2. Why businesses need money
• They are just starting and need to buy premises and
equipment.
• They have an opportunity to introduce a new product
or service.
• A major item of equipment or building needs to be
brought up to date.
Businesses need extra money at times because:
3. The sources of funds 1
• Owner’s funds – savings of the owner – or an additional
mortgage taken out on their house.
• Profits – profits which have been retained and not paid
out as dividends.
• Loans – from a bank or other financial institution.
• Government grants – available for specific reasons, eg
expanding in a deprived area.
4. The sources of funds 2
• Hiring and leasing – this saves having to buy
expensive items outright as payments are made in
regular instalments.(tangible assets only)
• Issuing shares – only applies to public limited
companies whose shares are bought and sold on the
Stock Exchange.
• Selling assets – such as unwanted buildings or spare
land.
• Venture capital – finance from a company which
specialises in lending to successful small businesses –
often in exchange for shares.
5. The amount required
Factors affecting the choice of funding
The length of time for
which the money is needed
The risk
involved
The cost of the
money
Loss of
control
Advice available
Choosing a funding
method
6. Making the choice 1 – internal
sources
Source Advantages Disadvantages
Owner’s
funds
Owner keeps
control
Could lose
everything if
business fails
Retained
profit
Owner(s)
make decision
Reduces reserves
and possibly future
dividend payments.
May be insufficient
for needs.
7. Making the choice 2 – bank options
Source Advantages Disadvantages
Bank loan Advice available.
Repaid over an
agreed period
Bank may refuse.
Repayments may
rise if interest rates
increase.
Overdraft Cheaper than loan
for short-term
finance
Bank may refuse.
Only very short-term.
8. Making the choice 3 – other external sources
Source Advantage Disadvantage
Government
grant
May not need to be
repaid though
spending closely
checked
Complicated and
restricted to
certain
areas/reasons
Hiring and
leasing
Saves paying ‘up-
front’ for an asset.
Asset may belong
to business
eventually.
Only useful for
obtaining assets.
Costs more than
outright
purchase.
9. Making the choice 4 – other external sources
Source Advantage Disadvantage
Issuing
shares
Large amounts
available, never
repaid
Only for plcs
Shareholders paid
dividends
Selling
assets
Converts unused
items into capital
Only appropriate if
have unused assets!
Venture
capital
Large amount may
be available +
advice
Owner may lose
some control over
business
10. Government Securities
• A Government security is a tradable instrument issued by
the Central Government or the State Governments.
• It acknowledges the Government’s debt obligation.
• Such securities are short term (usually called treasury bills,
with original maturities of less than one year) or long term
(usually called Government bonds or dated securities with
original maturity of one year or more).
• In India, the Central Government issues both, treasury bills
and bonds or dated securities while the State Governments
issue only bonds or dated securities, which are called the
State Development Loans (SDLs).
• Government securities carry practically no risk of default
and, hence, are called risk-free gilt-edged instruments.
11. Treasury Bills (T-bills)
• Treasury bills or T-bills, which are money market instruments, are
short term debt instruments issued by the Government of India and
are presently issued in three tenors, namely, 91 day, 182 day and
364 day.
• Treasury bills are zero coupon securities and pay no interest. They
are issued at a discount and redeemed at the face value at maturity.
• For example, a 91 day Treasury bill of Rs.100/- (face value) may be
issued at say Rs. 98.20, that is, at a discount of say, Rs.1.80 and
would be redeemed at the face value of Rs.100/-. The return to the
investors is the difference between the maturity value or the face
value (that is Rs.100) and the issue price
• The Reserve Bank of India conducts auctions usually every
Wednesday to issue T-bills. Payments for the T-bills purchased are
made on the following Friday. The 91 day T-bills are auctioned on
every Wednesday.
12. Cash Management Bills (CMBs)
• Government of India, in consultation with the Reserve Bank
of India, has decided to issue a new short-term instrument,
known as Cash Management Bills (CMBs), to meet the
temporary mismatches in the cash flow of the Government.
The CMBs have the generic character of T-bills but are
issued for maturities less than 91 days. Like T-bills, they are
also issued at a discount and redeemed at face value at
maturity.
• The tenure, notified amount and date of issue of the CMBs
depends upon the temporary cash requirement of the
Government. The announcement of their auction is made
by Reserve Bank of India through a Press Release which will
be issued one day prior to the date of auction.
13. Dated Government securities
• Dated Government securities are long term
securities and carry a fixed or floating coupon
(interest rate) which is paid on the face value,
payable at fixed time periods (usually half-
yearly). The tenor of dated securities can be
up to 30 years.
14. NOMENCLATURE
• The nomenclature of a typical dated fixed coupon
Government security contains the following features -
coupon, name of the issuer, maturity and face
value. For example, 7.49% GS 2017 would mean:
• Coupon : 7.49% paid on face value
Name of Issuer : Government of India
Date of Issue : April 16, 2007
Maturity : April 16, 2017
Coupon Payment Dates : Half-yearly (October
16 and April 16) every year
Minimum Amount of issue/ sale : Rs.10,000
15. STRIPS (Separate Trading of Registered
Interest and Principal of Securities)
• Steps are being taken to introduce new types of instruments like
STRIPS. Accordingly, guidelines for stripping and reconstitution of
Government securities have been issued.
• STRIPS are instruments wherein each cash flow of the fixed coupon
security is converted into a separate tradable Zero Coupon Bond
and traded. For example, when Rs.100 of the 8.24%GS2018 is
stripped, each cash flow of coupon (Rs.4.12 each half year) will
become coupon STRIP and the principal payment (Rs.100 at
maturity) will become a principal STRIP. These cash flows are traded
separately as independent securities in the secondary market.
• STRIPS in Government securities will ensure availability of sovereign
zero coupon bonds
• STRIPS have zero reinvestment risk, being zero coupon bonds, they
can be attractive to retail/non-institutional investors.
16. Diaspora Bonds
• In a bid to attract investment from NRIs (non-
resident Indians), India is considering
introduction of “diaspora bonds” to facilitate
greater inflow of funds in the infrastructure
sector.
• The bulk of diaspora investments are in portfolio
investments of a short-term nature.
• The prime consideration is longer-term
investment instruments such as ‘diaspora bonds’
to provide opportunities for overseas Indians
17. Debentures
• A Debenture is a debt security issued by a
company (called the Issuer), which offers to pay
interest in lieu of the money borrowed for a
certain period.
• In essence it represents a loan taken by the issuer
who pays an agreed rate of interest during the
lifetime of the instrument and repays the
principal normally, unless otherwise agreed, on
maturity.
• These are long-term debt instruments issued by
private sector companies.
18. What are the different types of
debentures?
• Debentures are divided into different
categories on the basis of:
1. Redemption or Tenure
2. Convertibility
3. Security
4. Transferability
5. Mode of redemption
6. Type of Interest Rates offered
19. Redemption or Tenure
• Redeemable debentures are offered for certain period
of time and carry a specific date of redemption on the
certificate. It becomes an obligation on the part of the
company to repay the principal amount to the
debenture holders on that particular date.
• Irredeemable debentures on the other hand are not
bound by time. Also known as perpetual debentures,
they are paid off either on the liquidation of the
company or whenever the company chooses to pay
them off by issuing a due notice to the debenture
holders beforehand.
20. Convertibility
Debentures can be classified on the basis of convertibility into:
• Non Convertible Debentures (NCD): These instruments retain the
debt character and can not be converted in to equity shares
• Partly Convertible Debentures (PCD): A part of these instruments
are converted into Equity shares in the future at notice of the issuer.
The issuer decides the ratio for conversion. This is normally decided
at the time of subscription
• Fully convertible Debentures (FCD): These are fully convertible into
Equity shares at the issuer's notice. The ratio of conversion is
decided by the issuer. Upon conversion the investors enjoy the
same status as ordinary shareholders of the company.
21. On basis of Security, debentures are
classified into:
· Secured Debentures: These instruments are
secured by a charge on the fixed assets of the issuer
company. So if the issuer fails on payment of either
the principal or interest amount, his assets can be
sold to repay the liability to the investors
· Unsecured Debentures: These instrument are
unsecured in the sense that if the issuer defaults on
payment of the interest or principal amount, the
investor has to be along with other unsecured
creditors of the company.
22. • First Mortgaged and Second Mortgaged
Debentures
• Secured debentures are further classified into
these two types.
• As is obvious by the name, the first mortgaged
debenture holders enjoy the preference over the
assets of the company while the second
debenture holder has the secondary charge.
• This means that the realization from the assets
will first fulfil obligation of first mortgage
debentures and then will do for second ones.
23. Transferability/Registration
• Registered & Unregistered Debentures (Bearer) Debenture:
• In the case of registered debentures, the name, address, and other
holding details are registered with the issuing company and
whenever such debenture is transferred by the holder; it has to be
informed to the issuing company for updating in its records.
Otherwise the interest and principal will go the previous holder
because company will pay to the one who is registered.
• Whereas, the unregistered commonly known as bearer debenture
can be transferred by mere delivery to the new holder. They are
considered as good as currency notes due to their easy
transferability. The interest and principal is paid to the person who
produces the coupons, which are attached to the debenture
certificate.
24. Mode of Redemption
• Callable and Puttable Debentures / Bonds:
• In case of callable debentures, the company
has an option to buy back the debentures
from the investors and repay them their due
whereas in case of puttable debentures, the
option lies with the investors.
• Puttable debenture holders can ask the
company to redeem their debenture and seek
repayment of the principal amount.
25. Types of Interest Rates
• Fixed and Floating Rate Debentures:
• Fixed rate debentures enjoy fixed interest rate
over the life of the debentures while floating
rate debentures have a rate of interest which
keeps on changing depending on some
benchmark rate like LIBOR etc.
26. Example
• The company redeems fully convertible debentures for
their entire value into shares of the company. For
example, a debenture holder who has $20,000 worth
of debentures gets $20,000 worth of shares on
conversion. With partially convertible debentures, the
company converts only a portion of the shares into
cash. For the remainder amount, the debenture holder
is paid cash. For example, for debentures worth
$10,000, the company may issue the debenture holder
shares worth $3,000 and paid $7,000 in cash.
27. Angel Investors
• Angel Investors: Individual investors who but
equity in small private firms are called angel
investors
• Receive a sizeable equity share in the business
in return for their funds.
• Often insufficient amount and consequently
turn to Venture Capital firms.
28. Business Angels
• Individuals looking for investment
opportunities
• Generally small sums up to £100,000
• Could be an individual or a small group
• Generally have some say in the running of the
company
29. Venture Capital
• Pooling of capital in the form of limited companies
– Venture Capital Companies
• Looking for investment opportunities in fast
growing businesses or businesses with highly
rated prospects
• May also buy out firms in administration who are
going concerns
• May also provide advice, contacts and experience
• In the UK, venture capitalists have invested £50
billion since 1983
30. Venture capital firms
• Is a limited partnership that specializes in raising money to invest in private equity
of young firms.
• Typically institutional investors such as pension funds are limited partners. The
general partners work for the venture capital firm and run the venture capital
firms and are called Venture Capitalists
• Venture capital firms offer limited partners a number of advantages over investing
directly in start ups themselves as Angel Investors. Because these firms invest in
many start ups, limited partners are more diversified. They can also benefit from
the expertise of general partners.
• Costs:- General partners generally charge substantial fees, taken mainly as a
percentage of the positive returns they generate. Most firms charge 20% of any
positive returns they make but the successful firms may charge more than 30%.
They also generally charge an annual management fee of about 2% of the funds
committed capital.
• As per a study the venture capitalists typically control one third of the seats on a
start up BODs and often represents a single largest voting block on the board. They
protect their investment so they may perform a key nurturing and monitoring role
of the firm
33. Institutional Investors
• Institutional investors such as Pension funds,
insurance companies, endowments and
foundations manage large quantities of
money. They are major investors in different
assets and not surprisingly they are active
investors in private companies. They may
directly invest or invest indirectly by becoming
limited partners in venture capital firms.
34. Initial Public Offering
• An initial public offering (IPO) or stock market launch is a type of public
offering where shares of stock in a company are sold to the general public,
on a securities exchange, for the first time. Through this process, a private
company transforms into a public company.
• Initial public offerings are used by companies to raise expansion capital, to
possibly monetize the investments of early private investors, and to
become publicly traded enterprises.
• A company selling shares is never required to repay the capital to its public
investors.
• After the IPO, when shares trade freely in the open market, money passes
between public investors. Although an IPO offers many advantages, there
are also significant disadvantages.
• Chief among these are the costs associated with the process, and the
requirement to disclose certain information that could prove helpful to
competitors, or create difficulties with vendors.
35. • Details of the proposed offering are disclosed
to potential purchasers in the form of a
lengthy document known as a prospectus.
• Most companies undertaking an IPO do so
with the assistance of an investment
banking firm acting in the capacity of an
underwriter.
• Underwriters provide a valuable service,
which includes help with correctly assessing
the value of shares (share price), and
establishing a public market for shares (initial
sale).
36. Why IPO?
• For Funding Needs
•Funding Capital Requirements for Organic Growth
•Expansion through Projects
•Diversification
•Funding Global Requirements
•Funding Joint Venture and Collaborations needs
•Funding Infrastructure Requirements, Marketing Initiatives and
Distribution Channels
•Financing Working Capital Requirements
•Funding General Corporate Purposes
•Investing in businesses through other companies
•Repaying debt to strengthen the Balance Sheet
•Meeting Issue Expenses
• For Non-funding Needs
•Enhancing Corporate Stature
•Retention and incentive for Employees through stock options
•Provide liquidity to the shareholders
37. Pricing of IPO
• A company planning an IPO typically appoints a lead manager,
known as a bookrunner, to help it arrive at an appropriate price at
which the shares should be issued.
• There are two primary ways in which the price of an IPO can be
determined. Either the company, with the help of its lead
managers, fixes a price (fixed price method) or the price can be
determined through analysis of confidential investor demand data,
compiled by the bookrunner. That process is known as book
building.
• Historically, some IPOs both globally and in the United States have
been underpriced. The effect of "initial underpricing" an IPO is to
generate additional interest in the stock when it first becomes
publicly traded.
• Flipping, or quickly selling shares for a profit, can lead to significant
gains for investors who have been allocated shares of the IPO at the
offering price. However, underpricing an IPO results in lost potential
capital for the issuer
38. Example of underpricing
• One extreme example is theglobe.com IPO which helped
fuel the IPO "mania" of the late 90's internet era.
Underwritten by Bear Stearns on November 13, 1998, the
IPO was priced at $9 per share.
• The share price quickly increased 1000% after the opening
of trading, to a high of $97. Selling pressure from
institutional flipping eventually drove the stock back down,
and it closed the day at $63.
• Although the company did raise about $30 million from the
offering it is estimated that with the level of demand for
the offering and the volume of trading that took place the
company might have left upwards of $200 million on the
table.
40. Leasing and Hire Purchase
• Lease: A lease transaction is a commercial arrangement
whereby an equipment owner or Manufacturer
conveys to the equipment user the right to use the
equipment in return for a rental. In other words, lease
is a contract between the owner of an asset (the
lessor) and its user (the lessee) for the right to use the
asset during a specified period in return for a mutually
agreed periodic payment (the lease rentals).
• The important feature of a lease contract is separation
of the ownership of the asset from its usage.
41. Hire Purchase
• Hire purchase is a type of installment credit
under which the hire purchaser, called the hirer,
agrees to take the goods on hire at a stated
rental, which is inclusive of the repayment of
principal as well as interest, with an option to
purchase.
• Under this transaction, the hire purchaser
acquires the property (goods) immediately on
signing the hire purchase agreement but the
ownership or title of the same is transferred only
when the last installment is paid.
42. The Hire Purchase Act
• The hire purchase system is regulated by the Hire
Purchase Act 1972. This Act defines a hire
purchase as “an agreement under which goods
are let on hire and under which the hirer has an
option to purchase them in accordance with the
terms of the agreement and includes an
agreement under which:
1) The owner delivers possession of goods thereof
to a person on condition that such person pays
the agreed amount in periodic installments
43. 2) The property in the goods is to pass to such
person on the payment of the last of such
installments, and
3) Such person has a right to terminate the
agreement at any time before the property so
passes”.
• Hire purchase should be distinguished from
installment sale wherein property passes to the
purchaser with the payment of the first
installment. But in case of HP (ownership remains
with the seller until the last installment is paid)
buyer gets ownership after paying the last
installment.
44. Difference between Leasing and H.P
• Meaning
A lease transaction is a commercial arrangement,
whereby an equipment owner or manufacturer
conveys to the equipment
user the right to use the equipment in return for a
rental.
• Hire purchase is a type of installment credit under
which the hire purchaser agrees to take the goods on
hire at a stated rental, which is inclusive of the
repayment of principal as well as interest, with an
option to purchase.
45. Option to user
• Lease: No option is provided to the lessee
(user) to purchase the goods
• H.P: Option is provided to the hirer (user).
46. Emerging Sources of Finance
• Private Equity(PE)
• Foreign Direct Investment(FDI)
• Foreign Currency Convertible Bonds(FCCB)
47. Private Equity
• In finance, private equity is an asset class consisting of
equity securities and debt in operating companies that
are not publicly traded on a stock exchange.
• A private equity investment will generally be made by a
private equity firm, a venture capital firm or an angel
investor.
• Each of these categories of investor has its own set of
goals, preferences and investment strategies; however,
all provide working capital to a target company to
nurture expansion, new-product development, or
restructuring of the company’s operations,
management, or ownership.
48. Leveraged Buyout
• The acquisition of another company using a
significant amount of borrowed money (bonds or
loans) to meet the cost of acquisition.
• Often, the assets of the company being acquired
are used as collateral for the loans in addition to
the assets of the acquiring company.
• The purpose of leveraged buyouts is to allow
companies to make large acquisitions without
having to commit a lot of capital.
49. Foreign Direct Investment
• Foreign direct investment (FDI) is a direct
investment into production or business in a
country by a company in another country, either
by buying a company in the target country or by
expanding operations of an existing business in
that country.
• Foreign direct investment is in contrast to
portfolio investment which is a passive
investment in the securities of another country
such as stocks and bonds.
50. Foreign Currency Convertible
Bonds(FCCBs)
• A type of convertible bond issued in a currency different than the issuer's
domestic currency. In other words, the money being raised by the issuing
company is in the form of a foreign currency.
• A convertible bond is a mix between a debt and equity instrument. It acts
like a bond by making regular coupon and principal payments, but these
bonds also give the bondholder the option to convert the bond into stock.
• These types of bonds are attractive to both investors and issuers. The
investors receive the safety of guaranteed payments on the bond and are
also able to take advantage of any large price appreciation in the
company's stock.
• Bondholders take advantage of this appreciation by means warrants
attached to the bonds, which are activated when the price of the stock
reaches a certain point.
• Due to the equity side of the bond, which adds value, the coupon
payments on the bond are lower for the company, thereby reducing its
debt-financing costs.
51. Weak rupee spells trouble for FCCB
issuers
• A falling rupee is bad news for companies that had raised
capital through foreign currency convertible bonds, if the
stock price is quoting at a steep discount to the conversion
price. What this means is that the bond holders will ask for
their money back, along with interest, instead of converting
the loans into equities.
• It is a double whammy for the FCCB issuing companies
because the weak rupee means not only will the companies
have to repay the loans, but there will be an added cost
because of the weak rupee.
• It is a double whammy for the FCCB issuing companies
because the weak rupee means not only will the companies
have to repay the loans, but there will be an added cost
because of the weak rupee.
53. Organic Growth
• Organic growth is the process
of business expansion due to increasing overall
customer base, increased output per customer or
representative, new sales, or any combination of
the above, as opposed to mergers and
acquisitions, which are examples of inorganic
growth.
• Typically, the organic growth rate also excludes
the impact of foreign exchange. Growth including
foreign exchange, but excluding divestitures and
acquisitions, is often referred to as core growth.
54. Inorganic Growth
• Inorganic growth is the rate of growth of business, sales
expansion etc. by increasing output and business reach by
acquiring new businesses by way of mergers, acquisitions
and take-overs.
• This kind of growth also takes place due to government
directives, leading to enhancement of business in some
identified priority sector/area. The inorganic growth rate
also factors in the impact of foreign exchange movements
or performance of other economies.
• As opposed to the organic growth, this kind of growth is
affected to a great extent by exogenous factors. It is also a
faster way for companies to grow compared with organic
growth (where the main focus is productivity enhancement
and cost reduction).
