LONG TERM SOURCES OF

FINANCE
-Naisha Sujan
 Equity Capital
• What is Equity?
• Types:
I. Authorized,
II. Issued,
III. Subscribed
 Equity Capital
• Features :
o Permanent capital
o Residual claim to income & assets,
o right to vote,
o pre-emptive right,
o ltd liability.
 Equity Capital
• Merits of Equity for company
– Perpetual capital
– No charge on assets
– No obligation for dividend
• Merits of equity to investor
– Voting rights / control
– Ltd liability
– Higher returns

• Demerits for company and investor.

• Types of issue:
Public issue – IPO, FPO
Right issue
Bonus issue
Private placement
Preferential issue
QIP
• Intermediaries for Issue
• Prospectus
• Book Building Process
 Debentures/Bonds
• Attributes
Interest
Maturity
Debenture redemption reserve
Security
Convertibility
Credit rating
Claim on income and assets
Embedded options
 Merits of Debentures/Bonds
Company Investor
• No dilution in ownership • Secured
• Option to convert to equity • Return is fixed
• Low cost of issue • Less risky
• More convenient • Instruments with different
• Cheaper source of finance features
• No dilution of control • Fixed Maturity
 Demerits of Debentures/Bonds
Company
• Legal obligation to pay
interest and repay principal
• Increases financial
leverage/risk
• Tough on company during
recession
• Reduces borrowing capacity
• Large cash outflow at
redemption
Investor
• Low liquidity
• Return not indexed to
inflation
• No profit sharing
• No voting rights
• Interest is taxable
 Debentures/Bonds
Issue Procedure
Public issue or Private placement
Credit rating
Listing
 Preference Capital
• Hybrid form of financing
• Features
 Prior claim on income and assets
 Redemption
 Cumulative dividends
 Fixed dividend
 Convertibility
 Voting Rights
 Participation in profits
 Merits of Preference shares
Company
• Long term source
• No legal obligation to pay
dividend
• No dilution of control
• No charge on assets
• Improves borrowing capacity
• Convertible shares can be
converted to equity
• Fixed cost of funding (generally
lesser than equity)
Investor
• Fixed return.
• Dividend is not taxable
• Less risky than equity
• Preference over equity for
dividend and claim on
assets
• Unpaid dividends can be
cumulated
 Demerits of Preference shares
Company Investor
• Expensive source of funding • Dividends can be skipped
• Skipping dividend may • No voting rights
damage the reputation • Low liquidity
• Fixed cost and redemption • Claim on assets is after debt
is repaid
• Non participation in profits
 Term loans
• For new projects, expansion, working capital
• Features:
 Maturity – 6-10yrs
 Negotiated
 Fixed interest
 Security
 Covenants
 Loan Amortization
 Term loans
• Procedure for obtaining term loan
– Firm submits an application and furnishes all
required information ( eg – promotor background,
project cost, means of finance, details of FA ,
marketing plans, profitability & cash flow, Govt
approvals etc)
– Bank reviews and may do a detailed project
appraisal – Market, technical, financial, managerial
– Once sanctioned, bank seeks periodic progress
report for periodic disbursements
 Merits Demerits for the company
• Merits:
 Less expensive :Low issue cost, interest tax deductible
 No dilution of control
 No participation in profits
 Imposes discipline
 Easier to share business info with one lender
 More convenient for lower finance requirements
 Large amount can be taken as loan
 Terms are negotiated

• Demerits:
 Covenants can restrain freedom
 Increased risk of bankruptcy
 Restricts further borrowing capacity
 Collateral required
 High risk
 Internal accruals
• Reserves & Surplus created from profits over
the years.
• Shows business financial strength
 Merits & Demerits of Internal Accruals

Merits Demerits
• No charge on assets • Investors may prefer
• No issue cost dividend pay-out over
• No dilution of control plough back
• No interest is paid. • Cost of finance is high
(equal to equity)
• Needs a long time to build
up such retained earnings
 Leasing
• Indirect finance
• Financing of capital asset
• Helps spread cash outflow (for acquiring asset)
over a number of years.
• Ita a contract between firm (user/lessee) and
supplier of asset (owner/ lessor) for use of asset
by lessee over a long period of time against
periodic lease rentals.
• A flexible mutual contract.
 Leasing
• Types of leasing:
– Operating lease (Computers, Projectors)
– Financial (Capital) lease (Land, building, machinery)
– Leveraged lease
– Sale and lease back
– Specialized service lease
– Net Lease
– Cross border
– International
https://accountlearning.com/different-types-of-leases/
 Operating lease Vs Financial lease

https://efinancemanagement.com/sources-of-finance/difference-between-operating-and-financial-lease
 Hire Purchase
– Hire Purchase is a kind of purchase where the businessman
(hirer) agrees to pay the cost of the equipment in different
instalments over a period of time.
– This installment covers the principal amount and the
interest
– The hirer gets the possession of the asset as soon as the
hire purchase agreement is signed.
– He becomes the owner of the equipment after the last
payment is made.
– Generally down payment is made at the time of agreement
– Ex – buying a car, laptop on hire purchase
 Leasing Vs Hire Purchase
Points of Distinction Leasing Hire Purchase

Lessor is the owner until Hirer has the option of

Ownership purchasing the asset at the
the end of the agreement end of the agreement
Duration Done for longer duration Done for a shorter duration
Lessor claims the Hirer claims the
Depreciation depreciation depreciation
Payments include the
Rental payments are the principal amount and the
Payments cost of using the asset effective interest for the
duration of the agreement

Lease rentals categorized as Only interest component is

Tax Impact categorized as expenditure
expenditure by the lessee
by the hirer
The Extent of Financing Complete financing Partial financing
Responsibility of the lessee
in the financial lease, and Responsibility of the hirer
Repairs and Maintenance of the lessor in operating
lease
 Hire Purchase

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