CHAPTE LONG TERM FINANCE: SHARES,

R 20 DEBENTURES AND TERM LOANS

 LEARNING OBJECTIVES
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 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
 INTRODUCTION
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 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.
 Ordinary Shares–Features
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 Claim on Income
 Claim on Assets
 Right to Control
 Voting Rights
 Pre-Emptive Rights
 Limited Liability
 Reporting of Ordinary Shares
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Tata Motors' Share Capital as on 31 March 2008

 Ordinary Shares–Pros and Cons
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 Advantages
 Permanent Capital
 Borrowing Base
 Dividend Payment Discretion
 Disadvantages
 Cost
 Risk
 Earnings Dilution
 Ownership Dilution
 Public Issue of Equity
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 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.
 Underwriting of Issues
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 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.
 Private Placement
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 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
 Right Issue of Equity Shares
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 Selling of Ordinary Shares to the existing shareholders of

the company.
 Price of share ex-rightPx=N *R +Ps
 N is no of rights needed to buy a share,R is the value of
right.
px  p s
 Value ofrRight
 :
n
 Effect on Shareholders’ Wealth
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 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.

Is the Subscription Price of any
Significance?
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 Itis irrelevant in terms of the impact on the shareholders’

wealth.

 It can be fixed at any level below the current market price.

 The primary objective in setting the subscription price low is

that after the rights offering, the market price should not fall
below it.
 Right Shares – Pros and Cons
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 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
 Preference Shares
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 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.
 Preference Shares–Features
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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
 Preference Shares–Pros and
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Cons
 Advantages:
 Risk less leverage advantage
 Dividend postponability
 Fixed dividend
 Limited Voting Rights
 Disadvantages:
 Non-deductibility of Dividends
 Commitment to pay dividends
 DEBENTURES
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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.
 Debentures–Features
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 InterestRate
 Maturity
 Redemption
 Sinking Fund
 Buy-back (call) provisions
 Indenture
 Security
 Yield
 Claims on Assets and Income
 Types of Debentures
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1. Non – Convertible Debentures

2. Fully – Convertible Debentures
3. Partly – Convertible Debentures
 Debentures–Pros and Cons
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 Advantages:
 Less Costly
 No ownership Dilution
 Fixed payment of interest
 Reduced real obligation

 Disadvantages:
 Obligatory Payment
 Financial Risk
 Cash outflows
 Restricted Covenants
 Term Loans–Features
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 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