#1 long term sources of funding

8/12/2019 #1 Long Term Sources of Funding

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#1LONG-TERM SOURCES OF

FINANCING

Dr. Kulbir Singh

Advanced Corporate Finance

(Term III) 2013-14

IMT-Nagpur


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INTRODUCTIONPrimary responsibility of Finance Manager

selection of appropriate source of funding

Objective of finance strategy .. Support long-term business strategy

Responsibility of CFO maintain contact with public and private sources ofcapital to make sure that company has adequate cash to invest and grow.

Companies have access to wide range array of instruments Prominent being straight debt and equity

Last 20 years have witnessed unprecedented advances in thetypeand themanner in which securities are offered to the investing public

DR. KULBIR SINGH (IMT-NAGPUR) ACF-2013-14 2


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CAPITAL MARKETS

Capital Markets are sub-part of the financial system

Financial system includes

Complex of institutions and mechanisms which affect generation of savings and theirtransfer to those who will invest

Main Elements of Financial System are: Financial instruments/assets/securities

Financial Intermediaries/Institutions

Financial Markets



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CAPITAL MARKETS..

Capital Market Deals with long-term sources of finance/funds

Deals with securities issues of both corporate and government

Backbone of capital markets Securities Exchanges

forum for equity (equity market) and debt (debt market) transactions.

Comprises of

Securities Exchanges/markets (Secondary Market) &

New Issue/Primary Market (IPO/FPO Market)

Govt. Securities/Debt Market .. RBI & SEBI Corporate Debt Market SEBI

Equity Market . SEBI



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CAPITAL MARKETS..

Other Sources of Finance. Do not directly come under CM Leasing/Lease Finance

Hire Purchase

Other Sources of Finance. Do not directly come under CM Venture Capital funds

Private Equity

Private Placement of Debt



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CLASSIFICATION OF INSTRUMENTS

Instruments used by corporate sector to raise funds are selected on thebasis of investor preference and regulatory framework

Investors preferences vary Attitudes towards risk

Investment goals and investment horizons

Tax liability



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CLASSIFICATION OF INSTRUMENTS Corporate are affected by:

Permissible Debt-Equity Ratio

SEBI Regulations on issue of capital

Formalities to be complied with while raising an issue Tax-liability of the company

Purpose of finance

Debt serving ability

Willingness to broad base the shareholding of the company

Instruments can be classified Hybrid instruments

Pure Instruments

Derivative Instruments



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CLASSIFICATION OF INSTRUMENTS Corporate are affected by:

Permissible Debt-Equity Ratio

SEBI Regulations on issue of capital

Formalities to be complied with while raising an issue Tax-liability of the company

Purpose of finance

Debt serving ability

Willingness to broad base the shareholding of the company


Pure Instruments

Derivative Instruments



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EQUITY SHARES/ORDINARY SHARES Equity shares:

Fractional ownership

Rank pari passu . Dividends(!?!)

Residual claim to income Residual claim to assets

Right to control operations/participate in mgt. of co.

Voting rights

Pre-emptive Right

Limited liability


Pure Instruments

Derivative InstrumentsDR. KULBIR SINGH (IMT-NAGPUR) ACF-2013-14 9


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EQUITY SHARES/ORDINARY SHARESMerits:

Permanent source of funds w/o any repayment liability

No obligatory dividend payment

Forms the basis of further LT financing Shareholders with limited liability exercise control and share

other ownership rights in the income/assets of the firm

De-Merits High cost of funds

High floatation costs

Dilution of control of existing shareholders on sale of new issue



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EQUITY SHARES/ORDINARY SHARES

Equity as a source of long-term fund, it has high cost,low/nil risk, does not dilute control and puts norestrain on the managerial freedom



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No.

Amt.

(Rs.) No.

Amt.

(Rs.) No.

Amt.

(Rs.) No.

Amt.

(Rs.) No.

Amt.

(Rs.)

2000-01 151 6,108 124 5,378 27 729 37 3,385 114 2,722

2001-02 35 7,543 20 6,502 15 1,041 28 6,341 7 1,202

2002-03 26 4,070 14 3,638 12 431 20 3,032 6 1,0392003-04 57 23,272 35 22,265 22 1,007 36 19,838 21 3,434

2004-05 60 28,256 34 24,640 26 3,616 37 14,507 23 13,749

2005-06 139 27,382 103 23,294 36 4,088 60 16,446 79 10,936

2006-07 124 33,508 85 29,796 39 3,710 47 5,002 77 28,504

2007-08 124 87,029 92 54,511 32 32,518 39 44,434 85 42,595

2008-09 47 16,220 22 3,582 25 12,637 25 12,637 21 2,0822009-10 76 57,555 47 49,236 29 8,319 34 30,359 39 24,696

2010-11 91 67,609 68 58,105 23 9,503 32 32,049 53 35,559

2011-12 71 48,468 55 46,093 16 2,375 17 6,953 54 41,515

Source: Handbook of Statistics on Indian Securities 2013 (SEBI)

Resources Mobilized from the Primary Market (2000-2012) (Rs. in Cr.)

Year

TotalCategory-Wise Issuer Type

Public Rights Listed IPOs



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PRIVATE PLACEMENT

Private Placement means an offer or invitation to less than fiftypersons to subscribe to the debt securities in terms of sub-section (3)

of section 67 of the Companies Act, 1956 (1 of 1956)

Dr. Kulbir Singh (IMT-Nagpur) ACF-

2013-14


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PRIVATE EQUITY Private equity, consists of equity securities of operating companies that are

not publicly traded on a stock exchange.

Generally made by a private equity firm, a venture capital firm or an angelinvestor.

Each has its own set of goals, preferences and investment strategies to nurtureexpansion, new product development, or restructuring of the companysoperations, management, or ownership.

Most common investment strategies - leveraged buyouts, venture capital, growth

capital, distressed investments and mezzanine capital.

Mezzanine: subordinated debt or preferred equity securities often represent thejunior portion of a company's capital structure


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PRIVATE EQUITY IN INDIA.


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PRIVATE EQUITY IN INDIA.


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PREFERENCE SHARESKinds of Preference shares dealt with by companies in India:

Cumulative Preference Shares

Non-Cumulative Preference Shares

Convertible Preference Shares

Redeemable Preference Shares

Participating Preference Shares

Non-Redeemable Preference Shares



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PREFERENCE SHARESCumulative Preference Shares:

Preference dividend gets accumulated & paid subsequently

Arrears of PD c/f and paid out of profits, before payment of equity dividend

In case of liquidation:

No arrears of PD paid, unless

AoA contains such specific provision to make payment even in winding

Non-Cumulative Preference Shares: No Profits/Inadequate Profits no accumulation of dividends & hence not paid

No specific provision in AoA no right to participate in surplus profit or assets incase of winding up of the co.

Entitled to payment of declared PD in a year & to repayment of Preferencecapital in event of winding up before payments to equity shareholders



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PREFERENCE SHARESConvertible Preference Shares:

Quasi-equity shares, common parlance

Conversion into equity shares at end of specified period

Company may charge premium as part of terms of conversion

Redeemable Preference Shares (RPS): If AoA of a company so authorize, the co. can issue RPS

Sec 80 of Companies Act regulates redemption of PS

Redeemed only out of profits or out of proceeds of fresh issue of shares made for

this purpose Premium, if any, paid out of profits or security premium a/c

If paid out of profits, amt. = Redeemable PS transferred to CRR (cap Redemptionreserve)



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PREFERENCE SHARESParticipative Preference Shares:

As per terms of issue

Entitled to participate in surplus profits, after payment of dividends to Preference& Equity shareholders

Subject to provisions in terms of issue, even entitled to bonus shares

Non-Participative Preference Shares: Unless terms of issue indicate specifically, all preference shares are regarded as

Non-participating PS.



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TERM LOANS, DEBENTURES/BONDS &SECURITIZATION Enterprises raise LT funds from creditors in form of:

Term loans, debentures, bonds and so on

Bulk of term loans were earlier provided by FIs such as IDBI, ICICI, & IFCI

Banks entered in term lending business few years ago particularly in infrastructure/core sector

Bonds/Debentures emerged as substantial source of debt finance to corporates inIndia due to Absence of term loan support by FIs

Freedom to corporates for design instruments

Withdrawal of IR ceiling on debt instruments

Credit rating of debt instruments

Setting up of WDM by NSE

Securitization of loan portfolios popular instrument



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DEBT MARKET IN INDIA.


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TERM LOANSTerm loans also known as Term/Project Finance

Primary Source: FI & Banks (limited way)

FIs: Term loan for new projects as well as for expansion/diversification andmodernization

Banks: WC Term Loan for WC gap

Banks: finance Infrastructure projects on LT basis, but quantum such financing ismarginal



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TERM LOANS..Features of Term Loan Maturity FI: 6-10 yrs., Banks; 3-5 yrs.

Rescheduled on maturity, if required

Negotiated

Security

Secured

All present & future immovable properties constitute a general mortgage/firstequitable mortgage/floating charges for entire institutional loan incld.commitment charges, interest, liquidated damages, so on.

Additionally secured by hypothecation of all movable properties subject to priorcharge in favor of banks for capital finance/advance



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TERM LOANS..

Term loans carry low cost and involve high risk. Thereis no adverse effect on control but there is a moderaterestraint on managerial freedom



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DEBENTURESSection 2(12) of Companies Act, 1956 def.

Debentures include debenture stock, bonds, and any other securities of a company,whether constituting a charge on the assets of the company or not.

Represents creditorship securities & holders are the LT creditors of co.

As a secured instrument, it promises to pay interest & principal at stipulated times

Debentures are issued in the following forms Naked or unsecured debentures

Secured Debentures/mortgage debentures

Redeemable debentures

Perpetual Debentures

Bearer Debentures

Registered DebenturesDR. KULBIR SINGH (IMT-NAGPUR) ACF-2013-14 30


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DEBENTURES. ATTRIBUTESTrust Indenture

Interest Fixed payment is legally binding payable annually/semi-annualy/quarterly

Tax-deductible Some PSU issue Tax-free bonds. Ex. NHAI NCD issue tax-free

Maturity

NCD. 7-10 years

Redemption can be done in two ways DRR & Call and Put provisions

Security generally secured

Credit Rating



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DEBENTURESBased on convertibility, debentures can be classified as

Fully Convertible Debentures (FCDs)

Non Convertible Debentures (NCDs)

Secured Premium Notes (SPNs)

Floating Rate Bonds (FRBs)

Credit Rating Symbolic indicator of relative ability of the issuer of the debt instruments to meet

obligations when due



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DEBENTURESInnovative Debt Instruments

Zero Interest Binds/Debentures (ZIB/D)

Deep Discount Bonds (DDB)

Partly Convertible Debentures (PCDs)

Advantages of Convertible Debentures Capitalization of Interest cost

Carry lower IR compared to rate charged by Banks & FIs

Popular form of financing

FIs treat convertible part as equity

good for D/E ratio and provides flexibility in financing future projects

Equity capital gets increased after conversion

Compared to Term Loan greater degree of autonomy for the companyDR. KULBIR SINGH (IMT-NAGPUR) ACF-2013-14 33


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ICRA RATING SYMBOLS

LAAA Highest Safety

LAA+, LAA, LAA- High SafetyLA+, LA, LA- Adequate Safety

LBBB+, LBBB, LBBB- Moderate Safety

LB+, LB, LB- Risk Prone

LC+, LC, LC- Substantial Risk

LD Default, Extremely Speculative



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DEBT MARKET IN INDIA


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DEBT MARKET IN INDIA.


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DEBENTURES .. FINANCIAL DISTRESS

The disadvantage of using debt is the possibility of financialdistress, which can be defined as:

business failure legal bankruptcy

technical insolvency

accounting insolvency.


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DEBENTURES

Debentures as long-term sources of funds, have lowcost, do not dilute control, involve high risk and putsome restraint on managerial freedom



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SECURITISATIONThe process of transforming financial institutions assets such as

mortgages, into marketable securities, by pooling and selling therights to the income streams.

Advantages:

Investornegotiable security provides both regular incomeand final payout.

Mortgage agencyconversion of an illiquid asset into amarketable security.

Dr. Kulbir Singh (IMT-Nagpur)

ACF-2013-14


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SECURITIZATION IN INDIA.


ACF-2013-14


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INDIAN CAPITAL MARKETS: CHALLENGES


ACF-2013-14

#1 long term sources of funding

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