parTiV CAPITALIZING A BUSINESS ENTERPRISE rive To know and unxierstand the reasons why there is @ need for OeET both for mRial captal and thous for business expansion and to know whare foobtain them. INITIAL SUMMARY: This topic doals with the captalization of 9 corporation, The sub-topes a0: Need for captal, the rola of finance in an enterprisa, the capa of tho forms of business organizations, the methods of raising the initial caprtal and the capital for business expansion, A. THE NEED FOR CAPITAL: In organizing a new business enterprce, a number of financial requirements are necessary. There must be enough money to buy equipment, materials and supplies and to pay rentals and wages and sufficient amount of cash available for operating expences dunng the penod when the business starts to function, hance, & cals for adequate inancing. 8, THE ROLE OF FINANCE IN AN ENTERPRISE: “TO AMASS & ADMINISTER CAPITAL" = Here, money plays a major role in an enterprise. Any activity or undertaking involves money or cash. In fact, at the start of the businass, money is needed to purchase the necessary tools & equipment, the required matenals, merchandise and other needs of the enterprise. During the operation, cash is needed to pay the salaries & wages of the employees & workers, to pay for electne bills, to pay for rentals, etc. Likewise, when a sale is made, the business receives money in the payment of the goods, products or services rendered. Money will then be used again to pay for materials, salaries, etc. This cycle continues as long as the business goes on with its activities and ts transactions, In short, money provides the needs and requirements of the different units of the enterprise. This can be compered to the function of the blood that s circulating within the human body. In this connection, amassing and administering captal should enter as 2 role of finance on the part of the businessman so as to understand and know how to utilize funds to be able to meet the fixed and variable charges. Fixed Charges = are those financial obligations which must be paid at regular intervals regardless of the amount transacted, Variable Charges = are those financial obligations which change with the change in the volume of business operations.& TERMINOLOGIES; 1. Capital ® ineans the invostmont wt an enterprise whic may be finances CY Hivssal Heperty and valuable tangible mecaee” parce anltal = eden 9 all toms of valia whether owned bo I} usext an the Innit eysratons nev to gon ate male, Capital Stock = tefors to the pormanontly invested captal of a TAR hic has boon contibuted by the stockholders aes, {ine of fs ovganization. This ts dvidedt Into shares, which ropeacone o by crag néte ownership interast in the corporation, which ws evigenead DY stock certitic 3 Fapitatization = vetors to the tetal valuo of all the secunties issued bY @ corporation, I also rofers to tho total par value of the authored eaptal stock of the corporation, In capstalizing 9 business enterprise, i ontarks the determination of the proper amount of capital to be ratcad 40.98 nok to Qvorestimate oF underestimate, thus, minimizing overcaptalization OF Undereapitalization, if not to eliminate such, Overeapitalization = thes occurs whon the earings of the corporations are not large enough to bang a fair return on the amount of securities that have been isstiod, In other words, it occurs when the amounts of secunties aro far in excess of the current value of the assots, Causes: 1, actual loss oF destruction of valuable assots; 2. depreciation of tangible assets duo to insufficient maintenance; 3. too great optimism on tho part of the promoters; 4. mathods of promotion used; 5. fraudulont transactions, Undercapitalization = this occurs when a corporation issvod an int of stock, the nominal value of which is very much lower than the fair value of the company’s assets ond ie extremly small when compared with its earning capacity, Effects: undoreapitalized company may be rated unfoitty; and y othe Profits, # tho business is successful will appear gargantuan when compared with its outstanding stock, which may lead to public/government attention,THE CAPITAL op Comnol tw bap HCHND Fe Usa | INESS OGANIZATIONS: Tho total ty financing and debt financing. lal tise mck = provided by tha ownars of Ue ating aia, kite! Ns andl earnings rutemned in the Nout "is hve alten onsie betiwonn total see Walaitins (Debt financing iv those borrcwed expt fer “ot Lstowod capital ie tormnod as Finan nt of Lesrowod capita, Hip = the capitol of a sole proprietorship is usually Uy personal savings of the owner, family or relates an Owners’ equity and sone funds may be i the form of borrowed capitat Known as creditors! capital, 2 Partnership » tho capital of a partnerstip called partners’ equity 1 dered from the contributions. of the partners sn terms of money, property and services depending on the kind of partners. Others may ‘bo obtained from outside sourcis known as creditors’ capital, Corporation » tho captal of a corporation 6 provided for by the stockholders of the corporation known as stockholders’ equity snd from the bondholders. and othor croditors. of the corporation known 3% Ereditors’ capital. Equity capital in young businesses is known ae Venture capital (money invested to finance a new firm) and it 1s provided by specialist ventura captal firms, wealthy indwiduals and vestment institutions such as pension funds. The capital of the corporation is divided inte: a) intial capital; and b) capital for business expancion, {METHODS OF RAISING INITIAL CAPITAL: 1. Raising Capital by Stock Issues, This refers to the issuance of shares of stocks to raise funds for long term financing requirements of the firm, otherwise known as stock financing. Stocks = aro units of co-ownership/part ownership to an issuing corporation, Stock Certificate = is an evidence of ownership to an issuing corporation, It shows the number of shares owned in the name of the owner and states tho rights of the stockholders. Rights of Stockholders: 1,” toa cottificate showing his ownership of shares; 2, tetranster his shares of ownership; 3. toelect & remove directors; to approve corporate actions; to restrain ultra vires acts of the corporation; to protect the corporation against wrongful acts of the directors; to inspect tha corporate books & records and to receive financial report of the corporation; to racaiva dividends when declared; and to subscribe for any new issue of stocks. ~ oes 2eMajor Classes of Stocks: ro Common Stock = \s that clats of stock sued by al corporations and WIkeh represents the real equity captal of the corperatien. It hat stun! claim to earnings and assets and cames the reas of busrent iccose oF folures. Te cass of Stock « usualy Known a wang Preferred Stock = is that class of stock which hat a cam on ateats before the common stock in the event of dissolution and a pret clam to divictendtey earnings Up to a specified amount or rate. Ths « waaay the non-voting stock Other Classes of Stocks: & 2 nn. Redeemable Stock = this stock gives the suing comoreton tre option to purchase back the stocks from the stockholders awning ther (under certain terms and conditions expressly indicated = the certificate of incorporation). Convertible Stock = ths is 2 preferred stock that could be easy exchanged into other form of securty, usually in the form of comeren Stock. Tha option to convert is on the stockholders, but once converted, anather recenversion 1s no longer allowed. Treasury Stock ~ a stock which has been issued by the corporation ‘and has tater come back into the company’s possession through donation, repurchase or payments of obligations. Founder's Stock = is issued to the founder of the corporation for ms ‘services in organizing it. Promoter's Stock = is issued to the promoter as his reward for ms arviens in helping the business come into being. Protected Preferred Stock = this is issued as inducements to investors to purchase preferred stocks by protecting the dividends on this stock. How? = by placing in a reserve a certain amount after the preferred Gividends have been paid for assurance of receipts of dimdends even uring business crisis. Guaranteed Stock = is issued when a parent company guaranteed dividend payments on the stock of its subsidiary company. Value Stock = means that each share has been given a face Par oat 1 mncicated on the face ofthe stock cortieate, No Par Value Stock © are those shares of stocks without @ face or fominal valve but rather a stated value. Voting Stocks ~ are those stocks that have the right to participate 19 MerinBnagement of the corporation by voting for the members of the Board of Directors, Non-Voting Stocks ~ thoso that have nether right nor part in the Non-vating Sine nfs tie corporation.2 ” Raising Capital Through Corporate fonds. 1h corporation to testa bonds te thw Gunveral paubler ars rhmaers ef potest, Addivonal nancing. “The corporation cle rove, that w eoressecce, cok ‘only “tse bonds whan a majority of the ‘tiene capital ise mic approve in a stockholdors! montin) called for the fasrtana Bond = fan unconditional promis of the iantig corporation tn my a slates say vy a thn rntty Ham ne Wl ne Ne kote he Vest ced on the stipulated parcontaga as evidenced in the Kedenture i Dead ‘of Trust, percortoge = Indonture/Deed of Trust = 2 dott contract the parties £0 a bond seine as wall vz thew ablugations Parties toa Bond Issue: a) debtor = the issuing corporation bb) craditor = the bondholders who purchased the bonds ©) trustee = an individual or trust company charged with the protection Of the bondholders interest. Features of Bonds: eters i the prone of 1. Redemption Provision = refers to the call feature of bares which brovides the right of the corporation to call in bonds before the date of ‘maturity and those are intended to enable the corporation to pay off the bonde avon belere the date of maturity. 2. Conversion Provision = it provides the right of the bondholders to exchange their bonds for some other security usually preferred or ‘common stock on a fixed basis. 3. Sinking Fund Provision = tt provides an obligation of the kung Corporation to set aside cortain sum of money from the earnings Periodically for the purpose of reducing the bonded indatedness. fications of Bonds: A. Asto Underlying Security 2, First Mortgage Bond = a bond sued which 1 secured by property offered as a collateral for the first timo. 2, Second Mortgage Bond = a bond issued which is secured by 2 proporty offered as a collateral for the second tine. 3. Third Mortgage Bond = a bond tesued which ts secured by a property offered as a collateral for the third time.AS to Purpose of Issue 1, Consolidation /Unifying Bonds = bonds issued to simplify all Sutstandng obligations by exchangng one esue- carrying @ Lunform rate of intorest for a number of urmilor meues put out at various rate of interests, 2. Funding Bonds = are issued to rare money to pay off a ‘maturing iexue oF to fund a floating dab. 3. Adjustment Bonds = are issued in case of reorganuation adjust the claims of creditors aganst an insolvent corporation Receiver’s Certificate = tsued by the receiver of an solvent ‘corporation to secure more or les temporary funds. AS to Method of Repayment 1. Convertibte Bond = a bond which 6 paid by converting « into stock ofthe corporation. 2. Redeemable Bond = this i paid by reting one issue and Feplace & by anew issue carrying @ lower rate of interest. 3. Secured/Debenture = provides for a sinking fund which Formally will help increase the secunty back of the obligation ‘and. wil make the redemption of ‘certain annual amounts ‘sable, es provided for inthe inderture. D. Aste Whois the Issuer 1, Government/Public Bonds = are those sued by the ‘government to finance te activities, bonds, MWS, oer fn ‘09. treasury 2 prme/cororste Bonde, = arta bode aud, by prwvate corporations to. finance thew fondieg eauirements, ‘Types of bonds: Mortgage Bond = 1 one, which indicates a pladgo of real estate, or some of the fired assets of the business. Hore, the contains ‘8 etmled descrztion ofthe property so mortgagad, 60 that In case of ‘detour, the said property can be accurately ilentied wie mw tion." The value of tho fixed assets pledgnd to a. bond asus ‘substantially higher than the amount of the debt. "Io some cases, Some sacurty provsion may be made a part of the indenture Inchas prepay er her nce wel tu Brepay ese the time of the mortgage. This provsion is termad as after-acquired property clause = 2 foature designed to further increase Ronience of the mvestor tough the addition of new auiets ledge 8 didasksa Types of Corporate Mortgages: 9) closed-end mortgage = ‘olers to mortgage by a comporaten ised as collateral security for a loan of fixed amount. The Imortoage can not be vse again as a sacunty for addtional bond eae oF hae any nd 5) Open-end mortgage = it permits the salo/ euance of ‘addtional bonds to be made under the orignal mortgage. ©) Limited open-end mortgage = this 's an improvement of the first two because & allows adeitional bends to be sold eter the ‘orginal issue under the original mortgage but stipulates» ‘Maximum amount that can not be exceeded, Collateral Trust Bond = » bond secured by a pledge of sachs anc Bonds oun by the Sorrow corporation, Father trent soon De noes recat Equipment Trust Bond = is usually secured by tangle property, the litle ef which rests with @ designated trustes while the property eased to the user. Debentures = referred to as a straight credit obligation that have no pledge of securty back of K except the general excellent standing of the lesuing corporation, Instances when Debentures are isued: a} when 2 corprten requres extensive use of cred to france Invertones end insolent correcta and thes areocy ‘mortgaged al te avaible seets ») Wher corporation enjoys unquestonable standing and reputation; ar c) Weare corporate has a rlsvaly sma parentage of tango . assets and tt is in need of funds for long period of time, ‘Serial Bonds = these are bonds issued at the same time but mature In several succeeding years, ‘Series Bonds = bends issued at different times under one large10. a 12. n Coupon Bond » i 4 bearer instrumont baci Mis Usually assurned that i belongs to tho parson having it i Ii posus “son, Income Bond = 1s on in) which the ar paint of in mace contingent on the company's sar, fost payment 1 Participating Bond = 9 bond that gives the holder the night to share the net profs of the corporation, Characteristics of Bonds: w 2 7 St Fepresents a direct obligation on tho part of the issuing corporation; Bonaholders, as creditors of the isting corporation, ara guaranteed e2mings on thoir investments irrespective of business fluctuations; bondholders have prior claim on assets over the other creditors of the ‘ssuing corporation; the date of payment of tho principal and intorast is more or less fixed; bonds represent a lesser risk than stocks; ‘the manner of payment of the principal and interest is stated in the debt contract; and bonds, like stocks could be used as collateral for loans. Bonds as distinguished from stocks: 1 2. 4, Rights to Income. Bonds pay intarasts which are fixed, while stocks pay dividends which ara contingent upon the eamings of the corporation and which must be declared by the board of directors Rights to a Voice in Management. tondholders: have no vote and influence on the management of the corporation (except when the Provisions of the bond and the indenture agroomant are not met), while stockholders have a part in the managemont of tho affairs of the corporation. ights to » Return of the Principal, Gonds have a specific matunty date, at which repayment of the principal 1s due. In contrast, stocks are instruments of permanent captal financing and do nét have maturity dates. As to Their Nature. A bond is a debt inctrumont while a stock ie an instrument of co-oymership or part-ownarship.F. RAISING CAPITAL FOR BUSINESS EXPANSION: Reasons/Conditions Requiring Ad (Monat Financing: new directions, S tO BUY oUt other concerns and to combine with ther: $. te provide temporary or working captal; 5. to-change the type ar term of atraady existing capital labaltie: & te refund/previde the means of payment for maturing securities; © change the ewnership of form of business organization oF to enable resent owners to withdraw thair invostments; and tg adjust conflicting interest ownership and creditors” interest in cases of reerganizatron. Sources of Capit for Business Expansion: 1) Internal Sources 1.1 through the reinvestment of earnings. After several penod of ‘operation, the corporation has earned profits which are: Subject for dividend declaration, but in here, instead of giving cash dividends to the stockholders, the corporation will just acc such amount @s their additional’ captal to the corporation, hence, the torm reinvestment, and as a result, stock tividends are issued instead, 1.2 through the sale of additional stacks, Ths is the most common method of raising additional permanent capital for corporation a) sale directly to stockholders = before additonal shares Of stocks are issued to anyone, these must be offered First to the stockholders because of their pre-emptive Nght = the naht of the stockholders in a corporation to woecnibe te the additional stocks in proportion to ther present hoicinas. 4) sale to the general public = prior to the offenng of stocks to the genaral public, those etéchs must be reyatered het with the Securities & Exchange Commission the Governing body of all securty market.Functions of the SEC: 2, registration function» the granting of primary f to associations, partnership and to” corporations, whether foreign or domestic. 2. Hieensing function = granting of secondary franchise Such as licensing of securties offered for sala to the ganaral ublic (educational, pension plans, momorial plans & other pra~ Feed activites nd short or long torm commorcial papers), 3. administrative function 3.1 supervision = tho SEC diroctly supervise all ‘stock and non-stock corporation through the submission Of their financial statements and annual reports. 3.2 examination = tho SEC examines the financial activities of ragisterad corporation to be ablo to monitor the contribution of these corporation to the country’s economic development. 3.3. prosecution function = there are laws & decrees geared towards economic development which are to be implemented by the registered & licensed corporations and whatever violations shall be prosecuted by the Trial Department of the SEC, ¢) by enlisting the services of investment bankers = here, investment bankers act as tha intermediary between the sources of capital (investor) and the user of funds (issuing corporation). The main job of an investment banking house = is to bring together tha ‘company needing investments and the prospective investors. who are looking for profitable investment ‘opportunities by which they could employ their idle funds to be more productive. d) sale to customers = the reasons for seling the company’s securities to the customers aro as follows: . inexpensive method of raising money; it may lead to the creation of additional goodwill ‘boosting more sales to the company; and2) External Sources 24 Bank Sources = a bank is a financial incttution that is Primarily engaged in tha receipts of deposits and in the loaning ut of funds, a) b) Public/Government Banks = those banks whove Capea! stock ws ently or majonty owned and these ara controlled and operat : 29. "hangko Sentral mp Pilipinas, Land Bank of the Philippines, Development Bank of the Philippines and the Islamic Bank (former Philippine Amanah Bank) Private Banks = these are owned, managed and ‘operated by private individuals. Furthermore, private banks are categorized as follows: b.1 Commercial Banks = are institutions whereby firms or individuals may tap as sources of short-term financing. It is defined as any corporation, which borrowers for the financing of inventories ranging from P 1,000 to P10,000 and is amortized on a daily or ‘weekly basis without collateral. Commercial banks also Rant agricutural, industrial ‘and realestate ial Banks are now categorized into: (a) ‘Coomercial Banks without Commercial Banking Authority (KB); and (b) Commercial Banks with Expanded ‘Commercial Banking Authority (EKB). b.2 Thrift Banks = robin the mal savings othe poopla. They prove ‘The following banks fall under the category of thnft banks: + Savings & Mortgage Banks; © Private Development Banks; © Stock Savings and Loan Association; and = Cooperative Banks| u %.3 Rural Banks = are organized primarily for the purpose of promcting and excancing the rural economy by catering. to the needs of email farmers and small merchants. Rural banks: Grant agncuitural loans, commercial loans, and industrial bans. 2.2 Non-Bank Sources *) The Government Service Insurance System = started its operations on May 31, 1937. It had an intial capstal of P200,000 for operating expanses. and a personnel of fifty (50) employees. There are three (3) functions of this system: ©) The Social Security System = this is another government non-bank financial insttution that started "ts operation on September 1, 1957 wth 211 Personnel and an assets of P6,372. Like the GSIS, it also grants loans to members such as: salary loan, policy & educational loans. wnshaops = refer to persons or entities engaged i business of lending money on personal property ©) 5 description of the pawn; and signature of the pawner or his authorized agent. 4) Private Insurance Companies = these constitute as important sources of loans. The premiums generated from policyholders constitute advances, which give rise to funds held for policyholders by the insurer. They Provide loan funds and they are engaged in the business of investments.e) Lp) hb) » Investment Companies = are financial institutions that raise funds in the captal market by seling their own issues of securities, mainly common stocks, to individual investors. These funds will be reinvested in the secunties of other enterprises. The objactive of an investment company ts to provide indwidual investors with safe and profitable use of their savings, and to Feleve them of the burden of direct responsibilty of managing their own savings. Finance Companies = these are primarily organized for the purpose of extending credit facilities to consumers, industrial, commercial or agricultural enterprises by granting direct loan or discounting or factoring of commercial papers. Finance companies are vided into three (3) categories: + installment companies = they discount consumer installment notes arising through the sale of merchandise; + consumer finance companies = engaged in lending cash directly to the ultimate user; and Small Business Corporation = A government Corporation created in January 1991 under R.A. 6977 known as the Magna Carta for Small Enterprises. Mandated to provide financing initiatives for Mero, Small and Medium Enterprises or MSMEa: ‘Commenced its operations on July 16, 1992. On November 2001, S8GRC and the Guarantee Fund for Small and Medium Enterpricas (GFSME) were merged through Executive Order 28 and became known as the Small Business Corporation. An attached agency of the Department of Trade and ‘Industry (DTI) and is under the polcy, program and administrative supervision of Development Council, Pe% In 2002, SBGFC played a key role in the drafting of the SME Development Pian, and is one of the Joad agencies implementing ‘the National SME Agenda. © Today, SBGFC is the National Government's third largest provider of SME financing, with a lending portfolio of #2 tilion, © Has over 3,000 MSME clients, 71 partner financial institutions, and serving 57 of the 75 provinces. ‘across the country Jnternational Lending Institutions / Foreign Creditors ®) World Bank or International Bank for Reconstruction & Development = is an intergovernmental institution, formed as corporate entity and all its capital stocks are owned by ts mamber governments. It was croated on December 27, 1945 as a result of the Bretton Woods Conference wivch was participated in by 44 Allied Nations. So (6) months later, on June 25, 1946, the World Bank opened for business. "It has two (2) financial lates: + International Development Association (DA) = the soft loan window of the World Bank. * International Finance Corporation (IFC) = has the specific task of economic b) The International Monetary Fund (IMF) = was 2 Procuct cf the Bretton Woods Conference in 1944, with the World Bank. Membership in the IMF is a prerequisite to membership in the WB. The IMF was organized in 1946. Ite financial assistance is in the form of a foreign exchange transaction. ‘The member country pays to the IMF an amount of fs currency equivalent to the amount of foreign currency I wishes to purchase, Membors with foreign payment problomne may secure an emergency loan within seventy-two (72) hours.©) M The Asian Development Bank (ADB) = is an international development finance institution owned by its member Asian countries. Its main role is to help Promote the economic and social growth of its developing member countries by lending funds and ‘extending technical assistance, It started its operations in December 1966 with its headquarters in Manila. It is dedicated to the task Of assisting in the economic development of its less- developed member countries and of fostering economic growth cooperation in the region of Asia & the Fi East, including the South Pacific. Sader Countries = U.S.A. JAPAN, GERMANY, ete.