Sources of Long -Term Finance

Dr. Swati Jha

Sources of Finance

Short • For working

Term
Finance capital needs

Long • For capital

Term budgeting
Finance decisions
 Long Term
Finance
Long term financing is a form of financing that
is provided for a period of more than a year.
Purpose of long term finance

1. Finance fixed assets.

2. To finance the permanent part of
working capital.
3. To finance growth and expansion
of business.
Factors determining long-term financial
requirements

Nature
of
Business

Nature of
goods
produced

Technology
used
Sources of long term finance
Debenture
Shares

D
e
f
e
r
r
 SHARES

The capital of a company is divided into

small units, each unit is called Share.

• Issue of shares is the main source of long term

finance.
• Shares are issued by joint stock companies to
the public.
 Share
s

Equity Preferenc
e
Share Shares
 1. Equity Shares
 Authorized
 Issued
 Subscribed and Paid up capital
 Par/face value
 Issue Price,
 Book value and Market Value
EQUITY SHARES

• Rights of equity shareholders

• Right to Income :PAT less preferred
dividends
• Right to Control: voting rights
• Pre-emptive Right: for additional issues,
rights issue in the same proportion
• Right in liquidation: residual claim over ass
Pros & Cons of Equity Capital

Pros Cons
No compulsion to pay Dilution of control
dividends
No maturity date
High cost
Enhances creditworthiness
Dividends are tax-exempt
in the hands of investors
(now taxable as
per tax slab)
 2. Preference
Shares
Preference Shares are the shares which
carry preferential rights of
receiving dividend over the equity shares.

These rights are:

• Receiving dividends at a fixed rate.
• Getting back the capital in case the company
closes.
• Investment in these shares are comparatively
safe, and a preference shareholder also gets
dividend regularly.
Features of Preference Shares

Similar to Equity Similar to Debentures

Dividend not an Dividend rate is fixed
obligatory payment No voting right
Dividend not a tax-
deductible payment

In India, No Irredeemable Preference Shares can be issued.

Maximum maturity can be 20 years (> 20 years for Infrastructure
Projects only)
Pros & Cons of Preference
Shares

Pros Cons
 No legal obligation  Costly source as
to pay dividends preference dividend NOT
tax deductible expense
 Enhances  Skipping preference
creditworthiness dividends adversely
 No dilution of affects image
control  Voting rights under
certain conditions
Types of Preference
Shares
1. Cumulative or non- cumulative
2. Redeemable or irredeemable
3. Participating or non-
participating
4. Convertible or non- convertible
Cumulative & Non- Cumulative

• The holder of cumulative preference shares

are entitled to recover the arrears of
preference dividend before any dividend is
paid on equity shares.
Cont…

• In case of non- cumulative preference shares,

arrears of dividend do not accumulate and
hence, if dividend is to be paid on equity
shareholders in any year, dividend at the
fixed rate for only one year will have to be
paid to preference shareholders before
equity dividend is paid.
Contd…

• Note :- Unless mentione

specifically
d otherwise, preference shares should
considered
be to be
cumulative.
Redeemable &
Irredeemable
• Redeemable preference shares are
preference shares those
whose amount can be
returned by the company to their holder
within the life time of the company subject to
the terms of the issue and the fulfillment of
certain legal conditions laid down in Sec. 80 of
the Companies Act.
 Cont…

• The amount of irredeemable

shares can be onl preference
returned is permanently wound
company y up.when the
Participating & Non-participating

• Participating preference shares are entitled

not only to fixed rate of dividend but also to a
share in surplus profits which remain after
dividend has beenpaid at a certain rate to
equity shareholders.
• The surplus profits are distributed in a certain
agreed ratio between the participating
preference shareholder and equity shareholder.
 Cont…

• Non- participating preference shares are

entitled to only the fixed rate of
dividend.
Convertible & Non- convertible

• The holder of convertible preference shares

enjoy the right to get the preference shares
converted into equity shares according to the
terms of issue.

• The holder of non- convertible preference

share do not enjoy this right.
 DEBENTURES

Debenture is a medium- to long-term

instrument debt by a large
used money, at acompanies
borrow fixed rate ofto
interest.

• Issue of Loan Certificate given to

• public.
Debenture holders have no rights to vote in
the
company's general
meetings.
Characteristics of
Debentures
• Holders are the creditors of the company.
• Holders do not carry voting rights.
• Debentures are secured.
• Debentures are repayable after a fixed period of
time
1. Redeemable Debentures

These debentures are redeemable on a pre-

determined date or at any time prior to their
maturity, provided the company so desires and
gives a notice to that effect.
2. Irredeemable Debentures
• These are also called perpetual debentures.
• A company is not bound to repay the
amount during its life time.
• If the issuing company fails to pay the
interest, it has to redeem such debentures.
3. Convertible Debentures

The holders of these debentures are given the

option to convert their debentures into equity
shares at a time and in a ratio as decided by
the company.
 4. Non Convertible
Debentures

These debentures cannot be converted

into equity shares.
Pros & Cons of Debentures

Pros Cons
 Fixed debt servicing
 Lower post-tax cost burden
 No dilution of  Financial Leverage-
control Raises the cost of
 Disciplining effect equity
 Imposes restrictions
 Retained Earnings

• The portion of the profits which is not distributed

among the shareholders but is retained and is used
in business is called retained earnings.
• As per Indian Companies Act., companies
are required to transfer a part of their
profits in reserves.
• The amount so kept in reserve may be used
to buy fixed assets. This is called internal
financing.
 Term Loans
• A term loan is a monetary loan that is repaid
in regular payments over a set period of
time.
• Term loans usually last between one and ten
years, but may last as long as 30 years in
some cases.
• Term loan is a loan made by bank/financial
institution to a business having an initial
maturity of more than one year.
 Term Loans
Pros
 Interest on debt is tax
deductible
 Does not result in dilution of
control
 Do not partake in value
created by the firm
Issue costs of debt is
 and operational flexibility
lower
 Increases financial leverage,
Interest cost is normally fixed,
protection against high
unexpected inflation

Has a disciplining effect on
management
Cons
 Entails fixed obligation for
interest and principal,
non payment can even
lead to bankruptcy/ legal
action

Debt contracts impose
restrictions on firm’s financial

excess raises cost of equity to
the firm
 If inflation rate dips, cost of
debt higher than expected
 Differed Credit

• A deferred credit could mean money received in

advance of it being earned, such as deferred revenue,
unearned revenue, or customer advances.
• A deferred credit could also result from complicated
transactions where a credit amount arises, but the
amount is not revenue.
• A deferred credit is reported as a liability
on the balance sheet.
• Depending on the specifics, the deferred
credit might be a current liability or a
noncurrent liability.
• In the past, it was common to see a
noncurrent liability section with the
heading Deferred Credits.
 Raising Long Term Finance

• Initial Public Offer (IPO)

• Follow up Public offer (FPO)
• Rights Issue
• Bought out deals
• Private Placement
• Preferential allotment
• Venture Capital/ Private Equity transactions
• Term loan
 Initial Public Offer
Pros Cons
• Access to larger amount of  Pricing may have to be
funds attractive to lure
• Further growth limited investors
companies not using this 
route  Loss of flexibility
• Listing: provides exit route Higher accountability
to promoters; ensures 
marketability of existing More disclosure
shares requirements to be
• Encash on value created in the 
met
firm Recognition in market 
• Stock prices provide Visibility in market
useful indicators to Cost of making a
management public issue quite high
 Steps in an IPO
1. Approval of BOD
2. Shareholders’ approval
3. Appointment of lead manager(s)
4. Due diligence by LM
5. Appointment of intermediaries like registrars, printers, bankers,
advertisers
6. Prepare draft prospectus
7. Filing with SEBI
8. Listing applications filed along with draft prospectus
9. Agreement with registrars and depositories
 Steps in an IPO

10. Appoint underwriters (if reqd.)

11. Make changes in draft prospectus as per SEBI observations,
SE suggestions
12. File prospectus with ROC
13. Issue marketing exercise commences
14. Application forms dispatched
15. Issue opened
16. Basis of allotment finalized
17. Allotments made, refunds posted,
shares listed on SEs
 Other aspects of a public issue

• Eligibility criteria defined: net worth, track record of

profitability, issue in same year; secondary issues have no
such restrictions
• Book Building process: process of tendering quantities at
prices within a band
• Issue expenses: underwriting, brokerage commissions,
fees to managers to the issue, registrars, printers,
advertisers, listing fees, stamp duty
• Issue pricing: free pricing, disclose basis for issue price
• Public issue of debt: appointment of debenture trustee,
creation of DRR, credit rating reqd., security to be created
 Rights Issue
• Issue of capital to existing shareholders
• Offer made on a pro rata basis
• Offer document called Letter of Offer
• Option given to apply for additional shares
• Rights renunciation: are tradeable, may be sold off in the
market.
• Comparison with Public issue: with familiar investors, hence
likely to be more successful; less floatation costs since no
underwriting; but lower pricing to benefit shareholders
 Private Placement
• Sale of securities directly to wholesale investors like FIs, banks, MFs, FIIs,PE
funds etc.
 Private Placement
Pros Cons
 Less expensive mode  Does not qualify for listing in
 Lesser an unlisted company
SEBI and other  Restrictive covenants may be
 regulations imposed by the investors
Easier to market  May call for management

the issue to a few investors participation
Entry of 
Issue pricing more tight
wholesale financially
sophisticated investors in

company’s profile
May use this
 route until IPO decision
taken
Less
administrative
 Venture Capital/equity
• Equity finance to potentially high growth firms
• Reasonably long to medium term commitment
• Hands on management approach, active participation in
management
• Considered value add investor
• VC: primarily high risk high return investment
• Can be in unlisted or listed Companies
• Exit route to be defined at the time of
investment
• Restrictive clauses on promoters’ holding sell off and other
financial/operational issues
• Detailed memorandum/business plan on company, its financials to be
prepared
• Shareholders agreement to be signed by both parties
• Valuation of Company key issue
• Leads to dilution of control by existing promoters
 Obtaining a Term Loan
1. Submission of loan application: a project report containing
complete details of the project given to the FI/Bank
2. Initial processing of loan application: prepare flash report to decide
if project worth an appraisal or not
3. Project Appraisal: Detailed appraisal done to decide if project taken
or not, in terms of market, technical, financial, managerial appraisal
4. Issue of Letter of Sanction: to the borrower containing
amount sanctioned and terms and conditions thereto
5. Acceptance of terms and conditions by the borrowing unit: thru
a board meeting and conveyed to the FI/Bank
6. Execution of loan agreement: signed by both parties
7. Disbursement of loan: in tranches based on progress of the project, tie
up of means of finance
8. Creation of security: formalities to be completed within a timeframe
9. Monitoring: at implementation and operational stage thru periodic
progress reports, site visits etc.
THANK YOU