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FINANCIAL MARKETS AND SERVICES(F){5TH SEM}

UNIT-3 LEASING AND HIRE PURCHASE:
ASSET/FUND BASED FINANACIAL SERVICES:

LEASING:
 A lease is a contract outlining the terms under which one party agrees to rent
property owned by another party. It guarantees the lessee, also known as the
tenant, use of an asset and guarantees the lessor, the property owner or landlord,
regular payments from the lessee for a specified number of months or years.
 Both the lessee and the lessor face consequences if they fail to uphold the terms of
the contract.
 A lease is a contractual arrangement calling for the lessee (user) to pay the lessor
(owner) for use of an asset. Property, buildings and vehicles are common assets that
are leased. Industrial or business equipment is also leased.
 Broadly put, a lease agreement is a contract between two parties, the lessor and the
lessee. The lessor is the legal owner of the asset; the lessee obtains the right to use
the asset in return for regular rental payments.
 The lessee also agrees to abide by various conditions regarding their use of the
property or equipment. For example, a person leasing a car may agree that the car
will only be used for personal use.
 The narrower term rental agreement can be used to describe a lease in which the
asset is tangible property.
 Language used is that the user rents the land or goods let out or rented out by the
owner. The verb to lease is less precise because it can refer to either of these
actions.
 Examples of a lease for intangible property are use of a computer program (similar
to a license, but with different provisions), or use of a radio frequency (such as a
contract with a cell-phone provider).
 The term rental agreement is also sometimes used to describe a periodic lease
agreement (most often a month-to-month lease) internationally and in some regions
of the United States.

PURPOSE OF LEASING
The purpose of choosing a lease can be many. Generally, a lease is structured for the
following reasons.
1. BENEFITS OF TAXES
The tax benefit is availed to both the parties, i.e. Lessor and Lessee. Lessor, being the owner
of the asset, can claim depreciation as an expense in his books and therefore get the tax
benefit. On the other hand, the lessee can claim the MLPs i.e. lease rentals as an expense
and achieve tax benefit in a similar way.
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2. AVOID OWNERSHIP AND THEREBY AVOIDING RISKS OF OWNERSHIP

Ownership is avoided to avoid the investment of money into the asset. It indirectly keeps
the leverage low and hence opportunities of borrowing money remain open for the
business. A Lease is an off-balance sheet item.

ADVANTAGES AND DISADVANATGES OF LEASING:

ADVANTAGES OF LEASING
1) BALANCED CASH OUTFLOW:The biggest advantage of leasing is that cash outflow or
payments related to leasing are spread out over several years, hence saving the
burden of one-time significant cash payment. This helps a business to maintain a
steady cash-flow profile.
2) QUALITY ASSETS : While leasing an asset, the ownership of the asset still lies with
the lessor whereas the lessee just pays the rental expense. Given this agreement, it
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becomes plausible for a business to invest in good quality assets which might look
unaffordable or expensive otherwise.
3) BETTER USAGE OF CAPITAL: Given that a company chooses to lease over investing in
an asset by purchasing, it releases capital for the business to fund its other capital
needs or to save money for a better capital investment decision.
4) TAX BENEFIT: Leasing expense or lease payments are considered as operating
expenses, and hence, of interest, are tax deductible.
5) OFF-BALANCE SHEET DEBT: Although lease expenses get the same treatment as that
of interest expense, the lease itself is treated differently from debt. Leasing is
classified as an off-balance sheet debt and doesn’t appear on the company’s balance
sheet.
6) BETTER PLANNING: Lease expenses usually remain constant for over the asset’s life
or lease tenor or grow in line with inflation. This helps in planning expense or cash
outflow when undertaking a budgeting exercise.
7) LOW CAPITAL EXPENDITURE: Leasing is an ideal option for a newly set-up business
given that it means lower initial cost and lower CapEx requirements.
8) NO RISK OF OBSOLESCENCE: For businesses operating in the sector, where there is a
high risk of technology becoming obsolete, leasing yields great returns and saves the
business from the risk of investing in a technology that might soon become out-
dated. For example, it is ideal for the technology business.
9) TERMINATION RIGHTS: At the end of the leasing period, the lessee holds the right to
buy the property and terminate the leasing contract, thus providing flexibility to
business.
DISADVANTAGES OF LEASING
1) LEASE EXPENSES: Lease payments are treated as expenses rather than as equity
payments towards an asset.
2) LIMITED FINANCIAL BENEFITS: If paying lease payments towards a land, the business
cannot benefit from any appreciation in the value of the land. The long-term lease
agreement also remains a burden on the business as the agreement is locked and
the expenses for several years are fixed. In a case when the use of asset does not
serve the requirement after some years, lease payments become a burden.
3) REDUCED RETURN FOR EQUITY HOLDERS: Given that lease expenses reduce the net
income without any appreciation in value, it means limited returns or reduced
returns for an equity shareholder. In such a case, the objective of wealth
maximization for shareholders is not achieved.
4) DEBT: Although lease doesn’t appear on the balance sheet of a company, investors
still consider long-term lease as debt and adjust their valuation of a business to
include leases
5) LIMITED ACCESS TO OTHER LOANS: Given that investors treat long-term leases as
debt, it might become difficult for a business to tap capital markets and raise further
loans or other forms of debt from the market.
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6) PROCESSING AND DOCUMENTATION: Overall, to enter into a lease agreement is a

complex process and requires thorough documentation and proper examination of
an asset being leased.

7) NO OWNERSHIP: At the end of the leasing period, the lessee doesn’t end up
becoming the owner of the asset though quite a good sum of payment is being done
over the years towards the asset.

8) MAINTENANCE OF THE ASSET: The lessee remains responsible for the maintenance
and proper operation of the asset being leased.

9) LIMITED TAX BENEFIT: For a new start-up, the tax expense is likely to be minimal. In
these circumstances, there in added tax advantage that can be derived from leasing
expenses.

CLASSIFICATION OF LEASING:

1) Financial Lease: Financial leasing is a contract involving payment over a longer

period. It is a long-term lease and the lessee will be paying much more than the cost
of the property or equipment to the lessor in the form of lease charges. It is
irrevocable. In this type of leasing the lessee has to bear all costs and the lessor does
not render any service.

2) Operating Lease: In an operating lease, the lessee uses the asset for a specific
period. The lessor bears the risk of obsolescence and incidental risks. There is an
option to either party to terminate the lease after giving notice. In this type of
leasing
lessor bears all expenses
lessor will not be able to realize the full cost of the asset
specialized services are provided by the lessor.
This kind of lease is preferred where the equipment is likely to suffer obsolescence.
3) Leveraged and non-leveraged leases: In leveraged and non-leveraged leases, the
value of the asset leased may be of a huge amount which may not be possible for
the lessor to finance. So, the lessor involves one more financier who will have charge
over the leased asset.

4) Conveyance type lease: In Conveyance type lease, the lease will be for a long-period
with a clear intention of conveying the ownership of title on the lessee.

5) Sale and leaseback: In a sale and leaseback, a company owning the asset sells it to
the lessor. The lessor pays immediately for the asset but leases the asset to the
seller. Thus, the seller of the asset becomes the lessee. The asset remains with the
seller who is a lessee but the ownership is with the lessor who is the buyer. This
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arrangement is done so that the selling company obtains finance for running the
business along with with the asset.

6) Full and non pay-out lease: A full pay-out lease is one in which the lessor recovers
the full value of the leased asset by way of leasing. In case of a non pay-out lease,
the lessor leases out the same asset over and over again.

7) Specialized service lease: The lessor or the owner of the asset is a specialist of the
asset which he is leasing out. He not only leases out but also gives specialized
personal service to the lessee. Examples are electronic goods, automobiles, air-
conditioners, etc.

8) Net and non-net lease: In non-net lease, the lessor is in charge of maintenance
insurance and other incidental expenses. In a net lease, the lessor is not concerned
with the above maintenance expenditure. The lessor confines only to financial
service.

9) Sales aid lease: In case, the lessor enters into any tie up arrangement with
manufacturer for the marketing, it is called sales aid lease.

10) Cross border lease: Lease across national frontiers are called cross border lease,
Shipping, air service, etc., will come under this category.

11) Tax oriented lease: Where the lease is not a loan on security but qualifies as a lease,
it will be considered a tax oriented lease.

12) Import Lease: In an Import lease, the company providing equipment for lease may
be located in a foreign country but the lessor and the lessee may belong to the same
country. The equipment is more or less imported.

13) International lease: Here, the parties to the lease transactions may belong to
different countries which is almost similar to cross border lease.

HIRE PURCHASE:
Definition
 “Under the Hire-Purchase system, goods are delivered to the buyer (called the “Hire-
purchaser”) in return for his undertaking to pay agreed amounts at specified
intervals for a certain period, and on the understanding that at the end of that
period when the payments completed, the goods become his absolute property.”
(Principles and Practice of book-keeping and Accounts by B.G. Vickery).
 “By hire-purchase is meant the system under which property or a Chattle is acquired
by payments made in instalments, during the period of which title in the property
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remains with the hire vendor. The payments made till the final instalment are
regarded as being purely in respect of hire, and the title in the property does not
pass to the hire-purchaser until such final payment or some other consideration
provided for in the contract has been fulfilled.”
Characteristics of Hire Purchase:

(a) Instantaneous delivery of goods : In the case of hire-purchase contracts, the seller is
supposed to hand over the possession of goods to the hire-purchaser immediately after the
singing of the agreement.
(b) Payment in instalments: Under a hire-purchase contact the payment for the goods sold
is stipulated to be paid by the hire-purchaser in instalments. These instalments may be of
fixed sums or of varying amounts depending upon the agreement entered into between the
two parties.
(c) Interest: Since the payment for the goods is deferred. Some interest is usually charged
by the hire vendor. Such interest is assumed to be included in the instalments unless the
agreement specifically provides otherwise.
(d) Deferment of transfer of property : The hire vendor parts with the possession of his
goods but not with the ownership to the hire-purchaser. The goods so delivered remain the
property of the hire vendor until the whole of the payments are completed.
(e) Right to repossess in case of default: As the property in the goods does not pass to the
hire-purchaser, the hire vendor has the right to repossess the goods so delivered in case the
hire purchaser makes a default in the payment of any instalment. The instalments already
paid by the hire-purchaser in such a case will be treated as hire for the commodity used by
him.
(f) Instalments to be treated as hire : As said above every instalment (except the last on e)
is treated as hire for the use of goods as against the purchase price thereof. But with the
payment of the last instalment, every prior instalment is retrospectively treated as a
payment for the price of the goods so delivered.
(g) Liability for the outstanding instalments : The hire-purchaser, under a hire purchase
agreement, is liable for the outstanding (due but unpaid) instalments even after the seller
decides to repossess the goods for non-payment of the instalment by the hire-purchaser.
(h) Liability for future or undue liability : The hire-purchaser is not required to pay the
future or undue instalments once the goods are repossessed by the hire-vendor.
(i) Undertaking by the hire purchaser : The hire-purchaser cannot sell, destroy, damage,
exchange or pledge the goods until the final payment he frequently has to undertake to
keep the goods in sound repair and good condition until the last payment is made. Whereas
the hire purchaser has the option to buy, the hire-vendor is bound to sell.
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MECHANISM/PROCEDURE/PROCESS OF HIRE PURCHASE:
DIFFERENCE BETWEEN LEASING AND HIRE PURCHASE:
BASIS OF COMPARISON LEASING
1)OWNERSHIP Lessor is the owner until the
end of the agreement
2)DURATION Done for longer duration
3)DEPRICIATION Lessor claims the
depreciation
4)PAYMENTS Rental payments are the
cost of using the asset
5)TAX IMPACT Lease rentals categorized as
expenditure by the lessee
HIRE PURCHASE
Hirer has the option of
purchasing the asset at the
end of the agreement
Done for a shorter duration
Hirer claims the
depreciation
Payments include the
principal amount and the
effective interest for the
duration of the agreement
Only interest component is
categorized as expenditure
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by the hirer
6)THE EXTENT OF Complete financing Partial financing
FINANCING
7)REPAIRS AND Responsibility of the lessee Responsibility of the hirer
MAINTENANCE in the financial lease, and of
the lessor in operating lease

VENTURE CAPITAL :
 Venture capital (VC) is a type of private equity,a form of financing that is provided by
firms or funds to small, early-stage, emerging firms that are deemed to have high
growth potential, or which have demonstrated high growth (in terms of number of
employees, annual revenue, or both).
 Venture capital firms or funds invest in these early-stage companies in exchange for
equity, or an ownership stake, in the companies they invest in.
 Venture capitalists take on the risk of financing risky start-ups in the hopes that
some of the firms they support will become successful.
 The start-ups are usually based on an innovative technology or business model and
they are usually from the high technology industries, such as information technology
(IT), clean technology or biotechnology.
 The typical venture capital investment occurs after an initial "seed funding" round.
The first round of institutional venture capital to fund growth is called the Series A
round. Venture capitalists provide this financing in the interest of generating a return
through an eventual "exit" event, such as the company selling shares to the public
for the first time in an initial public offering (IPO) or doing a merger and acquisition
(also known as a "trade sale") of the company

STAGES OF FINANCING:
1) The Seed Stage:
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Venture capital financing starts with the seed-stage when the company is often little more
than an idea for a product or service that has the potential to develop into a successful
business down the road. Entrepreneurs spend most of this stage convincing investors that
their ideas represent a viable investment opportunity. Funding amounts in the seed stage
are generally small, and are largely used for things like marketing research, product
development, and business expansion, with the goal of creating a prototype to attract
additional investors in later funding rounds.
2) The Startup Stage:
In the startup stage, companies have typically completed research and development and
devised a business plan, and are now ready to begin advertising and marketing their product
or service to potential customers. Typically, the company has a prototype to show investors,
but has not yet sold any products. At this stage, businesses need a larger infusion of cash to
fine tune their products and services, expand their personnel, and conducting any remaining
research necessary to support an official business launch.
3) The First Stage
Sometimes also called the “emerging stage,” first stage financing typically coincides with the
company’s market launch, when the company is finally about to start seeing a profit. Funds
from this phase of a venture capital financing typically go to actual product manufacturing
and sales, as well as increased marketing. To achieve an official launch, businesses usually
need a much bigger capital investment, so the funding amounts in this stage tend to be
much higher than in previous stages.
4) The Expansion Stage
Also commonly referred to as the second or third stages, the expansion stage is when the
company is seeing exponential growth and needs additional funding to keep up with the
demands. Because the business likely already has a commercially viable product and is
starting to see some profitability, venture capital funding in the emerging stage is largely
used to grow the business even further through market expansion and product
diversification
5) The Bridge Stage
The final stage of venture capital financing, the bridge stage is when companies have
reached maturity. Funding obtained here is typically used to support activities like mergers,
acquisitions, or IPOs. The bridge state is essentially a transition to the company being a full-
fledged, viable business. At this time, many investors choose to sell their shares and end
their relationship with the company, often receiving a significant return on their
investments.