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LONG TERM SOURCES OF FINANCING

SHARE CAPITAL OR EQUITY SHARE:
Equity shares or ordinary shares are those shares which are not preference shares. Dividend on these shares is paid after the fixed rate of dividend has been paid on preference shares. The rate of dividend on equity shares is not fixed and depends upon the profits available and the intention of the board. In case of winding up of the available and the intention of the board. In case of winding up of the company, equity capital can be paid back only after every other claim including the claim of preference shareholders has been settled. The most outstanding feature of equity capital is that its holders control the affairs of the company and have an unlimited interest in the company's profits and assets. They enjoy voting right on all matters relating to the business of the company. They may earn dividend at a higher rate and have the risk of getting nothing. The importance of issuing ordinary shares is that no organization for profit can exist without equity share capital. This is also known as risk capital. ADVANTAGES OF EQUITY SHARES: Advantages of company: The advantages of issuing equity shares may be summarized as below: I. Long-term and Permanent Capital: It is a good source of long-term finance. A company is not required to pay-back the equity capital during its life-time and so, it is a permanent source of capital. II. No Fixed Burden: Unlike preference shares, equity shares suppose no fixed burden on the company's resources, because the dividend on these shares is subject to availability of profits and the intention of the board of directors. They may not get the dividend even when company has profits. Thus they provide a cushion of safety against unfavorable development III. Credit worthiness: Issuance of equity share capital creates no change on the assets of the company. A company can raise further finance on the security of its fixed assets. IV. Risk Capital: Equity capital is said to be the risk capital. A company can trade on equity in bad periods on the risk of equity capital. V. Dividend Policy: A company may follow an elastic and rational dividend policy and may create huge reserves for its developmental programmers.

It is difficult to cure. The company may add to the profits by trading on equity. II. DISADVANTAGES OF EQUITY SHARES: DISADVANTAGES TO COMPANY: EQUITY SHARES HAVE THE FOLLOWING DISADVANTAGES TO THE COMPANY: I. IV. III. Their prices in security market are more fluctuating. It brings capital appreciation in their investments. Right to Participate in the Control and Management: Equity shareholders have voting rights and elect competent persons as directors to control and manage the affairs of the company. the company cannot trade on equity. This characteristic creates inflexibility in capital structure of the company. V. No flexibility in capital structure: Equity shares cannot be paid back during the lifetime of the company. an appreciation in the net worth of the company's assets will increase the market value of equity shares. An Attraction of Persons having Limited Income: Equity shares are mostly of lower denomination and persons of limited recourses can purchase these shares. Certain groups of equity shareholders may manipulate control and management of company by controlling the majority holdings which may be detrimental to the interest of the company. II. Equity shares are transferable and may bring about centralization of power in few hands. Capital profits: The market value of equity shares fluctuates directly with the profits of the company and their real value based on the net worth of the assets of the company. Over-capitalization: Excessive issue of equity shares may result in over-capitalization. Thus equity capital may get dividend at high in boom period. V. More Income: Equity shareholders are the residual claimant of the profits after meeting all the fixed commitments. III.ADVANTAGES TO INVESTORS: INVESTORS OR EQUITY SHAREHOLDERS MAY ENJOY THE FOLLOWING ADVANTAGES: I. High cost: It costs more to finance with equity shares than with other securities as the selling costs and underwriting commission are paid at a higher rate on the issue of these shares. IV. Other Advantages: It appeals most to the speculators. . Trading on equity not possible: If equity shares alone are issued. Dilution in control: Each sale of equity shares dilutes the voting power of the existing equity shareholders and extends the voting or controlling power to the new shareholders. Dividend per share is low in that condition which adversely affects the psychology of the investors.

the profits of the company come down and consequently the rate of dividend also comes down. III. equity shareholders are the worst suffers. Debenture holders are the creditors of the company to which company pays the interest at a fixed rate and at the intervals stated in the debenture. it is not a source of permanent capital. it should raise funds from other sources also. These are the instruments for raising long term debt capital. Thus. . Usually debentures are secured by charge on the assets of the company. yet it should not solely depend on it.VI. They are paid in the last only if any surplus is available after every other claim including the claim of preference shareholders is settled. 4) Return paid by the company is in the form of interest which is predetermined. Their prices fluctuate frequently which are not in the interest of the company. Speculation: Equity shares of good companies are subject to hectic speculation in the stock market. DISADVANTAGES TO INVESTORS: EQUITY SHARES HAVE THE FOLLOWING DISADVANTAGES TO THE INVESTORS: I. Loss on Liquidation: In case. Following are the features of debentures: 1) Debenture holders of the company are the creditors of the company and not the owners of the company. It is evident from the advantages and disadvantages of equity share capital discussed above that the issue of equity share capital is a must for a company. No voting rights are given to the debenture holders. DEBENTURES: Debenture means a document issued by the company as an acknowledgement of indebtedness to its debenture-holders and giving an undertaking to repay the debt at a specified date or at the option of the company. II. Uncertain and Irregular Income: The dividend on equity shares is subject to availability of profits and intention of the Board of Directors and hence the income is quite irregular and uncertain. They may get no dividend even three are sufficient profits. Due to low rate of dividend and certain other factors the market value of equity shares goes down resulting in a capital loss to the investors. 2) Capital raised by way of debentures is required to be repaid during the life time of the company at the time stipulated by the company. Capital loss During Depression Period: During recession or depression periods. the company goes into liquidation. 3) Debentures are generally secured. In order to make its capital structure flexible.

3) They have priority over other unsecured creditors when it comes to debt repayment. it should be pointed out the attributes that both venture capital firms and business angels look for in potential investments are often very similar. 2) Debentures are more secure than stocks. THE DISADVANTAGES OF DEBENTURES ARE: 1) unlike ordinary shares. In these notes. VENTURE CAPITAL FUNDING: Venture Capital is a form of "risk capital". In case of bankruptcy.a business) where there is a substantial element of risk relating to the future creation of profits and cash flows. 8) Debentures are a cheap source of funds from the company’s point of view. . ADVANTAGES AND DISADVANTAGES OF DEBENTURES The Advantages of Debentures are as follows: 1) the holders of the debentures are entitled to a fixed rate of interest. 7) Debenture holders do not carry any voting rights. The main sources of venture capital in the UK are venture capital firms and "business angels" private investors. 2) Debentures are for those who want a safe and secure income as they are guaranteed payments with high interest rates. debenture holders are not considered the owners of the company.5) Debentures are very risky from company’s point of view for raising long term funds. Separate Tutor2u revision notes cover the operation of business angels. 6) Risk on the part of debenture holders is very less. Risk capital is invested as shares (equity) rather than as a loan and the investor requires a higher “rate of return" to compensate him for his risk. However. but will lead to a lower rate of theoretical return. In other words. 3) It is a type of debt instrument which is not secured by collateral (or physical asset). capital that is invested in a project (in this case . It can be presented as "5% Debenture". the bond holders are given priority over the debenture holders. They are long term loan capital and holders will have no right to vote at the annual general meeting. we principally focus on venture capital firms.

This informal method of financing became an industry in the late 1970s and early 1980s when a number of venture capital firms were founded. Lenders have a legal right to interest on a loan and repayment of the capital. As a shareholder. irrespective of the success or failure of a business. buy-out a business in which he works. Venture capital is invested in exchange for an equity stake in the business. expand. rather than by current size. Rather. the venture capitalist's return is dependent on the growth and profitability of the business. The term of the investment is often linked to the growth profile of the business. unless a business can offer the prospect of significant turnover growth within five years. There are now over 100 active venture capital firms in the UK. to help unquoted companies grow and succeed. where the business performance can be improved quicker and easier. which provide several billion pounds each year to unquoted companies mostly located in the UK. buy-into a business. are often sold sooner than investments in early-stage or technology companies where it takes time to develop the business model.S. What kinds of businesses are attractive to venture capitalists? Venture capitalists prefer to invest in "entrepreneurial businesses". Venture capital in the UK originated in the late 18th century. which are managed by experienced and ambitious teams who are capable of turning their business plan into reality. Investments in more mature businesses. If an entrepreneur is looking to start-up. Such businesses are aiming to grow rapidly to a significant size. For how long do venture capitalists invest in a business? Venture capital firms usually look to retain their investment for between three and seven years or more. Venture capital investors are only interested in companies with high growth prospects. This does not necessarily mean small or new businesses. venture capital could help do this. . when entrepreneurs found wealthy individuals to back their projects on an ad hoc basis. Obtaining venture capital is substantially different from raising debt or a loan from a lender. This return is generally earned when the venture capitalist "exits" by selling its shareholding when the business is sold to another owner. turnaround or revitalize a company. states and U. committed share capital. municipalities. BOND: Definition of 'Bond' A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. and foreign governments to finance a variety of projects and activities. it is more about the investment's aspirations and potential for growth. As a rule of thumb.What is venture capital? Venture capital provides long-term. it is unlikely to be of interest to a venture capital firm. Bonds are used by companies.

Face Value/Par Value The face value (also known as the par value or principal) is the amount of money a holder will get back once a bond matures. must continue to make profits. However. the U. Also. For example. The reason behind this is that a government will always be able to bring in future revenue through taxation. government securities are known as risk-free assets.S. but this amount can be much greater for government bonds. along with stocks and cash equivalents. Nowadays.this is the risk/return tradeoff in action. records are more likely to be kept electronically. the longer the time to maturity. the higher the interest rate. Issuer The issuer of a bond is a crucial factor to consider. all things being equal. A newly issued bond usually sells at the par value.Bonds are commonly referred to as fixed-income securities and are one of the three main asset classes. on the other hand. All of these factors play a role in determining the value of a bond and the extent to which it fits in your portfolio. Therefore. This added risk means corporate bonds must offer a higher yield in order to entice investors . Corporate bonds normally have a par value of $1. Maturities can range from as little as one day to as long as 30 years (though terms of 100 years have been issued). Its default risk (the chance of the debt not being paid back) is extremely small . this was more common in the past. Characteristics Bonds have a number of characteristics of which you need to be aware. . A company.so small that U. Coupon (The Interest Rate) The coupon is the amount the bondholder will receive as interest payments. which is far from guaranteed.S.000. It's called a "coupon" because sometimes there are physical coupons on the bond that you tear off and redeem for interest. as the issuer's stability is your main assurance of getting paid back. A bond that matures in one year is much more predictable and thus less risky than a bond that matures in 20 years.. a longer term bond will fluctuate more than a shorter term bond. in general. Maturity The maturity date is the date in the future on which the investor's principal will be repaid. government is far more secure than any corporation.

INTERMEDIATE TERM FINANCING: PREFERENCE SHARES Preference shares (or preferred stocks) are different from the ordinary shares in that they are given a preference over the rest. however. Whether the company has low or high profits. The companies offer interest to the investors over public deposits. they are paid dividend first out of the profits made by a company. . The companies generally offer 8 to 9 percent interest rate on the deposits made for one year. Non-participation in prosperity: On account of fixed dividends. Return of capital: These shareholders are paid their capital first in case of winding up of the company. Fixed dividend: Preference shares have a fixed rate of dividend and that is the reason they are called fixed income securities. these shares do not have any change to share in the prosperity of the company's business. dividend. varies with the time period of the public deposits. they are entitled only to a fixed rate of dividend. The public deposits are generally solicited by the firms in order to finance the working capital requirements of the firm.e. Features of Preference Shares:  Return on investment: Preference shares are given preference to get a return on investment i. There are rules regulating the fixed deposits. The companies offer 9 to 10 percent interest rate over public deposits for two years while 10 to 11 percent interest rate is offered for the three year deposits.     PUBLIC DEPOSITS The public deposits refer to the deposits that are attained by the numerous large and small firms from the public. These shares are market instrument issued by the companies to the public with the primary aim of raising capital for the company. The rate of interest. (except in case of participating preference shares.) Non-participation in management: Preference shareholders do not participate in the management of the company's affairs.

DEBT FACTORING A business sells its outstanding customer accounts (those who have not paid their debts to the business) to a debt factoring company.say 80-90% of face value of the debts . The advantages of leasing are:    Cheaper in the short run than buying a piece of equipment outright. . LEASING Leasing is like renting a piece of equipment or machinery. The business pays a regular amount for a period of time. The factoring company pays the business .and then collects the full amount of the debts. but the item belongs to the leasing company. If technology is changing quickly or equipment wears out quickly it can be regularly updated or replaced. The business pays a monthly fee for the car and at the end of the period (normally about two years). BUT it is not so good for profits since it reduces the total revenue received from those sales. here is the list of rules for public deposits:       The maximum maturity period for a public deposit is 3 years The minimum maturity period for public deposits is 6 months The maximum maturity period for a public deposit for Non-Banking Financial Corporation is 5 years The public deposits of a company cannot go past 25% of free reserves and share capitals The companies asking for public deposits need to publish information regarding the position and financial performance of the firm The companies having public deposits need to keep aside the 10% of the deposits by 30th April every year that will mature by 31st March next year. the business swaps the car for a newer model. Once it has done this it will pay the remaining amount to the business less a charge. Most company cars are leased to businesses. The disadvantages of leasing are:  More expensive in the long run. because the leasing company charges fees which make the total cost greater than the original cost. It is a good way of raising cash quickly. Cash flow management easier because of regular payments.According to the Companies Amendment Rules 1978. without the hassle of chasing payments.

It does not make available the funds in cash. The finance companies usually make advances up to 60 per cent of the value of the accounts receivable pledged. BANK CREDIT Commercial Banks play an important role in financing the short-term requirements of business concerns. The customer advance represents a part of the price of the products that have been ordered by the customer and which will be delivered at a later date. the accounts receivable of a business concern are purchased by a financing company or money is advanced on security of accounts receivable. particularly in cases of special order or big orders. location of the customer. financial resources of the suppliers and the eagerness of suppliers to sell his stocks.SHORT-TERM FINANCE MAY BE RAISED BY THE COMPANIES FROM THE FOLLOWING SOURCES:- TRADE CREDIT It is the credit which the firms get from its suppliers. The ownership of the equipment remains with the supplier until all the installments have been paid by the buyer. Some portion of the cost price of the asset is paid at the time of delivery and the balance is paid in a number of installments. The debtors of the business concern make payment to it which in turn forwards to the finance company. degree of competition in the market. but it facilitates the purchase of supplies without immediate payment. No interest is payable on the trade credits. The supplier charges interest on the installment credit which is included in the amount of installment. ACCOUNTS RECEIVABLE FINANCING Under it. The period of trade credit depends upon the nature of product. CUSTOMER ADVANCE Manufacturers of goods may insist the customers to make a part of the payment in advance. They provide finance in the following ways:- . INSTALLMENT CREDIT Firms may get credit from equipment suppliers. The supplier may allow the purchase of equipment with payments extended over a period of 12 months or more.

the whole of which is withdrawn to cash immediately by the borrower who undertakes to repay it in one single installment. These documents are discounted by the bank at a price lower than their face value. it is known as clean cash credit. In case of clean cash credit the borrower gives a promissory note which is signed by two or more sureties. Loans:. Overdrafts:. When a borrower is allowed to borrow up to a certain limit against the security of tangible assets or guarantees.When a bank makes an advance in lump sum. promissory notes and hundies. Cash credit:.Commercial banks finance the business concern by discounting their credit instruments like bills of exchange.Under this.    . it is called a loan. Discounting of bills:. The borrower has to pay interest only on the amount actually utilised. it is known as secured credit but if the cash credit is not backed by any security. the commercial bank allows its customer to overdraw his current account so that it shows the debit balance. The borrower is required to pay the interest on the whole amount.It is the most popular method of financing by commercial banks. The customer is charged interest on the account actually overdrawn and not on the limit sanctioned.