
A company is able to enjoy the tax advantage on lease payments as lease payments can be
deducted as a business expense.

Cheaper:
Leasing is a source of financing which is cheaper than almost all other sources of financing.

Technical Assistance:
Lessee gets some sort of technical support from the lessor in respect of leased asset.

Inflation Friendly:
Leasing is inflation friendly, the lessee has to pay fixed amount of rentals each year even if
the cost of the asset goes up.

Ownership:
After the expiry of primary period, lessor offers the lessee to purchase the assets— by paying
a very small sum of money.

3.32 Disadvantages
Lease financing suffers from the following disadvantages

a. To Lessor:
Lessor suffers from certain limitations which are discussed below:
Unprofitable in Case of Inflation:
Lessor gets fixed amount of lease rental every year and they cannot increase this even if the
cost of asset goes up.

Double Taxation:
Sales tax may be charged twice:
First at the time of purchase of asset and second at the time of leasing the asset.

Greater Chance of Damage of Asset:

As ownership is not transferred, the lessee uses the asset carelessly and there is a great chance
that asset cannot be useable after the expiry of primary period of lease.

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b. To Lessee:
The disadvantages of lease financing from lessee’s point of view are given below:
Compulsion:
Finance lease is non-cancellable and even if a company does not want to use the asset, lessee
is required to pay the lease rentals.

Ownership:
The lessee will not become the owner of the asset at the end of lease agreement unless he
decides to purchase it.

Costly:
Lease financing is more costly than other sources of financing because lessee has to pay lease
rental as well as expenses incidental to the ownership of the asset.

Understatement of Asset:
As lessee is not the owner of the asset, such an asset cannot be shown in the balance sheet
which leads to understatement of lessee’s asset.

4.0 HYBRID SECURITIES

There is a third category of assets, sometimes called hybrid securities, that is between equity
and debt. Examples include warrants, convertible bonds and preferred stock. They all have
some features that seem like equity and other features that seem like debt.

4.1. Convertible Debt

A convertible bond is a bond that can be converted into a predetermined number of shares,
at the discretion of the bondholder. Although it generally does not pay to convert at the time
of the bond issue, conversion becomes a more attractive option as stock prices increase.
Firms generally add conversions options to bonds to lower the interest rate paid on the bonds.
In a typical convertible bond, the bondholder is given the option to convert the bond into a
specified number of shares of stock.

4.2. Preferred Stock

Preferred stock is another security that shares some characteristics with debt and some with
equity. Like debt, preferred stock has a fixed dollar dividend; if the firm does not have the
cash to pay the dividend; it is accumulated and paid in a period when there are sufficient

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earnings. Like debt, preferred stockholders do not have a share of control in the firm, and
their voting privileges are strictly restricted to issues that might affect their claims on the
firm’s cash flows or assets. Like equity, payments to preferred stockholders are not tax
deductible and come out of after-tax cash. Also like equity, preferred stock does not have a
maturity date when the face value is due. In terms of priority, in the case of bankruptcy,
preferred stockholders have to wait until the debt holders’ claims have been met before
receiving any portion of the assets of the firm

4.3. Option-Linked Bonds

Firms have recognized the value of combining options with straight bonds to create bonds
that more closely match the firm’s specific needs .For example, commodity companies issued
bonds linking the principal and even interest payments to the price of the commodity. Thus
interest payments would rise if the price of the commodity increased and vice versa. These
commodity-linked bonds can be viewed as a combination of a straight security and a call
option on the underlying commodity

4.31 Advantages
Paid Dividends First
As mentioned, the chief benefit for shareholders is that preference shares have a fixed
dividend that must be paid before any dividends can be paid to common shareholders. While
dividends are only paid if the company turns a profit, some types of preference shares
(called cumulative shares) allow for the accumulation of unpaid dividends. Once the business
is back in the black, all unpaid dividends must be remitted to preferred shareholders before
any dividends can be paid to common shareholders.

Higher Claim on Company Assets

In addition, in the event of bankruptcy and liquidation, preferred shareholders have a higher
claim on company assets than common shareholders do. This makes preference shares
particularly enticing to investors with low risk tolerance. The company guarantees a dividend
each year, but if it fails to turn a profit and must shut down, preference shareholders are
compensated for their investments sooner.

Additional Investor Benefits

Other types of preference shares carry additional benefits. Convertible shares allow the
shareholder to trade in preference shares for a fixed number of common shares. This can be a

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lucrative option if the value of common shares begins to climb. Participating shares offer the
shareholder the opportunity to enjoy additional dividends above the fixed rate if the company
meets certain predetermined profit targets. The variety of preference shares available and
their attendant benefits means that this type of investment can be a relatively low-risk way to
generate long-term income.

Preference shares also have a number of advantages for the issuing company, including:

Lack of Shareholder Voting Rights

The lack of shareholder voting rights that may seem like a drawback to investors is beneficial
to the business because it means ownership is not diluted by selling preference shares the way
it is when ordinary shares are issued. The lower risk to investors also means the cost of
raising capital for issuing preference shares is lower than that of issuing common shares.

Right to Repurchase Shares

Companies can also issue callable preference shares, which afford them the right to
repurchase shares at their discretion. This means that if callable shares are issued with a 6%
dividend but interest rates fall to 4%, the company can purchase any outstanding shares at the
market price and then reissue shares with a lower dividend rate, thereby reducing the cost of
capital. Of course, this same flexibility is a disadvantage to shareholders.

[Important: Financing through shareholder equity, either common or preferred, lowers a

company's debt-to-equity ratio, which is considered by both investors and lenders to be a
sign of a well-managed business.]

4.32 Disadvantages
Preferred shares also present disadvantages for investors and shareholders.

Investors Can't Vote

From the investor's perspective, the main disadvantage of preference shares is that preferred
shareholders do not have the same ownership rights in the company as common shareholders.
The lack of voting rights means the company is not beholden to preferred shareholders the
way it is to equity shareholders, though the guaranteed return on investment largely makes up
for this shortcoming. However, if interest rates rise, the fixed dividend that seemed so
lucrative can quickly look like less of a bargain as other fixed-income securities emerge with
higher rates.
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 Higher Cost than Debt for Issuing Company
The chief disadvantage to companies is the higher cost of this type of equity capital relative
to debt.

5.0 CONCLUSION
It is generally notable from the above discussion that the major ways of raising capital for a
corporate entity are through debt and equity financing. Whereas debt financing entails giving
a loan to an institution, equity financing involves investors having an ownership claim arising
from their funding of the institution. Debt instruments include bank debts, bonds, leases etc.
Equity instruments on their part include initial public offers (IPOs), rights issues etc. There
are also other hybrid means of raising capital such as convertible debts, preferred stock and
option-linked bonds. Generally, entities employ a blend of both debt and equity instruments
to raise capital.

6.0 REFERENCES
Gibendi, R. (2015, March 10). Daily Nation. Why it will take more than Sh 5bn to revive Mumias.

Investopedia. (2014, April 2). Equity Financing.

Kamau, M. (2014, May 11). Standard Digita. Investors wait for Safaricom IPO refunds worth Sh 120m.

KeithAbbot, N. P. (2002). In Business Law (p. 388).

Maina, L. a. (2014). Capital Structure and Financial Performances In Kenya. International Journal of
Social Sciences and Entrepreneurshi.

Mwaniki, C. (2015, January 8th). Business Daily. IPO Investors set to lose a big capital gains tax.

Pinto, J. D. (1994). Debt or Equity. World Bank Publications.

VictorJuma. (2013, June 6th). Business Daily. Mixed fortunes for safaricom investors years after IPO.

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