Chapter 4

Other Long-Term Financing

and Investment Banking
 4.1 Long Term Financial Source
There are four sources of Long term Finance
1. Internal source
– Retained earning
2. External source
– Long term debt
• Bond
• Bank loans
– Preferred stock
– Common stock
1. Retained Earning
• Advantages of Retained Earning
1. Readily available
2. It eliminate floatation cost
3. No tax is paid on Retained Earning
• Disadvantages of Retained Earning
1. It is limited in amount
2. Reduce Shareholders’ dividend
2. Long Term Debt
• Includes Bond and Long Term Bank Loan
• Debt Financing is appropriate when
1. There is stable revenue
2. The debt equity ratio is low
3. Inflation is expected
• Advantages of long term debt
1. Cheap form of financing
2. It is highly beneficial during inflation
• Disadvantages of long term debt
1. Increase firms’ financial risk
2. May involve Some restrictive covenant
3. Cost of debt is high during deflation
3. Common Stock
– Advantage of Common stock
1. Limited liability
2. Enhance credibility of the firm
3. No obligation to pay dividend
– Disadvantage of Common stock
1. More costly
2. Double taxation
4. Preferred Stock
– Advantage of preferred stock
1. Dividend is not mandatory
2. Enhance credit worthiness
3. Limit the span of control of common stockholders
4. Dividend payment is limited in amount
– Disadvantages of preferred stock
1. Dividend is not tax deductable
2. They have preferential right in dividend and asset
sharing
3. Fixed dividend increase financial risk
 4.3 Investment Banks
• Investment banks were essentially created in the U.S. by the
passage of the Glass-Steagall Act after 1930 depression. Prior
to this, investment banking activities were part of large,
money-center commercial banks. Investment banks perform
a variety of crucial functions in financial markets. They are sub
part of banks mainly works for financing of firms.
- -Underwrite the initial sale of stocks and bonds
– Facilitate mergers and acquisitions
– Middleman in the purchase and sale
of companies
– Private brokerage and consultancy service
 4.4 Venture Capital Firms
These firms provide funds for
start-up companies and Often become very
much involved with firm’s management and
provide expertise. Managers of start-ups may have
objectives that differ significantly from profit
maximization. Venture capitalists can reduce this
information problem in several ways
– Long-term motivation
– Sit on the board of directors
– Disburse funds in stages, based on required results
– Invest in several firms, diversifying some risk
 Origins of Venture Capital
• First U.S. venture capital firm was established
in 1946.
• Most venture capital firms in the 1950s and 1960s
funded development in oil and real estate.
• Funding has shifted from wealthy individuals to
pension funds / corporations.
 Life of Venture Capital Deal
1. Fundraising
– Venture firm solicits commitments, usually less than 100
per deal
2. Investment phase
– Seed investing
– Early stage investing
– Later stage investing
3. Exit
The Business Life Cycle & Venture Capital