INTRODUCTION

Capital is the money available to your business for operations. As your business grows,

so does your need for capital. There is more than one way and more than one place to

find the money you need. Choosing the right form of additional money for your business

is related to why the business needs capital.

Bank credit Issue of Issue of share

Customer debentures Issue of debenture
advances Issue of requirements
Financial Ploughing back of
Trade credit preference profits
Factoring share Loan from
Short Accrtuals
term Bank loansterm
medium specialized
long term
Deferred Public deposit / financial
incomes fixed deposit institutions
Commercial Loan from
paper financial
Installment institutions
credit

There are many factors that can create a need for additional capital. Some of the more

common are:

• Sales growth requires inventories to be built to support the higher sales level.

• Sales growth creates a larger volume of accounts receivable.

• Growth requires the business to carry larger cash balances in order to meet its

current obligations to employees, trade creditors, and others.

• Expansion opportunities such as a decision to open a new branch, add a new

product, or increase capacity.

• Cost savings opportunities such as equipment purchases that will lower

production costs or reduce operating expenses.

• Opportunities to realize substantial savings by taking advantage of quantity

discounts on purchases that will lower production costs or reduce operating

expenses.

• Opportunities to realize substantial savings by taking advantage of quantity

discounts on purchases for inventory, or building inventories prior to a supplier's

price increase.

• Seasonal factors, where inventories must be built before the selling season begins

and receivables may not be collected until 30 to 60 days after the selling season

ends.

• Current repayment of obligations or debts may require more cash than is

immediately available.

• Local or national economic conditions which cause sales and profit to decline

temporarily.

• Economic difficulties of customers that can cause them to pay more slowly than

expected.

• Failure to retain sufficient earnings in the business.

• Inattention to asset management may have allowed inventories or accounts

receivable to get out of hand.

Frequently, the cause cannot be entirely attributed to any one of these factors, but results

from a combination of them. For example, a growing, apparently successful business may

find that it does not have sufficient cash on hand to meet a current debt installment or to

expand to a new location because customers have been slow in paying.

Capital needs can be classified as either short- or long-term. Short-term needs are

generally those of less than one year. Long-term needs are those of more than one year.

Short-Term

Short-term financing is most common for assets that turn over quickly such as accounts

receivable or inventories. Seasonal businesses that must build inventories in anticipation

of selling requirements and will not collect receivables until after the selling season often

need short-term financing for the interim. Contractors with substantial work-in-process

inventories often need short-term financing until payment is received. Wholesalers and

manufacturers with a major portion of their assets tied up in inventories and/or

receivables also require short-term financing in anticipation of payments from customers.

Long-Term

Long-term financing is more often associated with the need for fixed assets such as

property, manufacturing plants, and equipment where the assets will be used in the

business for several years. It is also a practical alternative in many situations where short-

term financing requirements recur on a regular basis.

A series of recurring, short-term needs could often be more realistically viewed as a long-

term need. The addition of long-term capital should eliminate the short-term problems

and the crises that could occur if capital were not available to meet a short-term need.

Whenever the need for additional capital grows continually without any significant

pattern, as in the case of a company with steady sales and profit from year to year, long-

term financing is probably more appropriate.

CLASSIFICATION OF
CORPORATE SECURITIES

OWNERSHIP SECURITIES CREDITOR SHIP SECURITIES

DEBENTURE

ORDINARY OR PREFERENCE NO PAR DEFERRED

EQUITY SHARES SHARES STOCK SHARES
 NEED

Your strategic and liquidity plans will reveal your need for one of four types of capital.

Mismatching sources and needs will result in cash flow shortfalls and strained

relationships.

• Working capital needs emerge from cash flow cycles. For instance, cash flow needs

arise until a company can collect receivables. Typically, working capital needs should be

financed by bank lines of a year or less in maturity. The cost of the bank line and the

covenants attached to it should match working capital needs.

• Bridge capital can finance either a specific project or the acquisition of long-term

assets, such as building a new plant or purchasing a new machine. It’s important to match

the duration of the financing with the useful life of the asset or project. Bank financing or

institutional debt is usually the most appropriate source for bridge capital. The term tends

to be fixed-rate, amortized over the life of the project or asset involved. The servicing and

repayment of the debt should be matched to the cash flow generated by the project or

asset. Debt repayment must be structured to begin only after the venture is likely to

generate cash.

• Transitional capital needs arise when companies face ownership or strategic

transitions. Ownership transitions may involve the buyout of some shareholders. A

strategic transition might involve taking the business to the next level of growth, such as

developing a new market or new product, or even a long-term acquisition. Such

transitions result in shareholder value growth, so the most appropriate sources of capital
are private equity funds or subordinated debt lenders. Their investment typically involves

equity participation and a relatively short-term exit—typically five years. The key issue is

the company’s ability to generate sufficient value from such transitions to provide for the

exit of the capital sources and a healthy return to the family.

• Strategic capital supports long term development of a business, such as expansion into

a new geographic area that requires taking on a local partner, or a buyout of a whole

branch of the family. These initiatives can be financed via strategic, joint-venture partners

with deep experience in the industry or expertise in areas such as international

distribution. Family business investors who are willing to partner with your family might

be another source of capital to consider. Seek out a partner who can bring strategic or

ownership value in addition to capital. Before you accept any offers, define your growth

opportunities as well as your shareholders’ dreams and expectations. Analyzing your

needs and matching them with the sources of capital at hand will pave the way to a

healthy relationship with outside capital providers.

 STOCK

In the investment world, a share of stock (also referred to as equity share) represents a

share of ownership in a corporation (company).

Types of stock

Stock typically takes the form of shares of either common stock or preferred stock. As a

unit of ownership, common stock typically carries voting rights that can be exercised in

corporate decisions. Preferred stock differs from common stock in that it typically does

not carry voting rights but is legally entitled to receive a certain level of dividend

payments before any dividends can be issued to other shareholders. Convertible preferred

stock is preferred stock that includes an option for the holder to convert the preferred

shares into a fixed number of common shares, usually anytime after a predetermined

date. Shares of such stock are called "convertible preferred shares" (or "convertible

preference shares" in the UK)

Although there is a great deal of commonality between the stocks of different companies,

each new equity issue can have legal clauses attached to it that make it dynamically

different from the more general cases. Some shares of common stock may be issued

without the typical voting rights being included, for instance, or some shares may have

special rights unique to them and issued only to certain parties. Note that not all equity

shares are the same.

Preferred stock may hybrid by having the qualities of bonds of fix return and common

stock having voting right. They also have preference in the payment of dividend over

prefer stock and also have given the preference at the time of liquidation over common

stock. they have other features of accumulation in dividend.

Stock derivatives

A stock derivative is any financial instrument which has a value that is dependent on the

price of the underlying stock. Futures and options are the main types of derivatives on

stocks. The underlying security may be a stock index or an individual firm's stock, e.g.

single-stock futures.

Stock futures are contracts where the buyer is long, i.e., takes on the obligation to buy on

the contract maturity date, and the seller is short, i.e., takes on the obligation to sell. Stock

index futures are generally not delivered in the usual manner, but by cash settlement.

A stock option is a class of option. Specifically, a call option is the right (not obligation)

to buy stock in the future at a fixed price and a put option is the right (not obligation) to

sell stock in the future at a fixed price. Thus, the value of a stock option changes in

reaction to the underlying stock of which it is a derivative. The most popular method of

valuing stock options is the Black Scholes model. Apart from call options granted to

employees, most stock options are transferable.

AUTHORIZED CAPITAL

The authorised capital of a company (sometimes referred to as the authorised share

capital or the nominal capital, particularly in the United States) is the maximum amount

of share capital that the company is authorised by its constitutional documents to issue to

shareholders. Part of the authorised capital can (and frequently does) remain unissued.

The part of the authorised capital which has been issued to shareholders is referred to as

the issued share capital of the company.

ISSUED SHARE CAPITAL / SUBSCRIBED CAPITAL

The issued share capital of a company is the total nominal value of the shares of a

company which have been issued to shareholders and which remain outstanding (ie. have

not been redeemed or repurchased to be held in treasury). These shares, along with the

share premium account, represent the capital invested by the shareholders in the

company. The issued share capital may be less than the authorised share capital, the latter

being the total value of the shares that are available for issue by the company.

PAID- UP CAPITAL

Paid up capital is that part of company's capital which is paid in full by share holders and

the shares of owner of the company. It excludes capital thru borrowing and retained

earnings.

Paid up capital= capital invested by owner of company + (capital invested by retail,

institutional & other investors)

In India, there is the concept of par value of shares. Par value of shares means the face

value of the shares. A share under the Companies act, can either of Rs10 or Rs100 or any

other value which may be the fixed by the Memorandum of Association of the company.

When the shares are issued at the price which is higher than the par value say, for

example Par value is Rs10 and it is issued at Rs15 then Rs5 is the premium amount i.e,

Rs10 is the par value of the shares and Rs5 is the premium. Similarily when a share is

issued at an amount lower than the par value, say Rs8, in that case Rs2 is discount on

shares and Rs10 will be par value.

INITIAL PUBLIC OFFERING

Initial public offering (IPO), also referred to simply as a " offering" or "flotation," is

when a company issues common stock or shares to the public for the first time. They are

often issued by smaller, younger companies seeking capital to expand, but can also be

done by large privately-owned companies looking to become publicly traded.

In an IPO the issuer may obtain the assistance of an underwriting firm, which helps it

determine what type of security to issue (common or preferred), best offering price and

time to bring it to market.

An IPO can be a risky investment. For the individual investor, it is tough to predict what

the stock or shares will do on its initial day of trading and in the near future since there is

often little historical data with which to analyze the company. Also, most IPOs are of

companies going through a transitory growth period, and they are therefore subject to

additional uncertainty regarding their future value.

 Reasons for listing

When a company lists its shares on a public exchange, it will almost invariably look to

issue additional new shares in order to raise extra capital at the same time. The money

paid by investors for the newly-issued shares goes directly to the company (in contrast to

a later trade of shares on the exchange, where the money passes between investors). An

IPO, therefore, allows a company to tap a wide pool of stock market investors to provide

it with large volumes of capital for future growth. The company is never required to

repay the capital, but instead the new shareholders have a right to future profits

distributed by the company and the right to a capital distribution in case of a dissolution.

The existing shareholders will see their shareholdings diluted as a proportion of the

company's shares. However, they hope that the capital investment will make their

shareholdings more valuable in absolute terms.

In addition, once a company is listed, it will be able to issue further shares via a rights

issue, thereby again providing itself with capital for expansion without incurring any

debt. This regular ability to raise large amounts of capital from the general market, rather

than having to seek and negotiate with individual investors, is a key incentive for many

companies seeking to list.

Procedure

IPOs generally involve one or more investment banks as "underwriters." The company

offering its shares, called the "issuer," enters a contract with a lead underwriter to sell its
shares to the public. The underwriter then approaches investors with offers to sell these

shares.

The sale (that is, the allocation and pricing) of shares in an IPO may take several forms.

Common methods include:

• Best efforts contract

• Firm commitment contract

• All-or-none contract

• Bought deal

• Dutch auction

• Self distribution of stock

A large IPO is usually underwritten by a "syndicate" of investment banks led by one or

more major investment banks (lead underwriter). Upon selling the shares, the

underwriters keep a commission based on a percentage of the value of the shares sold.

Usually, the lead underwriters, i.e. the underwriters selling the largest proportions of the

IPO, take the highest commissions—up to 8% in some cases.

Multinational IPOs may have as many as three syndicates to deal with differing legal

requirements in both the issuer's domestic market and other regions. For example, an

issuer based in the E.U. may be represented by the main selling syndicate in its domestic

market, Europe, in addition to separate syndicates or selling groups for US/Canada and

for Asia. Usually, the lead underwriter in the main selling group is also the lead bank in

the other selling groups.

Because of the wide array of legal requirements, IPOs typically involve one or more law

firms with major practices in securities law, such as the Magic Circle firms of London

and the white shoe firms of New York City.

Usually, the offering will include the issuance of new shares, intended to raise new

capital, as well the secondary sale of existing shares. However, certain regulatory

restrictions and restrictions imposed by the lead underwriter are often placed on the sale

of existing shares.

Public offerings are primarily sold to institutional investors, but some shares are also

allocated to the underwriters' retail investors. A broker selling shares of a public offering

to his clients is paid through a sales credit instead of a commission. The client pays no

commission to purchase the shares of a public offering; the purchase price simply

includes the built-in sales credit.

The issuer usually allows the underwriters an option to increase the size of the offering

by up to 15% under certain circumstance known as the greenshoe or overallotment

option.

Business cycle

In the United States, during the dot-com bubble of the late 1990s, many venture capital

driven companies were started, and seeking to cash in on the bull market, quickly offered

IPOs. Usually, stock price spiraled upwards as soon as a company went public. Investors

sought to get in at the ground-level of the next potential Microsoft and Netscape.
Initial founders could often become overnight millionaires, and due to generous stock

options, employees could make a great deal of money as well. The majority of IPOs

could be found on the Nasdaq stock exchange, which lists companies related to computer

and information technology. However, in spite of the large amounts of financial resources

made available to relatively young and untested firms (often in multiple rounds of

financing), the vast majority of them rapidly entered cash crises. Crisis was particularly

likely in the case of firms where the founding team liquidated a substantial portion of

their stake in the firm at or soon after the IPO (Mudambi and Treichel, 2005).

This phenomenon was not limited to the United States. In Japan, for example, a similar

situation occurred. Some companies were operated in a similar way in that their only goal

was to have an IPO. Some stock exchanges were set up for those companies, such as

Osaka Securities Exchange.

Auction

A venture capitalist named Bill Hambrecht has attempted to devise a method that can

reduce the inefficient process. He devised a way to issue shares through a Dutch auction

as an attempt to minimize the extreme underpricing that underwriters were nurturing.

Underwriters, however, have not taken to this strategy very well. Though not the first

company to use Dutch auction, Google is one established company that went public

through the use of auction. Google's share price rose 17% in its first day of trading

despite the auction method. Perception of IPOs can be controversial. For those who view

a successful IPO to be one that raises as much money as possible, the IPO was a total

failure. For those who view a successful IPO from the kind of investors that eventually
gained from the underpricing, the IPO was a complete success. It's important to note that

different sets of investors bid in auctions versus the open market—more institutions bid,

fewer private individuals bid. Google may be a special case, however, as many individual

investors bought the stock based on long-term valuation shortly after it launched its IPO,

driving it beyond institutional valuation.

Pricing

Historically, 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. Through flipping, this 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 "money left on the table"—lost capital that could have

been raised for the company had the stock been offered at a higher price. One great

example of all these factors at play was seen with 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 stock had been priced at $9 per share, and famously jumped 1000% at the

opening of trading all the way up to $97, before deflating and closing at $63 after large

sell offs from institutions flipping the stock . 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.

The danger of overpricing is also an important consideration. If a stock is offered to the

public at a higher price than the market will pay, the underwriters may have trouble
meeting their commitments to sell shares. Even if they sell all of the issued shares, if the

stock falls in value on the first day of trading, it may lose its marketability and hence

even more of its value.

Investment banks, therefore, take many factors into consideration when pricing an IPO,

and attempt to reach an offering price that is low enough to stimulate interest in the stock,

but high enough to raise an adequate amount of capital for the company. The process of

determining an optimal price usually involves the underwriters ("syndicate") arranging

share purchase commitments from leading institutional investors.

Issue price

A company that is planning an IPO appoints lead managers to help it decide on an

appropriate price at which the shares should be issued. There are two ways in which the

price of an IPO can be determined: either the company, with the help of its lead

managers, fixes a price or the price is arrived at through the process of book building.

Note: Not all IPOs are eligible for delivery settlement through the DTC system, which

would then either require the physical delivery of the stock certificates to the clearing

agent bank's custodian, or a delivery versus payment (DVP) arrangement with the selling

group brokerage firm . This information is not sufficient.

Quiet period

There are two time windows commonly referred to as "quiet periods" during an IPO's

history. The first and the one linked above is the period of time following the filing of the
company's S-1 but before SEC staff declare the registration statement effective. During

this time, issuers, company insiders, analysts, and other parties are legally restricted in

their ability to discuss or promote the upcoming IPO.

The other "quiet period" refers to a period of 40 calendar days following an IPO's first

day of public trading. During this time, insiders and any underwriters involved in the

IPO, are restricted from issuing any earnings forecasts or research reports for the

company. Regulatory changes enacted by the SEC as part of the Global Settlement,

enlarged the "quiet period" from 25 days to 40 days on July 9, 2002. When the quiet

period is over, generally the lead underwriters will initiate research coverage on the firm.

Additionally, the NASD and NYSE have approved a rule mandating a 10-day quiet

period after a Secondary Offering and a 15-day quiet period both before and after

expiration of a "lock-up agreement" for a securities offering.

RIGHTS ISSUE

Under a secondary market offering or seasoned equity offering of shares to raise money,

a company can opt for a rights issue to raise capital. The rights issue is a special form of

shelf offering or shelf registration. With the issued rights, existing shareholders have the

privilege to buy a specified number of new shares from the firm at a specified price

within a specified time. A rights issue is in contrast to an initial public offering (primary

market offering), where shares are issued to the general public through market exchanges.
How it works

A rights issue is offered to all existing shareholders individually and may be rejected,

accepted in full or accepted in part. Rights are often transferable, allowing the holder to

sell them on the open market. A right to a share is generally issued on a ratio basis (e.g.

one-for-three rights issue). Because the company receives shareholders' money in

exchange for shares, a rights issue is a source of capital.

Considerations

To issue rights the financial manager has to consider:

• Subscription price per new share

• Number of new shares to be sold

• The value of rights

• The effect of rights on the value of the current share

• The effect of rights to existing and new shareholders

Underwriting

Rights issues may be underwritten. The role of the underwriter is to guarantee that the

funds sought by the company will be raised. The agreement between the underwriter and

the company is set out in a formal underwriting agreement. Typical terms of an

underwriting require the underwriter to subscribe for any shares offered but not taken up

by shareholders. The underwriting agreement will normally enable the underwriter to

terminate its obligations in defined circumstances. A sub-underwriter in turn sub-

underwrites some or all of the obligations of the main underwriter; the underwriter passes

its risk to the sub-underwriter by requiring the sub-underwriter to subscribe for or

purchase a portion of the shares for which the underwriter is obliged to subscribe in the

event of a shortfall. Underwriters and sub-underwriters may be financial institutions,

stock-brokers, major shareholders of the company or other related or unrelated parties.

The Panel’s guidance covers both non-underwritten and underwritten rights issues.

BONUS ISSUE

A company issue shares in lieu for cash or sometimes against transfer of physical or

intellectual property to the company's hands.

But bonus shares are issued to the existing shareholders by converting free reserves or

share premium account to equity capital without taking any consideration from investors.

Bonus shares do not directly affect a company's performance.

Bonus issue has following major effects.

1. Share capital gets increased according to the bonus issue ratio.

2. Liquidity in the stock increases.

3. Effective Earnings per share, Book Value and other per share values stand

reduced.

4. Markets take the action usually as a favorable act.

5. Market price gets adjusted on issue of bonus shares.

6. Accumulated profits get reduced.

Bonus shares are issued by converting the reserves of the company into share capital. It is

nothing but capitalization of the reserves of the company. Bonus shares can be issued by

a company only if the Articles of Association of the company authorises a bonus issue.

Where there is no provision in this regard in the articles, they must be amended by

passing special resolution act at the general meeting of the company. Care must be taken

that issue of bonus shares does not lead to total share capital in excess of the authorised

share capital. Otherwise, the authorised capital must be increased by amending the capital

clause of the Memorandum of association. If the company has availed of any loan from

the financial institutions, prior permission is to obtained from the institutions for issue of

bonus shares. If the company is listed on the stock exchange, the stock exchange must be

informed of the decision of the board to issue bonus shares immediately after the board

meeting. Where the bonus shares are to be issued to the non-resident members, prior

consent of the Reserve Bank should be obtained.

Only fully paid up bonus share can be issued. Partly paid up bonus shares cannot be

issued since the shareholders become liable to pay the uncalled amount on those shares.

FEATURES OF EQUITY SHARE

Equity shares are the corner stones of the financial structure of the company. On the

strength of these shares, the company procures other sources of capital. Equity Shares as

a source of long term funds for the company has certain features they are:
 1. Investors in the equity share are the real owners of the company. The investors in

equity share are entitled to the profits earned by the company or the losses

incurred by the company.

2. Funds raised by the company by way of equity shares are available on permanent

basis. It means th at funds raised by the company by way of equity shares are n ot

required to be repaid by the company during the lifetime of the company. They

are required to be repaid only at the time of closing down of the company.

3. Funds raised by the company by way of equity shares are available to the

company on unsecured basis.

4. Return which the company pays on equity share is in the form of dividend.

5. Equity shares as a source of raising the long term funds is a risk free soruce for

the company as the company does not commit anything on equity shares.

6. Equity shares as an investment is very risky for the investors.

7. Equity shareholders may not be able to compel the company to pay the dividend

but they enjoy the right to maintain the proportionate interest in profits, assets and

control of the company.

8. In financial terms, equity shares as a source of raising the funds is costly source

available to the company.

ADVANTAGE AND DISADVANTAGE

Advantage

Equity sharing offers benefits to the investor, including the elimination of the landlord

problem, elimination of negative cash flow from monthly payments, and the potential to
purchase superior property. Depending on your situation, you may also recognize

additional benefits from co-owning investment property with a home buyer/occupier.

Rental Property Owners

If you already own a rental property and want to relinquish your landlord responsibilities,

equity sharing may be the answer. By equity sharing your existing property with a home

buyer/occupier as a partner, you can eliminate all the headaches associated with rental

property.

Long Distance Investors

If you’re interested in buying property in a hot market outside your locale, or even in an

international location, equity sharing offers special advantages. By partnering with

someone in the desired market, you can put their expertise to work throughout the

property selection and negotiation process. You also avoid the difficulty of renting the

property remotely, or the expense of hiring a property management company to rent and

maintain the house on your behalf.

Family Members

When helping a family member purchase property, there are numerous advantages to

equity sharing. Everyone stands to gain financially, and the agreement gives your family

member an incentive to make all of their mortgage payments and maintain the property.

Most importantly, having a detailed agreement in place eliminates misunderstandings and

protects valued relationships.

Sellers

Equity sharing is a solution worth considering when you’re having trouble selling a

property. Joint ownership allows you to pass responsibility for the debt and monthly

payments to your partner, while keeping a partial interest in the property so you can

recognize a return on your investment when the market improves.

Retirement Account Holders

If you have an IRA, you might not realize that you can use those funds to invest directly

in real estate. Diversifying your IRA into real estate is simple and affordable using equity

sharing, and only requires the use of a self-directed IRA custodian.

Disadvantage

While the benefits of real-estate co-ownership are fairly obvious, it’s important to

consider the risks and disadvantages as well. When you enter into an equity-sharing

arrangement you are making certain commitments to your partner, and giving up certain

rights.

Partnership Risk

When you engage in joint ownership of real estate, your partner is responsible for

maintaining the property, but you’ll want to gain agreement on what is required and

expected. You’ll also need agreement from your partner if you decide you want to sell

early or otherwise amend your agreement.

Financial Risk

Like any investment, the purchase of real estate involves financial risk. It is illiquid

during the term of the agreement, and subject to market forces. You can lower your risk

by carefully selecting property likely to appreciate in value, having it inspected prior to

purchase and selecting a partner with good credit. Nonetheless, there is always the risk

that your investment won’t provide the expected rate of return.

Credit Risk

Depending on the lender you chose and the rate of return you’re seeking, you may decide

to be a co-borrower with your partner on the mortgage. While the equity sharing

agreement has language designed to protect you, there is a possibility that your credit

may be affected should your partner fail to make timely mortgage payments. This risk

can be reduced by working with a lender that will make the loan to your partner only

while you remain on the title, and by insisting on proof of payment from your partner

each month.

Complexity Risk

Buying real estate is a complicated process with many steps and legal documents

involved. When you buy as tenants-in-common there are a few additional documents

required, and it may be confusing to people unfamiliar with the concept. To help lower

this risk Home Equity Share provides the necessary documents and we offer support to

real estate agents new to equity sharing.

 PREFERENCE CAPITAL

According to financial theory, preference capital is one type of financing. Preference

capital carries preference to the shareholders at the time of winding up of company and

dividend payment.

The preference capital is also referred to as the capital contributed by the preference

shareholders. The preference shareholders receive dividends in the fixed rate but they do

not enjoy voting rights.

Every business may be in the need of financing in order to meet the cost of new projects.

The various means of financing are – share capital, debenture capital, term loan, deferred

credit and IOU incentive sources.

The share capital may be further divided into two parts - equity capital and preference

capital.

The concept of preference capital financing is believed to be the hybrid of two financing

forms that are – debenture financing and equity financing.

Like equity financing, in the preference capital financing also the preference dividends

are paid depending on the distributable profit and the preference dividends are not

obligatory payments. Like equity dividends, the preference dividends are also not tax-

deductible. The similarities of preference capital with debenture are – preference capital

is redeemable, preference capital dividend rate is fixed and the preference shareholders

cannot vote.
The various features of preference capital are:

• Dividends Cumulating

• Callability

• Convertibility

• Redeemability

• Participation in surplus profits and assets

• Voting rights

The advantages of preference capital are:

• Preference capitals are usually considered as a part of the net worth.

• There is no legal obligation for the company to pay the preference dividends.

• Usually preference shares do not carry voting rights.

• Financial distress due to obligation of redemption is not high in preference capital

because the periodic sinking fund payments are not needed.

• No assets need to be pledged favoring the preference shareholders.

The disadvantages of preference capital are:

• The preference capitals can be very expensive financing source while compared

with debt financing.

• The preference shareholders enjoy prior claims on the earnings and assets of the

company.

• Skipping dividend payment may affect the image of the company adversely.
• The preference shareholders may gain voting rights if the company skips

dividends for a period of time.

 DEBENTURE

A debenture (also called a note) is a certificate issued by a company acknowledging that

it has borrowed money on which interest is being paid. It is an unsecured corporate bond

or a corporate bond that does not have a certain line of income or piece of property or

equipment to guarantee repayment of principal upon the bond's maturity. Debentures are

long-term debt instrument used by large companies to obtain funds. Where securities are

offered, loan stocks or bonds are termed 'debentures' in the UK or 'mortgage bonds' in the

US.

A corporation receives an advantage when it issues debentures (as opposed to issuing

secured corporate bonds) because it means that the company does not have to set aside

certain assets or income in order to guarantee against its default in paying back the

principal at maturity. Therefore, a corporation that issues debentures may use those assets

or funds that would otherwise be held a separate account for other financing activities.

Debentures are generally freely transferable by the debenture holder. Debenture holders

have no voting rights and the interest given to them is a charge against profit in

company's financial statements.

In law, a debenture is a document that either creates a debt or acknowledges it. It is a

medium to long-term borrowing facility created by a company. Where repayment is

secured by a charge over land, the document is called a 'mortgage'. Where repayment is

secured by a charge other assets of the company, the document is called a 'debenture'.

Where no security is involved, the document is called a note or 'unsecured deposit note'..
 Nomenclature

In practice, the distinction between bond and debenture is not always maintained. Bonds

are sometimes called debentures and vice-versa[clarification needed].

Types

There are two types of debentures:

1. Convertible Debentures, which are convertible bonds or bonds that can be

converted into equity shares of the issuing company after a predetermined period

of time. "Convertibility" is a feature that corporations may add to the bonds they

issue in order to make them more attractive to buyers. In other words, it is a

special feature that a corporate bond may carry. As a result of the advantage a

buyer gets from the ability to convert, convertible bonds typically have lower

interest rates than non-convertible corporate bonds.

2. Non-Convertible Debentures, which are simply regular debentures, cannot be

converted into equity shares of the liable company. They are debentures without

the convertibility feature attached to them. As a result, they usually carry higher

interest rates than their convertible counterparts.

ADVANTAGE AND DISADVANTAGE

Some people have probably never even heard of the term debenture before, but it will be

defined in this article. We have to first understand how companies offer and sell bonds to
the public. This process is somewhat easier to understand and simply takes a little bit of

education to comprehend.

Whenever a company needs more money to help it function and grow, it will sometimes

try to sell company bonds to people. A company bond is simply an amount of money that

the company borrows from you to use on various business related expenditures. In return

for using your money, the company promises to pay back the full amount of money they

initially borrowed plus interest over an extended period of time.

Companies also provide things that offer you financial protection in cases they are unable

to pay back the amount of borrowed money and interest in the form of immediate cash.

Some of this protection comes in the form of assets such as company stock or debentures,

which are basically promises that the company will eventually pay you back. Company

bonds can be a great thing to invest in, but they also have quite a few risks that need to be

addressed before purchasing.

There are a few advantages that come from investing in corporate debentures, which will

be examined first in this article. These advantages are highly dependable on the success

rate of the current interest rate and economic situation of society.

Greater Returns

Corporate bonds and debentures are usually much more rewarding then government

bonds or bank investments and provide a higher rate of financial return for their

investors. If a company is selling bonds to people, it means that they definitely need the

money and are willing to pay you quite a bit of additional money to use it. The fact of
receiving a greater return on corporate bonds is a great advantage to these types of

investment.

Financially Convertible

Another great advantage to debentures is that at the end of the lending period companies

usually offer the assets in the form of stock, which can ultimately be very valuable.

Stocks are another great form of investment and are sometimes better than receiving

immediate cash in return.Although the advantages of debentures can be clearly seen,

there are a number risks and disadvantages to investing in corporate bonds.

Success or Failure

You are taking a great risk when investing in a corporate bond because the success of the

company will determine how valuable your bond is. A company bond is only valuable

when the company is successful and profitable, but if it fails, then you will lose a great

amount of money. Debentures and bonds hold greater risks because the company could

eventually go out of business, so this type of investment should be done very carefully.

Debentures can be a very attractive form of investment, but only should be taken

advantage of with companies that have a very high probability of being successful. Large

and already successful businesses are smart forms of investments when considering

buying corporate debentures.

 CREDIT RATING

A credit rating estimates the credit worthiness of an individual, corporation, or even a

country. It is an evaluation made by credit bureaus of a borrower’s overall credit history.

Credit ratings are calculated from financial history and current assets and liabilities.

Typically, a credit rating tells a lender or investor the probability of the subject being able

to pay back a loan. However, in recent years, credit ratings have also been used to adjust

insurance premiums, determine employment eligibility, and establish the amount of a

utility or leasing deposit.

A poor credit rating indicates a high risk of defaulting on a loan, and thus leads to high

interest rates, or the refusal of a loan by the creditor

Personal credit ratings

An individual's credit score, along with his or her credit report, affects his or her ability to

borrow money through financial institutions such as banks.

The factors which may influence a person's credit rating are:

• ability to pay a loan

• interest

• amount of credit used

• saving patterns

• spending patterns

• debt
In different parts of the world different personal credit rating systems exist.

Corporate credit ratings

The credit rating of a corporation is a financial indicator to potential investors of debt

securities such as bonds. These are assigned by credit rating agencies such as Standard &

Poor's, Moody's or Fitch Ratings and have letter designations such as AAA, B, CC. The

Standard & Poor's rating scale is as follows, from excellent to poor: AAA, AA, A, BBB,

BB, B, CCC, CC, C, D. Anything lower than a BBB rating is considered a speculative or

junk bond. The Moody's rating system is similar in concept but the naming is a little

different. It is as follows, from excellent to poor: AAA, Aa1, Aa2, Aa3, A1, A2, A3,

Baa1, Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, C.

Sovereign credit ratings

A sovereign credit rating is the credit rating of a sovereign entity, i.e. a country. The

sovereign credit rating indicates the risk level of the investing environment of a country

and is used by investors looking to invest abroad. It takes political risk into account.

Importance of Credit Rating

Credit ratings establish a link between risk and return. They thus provide a yardstick

against which to measure the risk inherent in any instrument. An investor uses the ratings

to assess the risk level and compares the offered rate of return with his expected rate of

return (for the particular level of risk) to optimise his risk-return trade-off. The risk

perception of a common investor, in the absence of a credit rating system, largely

depends on his familiarity with the names of the promoters or the collaborators. It is not

feasible for the corporate issuer of a debt instrument to offer every prospective investor

the opportunity to undertake a detailed risk evaluation. It is very uncommon for different

classes of investors to arrive at some uniform conclusion as to the relative quality of the

instrument. Moreover they do not possess the requisite skills of credit evaluation. Thus,

the need for credit rating in today’s world cannot be overemphasised. It is of great

assistance to the investors in making investment decisions. It also helps the issuers of the

debt instruments to price their issues correctly and to reach out to new investors.

Regulators like Reserve Bank of India (RBI) and Securities and Exchange Board of India

(SEBI) use credit rating to determine eligibility criteria for some instruments. For

example, the RBI has stipulated a minimum credit rating by an approved agency for issue

of commercial paper. In general, credit rating is expected to improve quality

consciousness in the market and establish over a period of time, a more meaningful

relationship between the quality of debt and the yield from it. Credit Rating is also a

valuable input in establishing business relationships of various types. However, credit

rating by a rating agency is not a recommendation to purchase or sale of a security.

OVERVIEW OF MAJOR CREDIT RATING AGENCIES

ONICRA Credit Rating Agency of India Ltd.

The Simple, Effective and Complete Rating Solution providers;

accredited by the Govt.

Tel: +91 (0)11 51654525

Fax: +91 (0)11 504 8501

Cellular Phone: +91 93121 14134

E-mail: santoshm@onicra.com

Onicra a path breaking innovative organization analysis data and provides individual

credit rating solutions that enable the lender or service provider to take a valued judgment

on financial and other transactions . Onicra facilitates over 100,000 transactions per day

through a single window clearance on a national basis in the TELECOM , BANKING ,

INSURANCE , HEALTH AND EDUCATION SECTOR . Over the years, Onicra has

developed a long list of esteemed clients. With the high expectations placed on

relationships today, we're pleased our client list continues to grow. This includes some of

India Inc's top 500 companies . Our clients include: Airtel, Mahindra & Mahindra,

Reliance, Volkswagon, HDFC and Genpact, etc.

Onicra has been acknowledged as pioneers in this field by the Ministry of Finance in the

Economic Survey (1993-1994) .It is also recognized and empanelled by the likes of

NSIC (National Small Industries Corporation) for SSI (Small Scale Industry)

assessment. Our Ratings have also been accepted by the Indian Banks Association.

We deliver services from a national network of 88 operation centers. Our integrated

network also comprises of 2414 FOS (Fleet on Street) personnel located at various

strategic locations nationwide. Our presence in 400 locations coupled with multilingual

capabilities lends us a competitive advantage to manage complex processes in multiple

geographic regions.
The operations architecture allows for business or services to be conducted in the lowest

turnaround time using our revolutionary PTS technology. Operations not only run round

the clock but also meet customer needs for proximity, language and cultural compatibility

without hampering productivity. This operational efficiency and complexity allows us to

process over 30000 unique cases per day.

Credit Rating Information Services of India Limited (CRISIL)

Head office:

254/B, 2nd Floor, Nirlon House,

Dr. A.B. Road, Worli,

Mumbai - 400 025, India.

Tel : (91 22) 493 94 45 - 9

Fax : (91 22) 493 94 41

E-mail: rvasantraj@crisil.com

At the core of CRISIL are its unimpeachable credibility and unmatched analytical rigour.

Leveraging these core strengths CRISIL delivers opinions and solutions that:

• Make markets function better, and,

• Help clients mitigate and manage their business & financial risks

• Help shape public policy.

CRISIL offers domestic and international customers a unique combination of local

insights and global perspectives, delivering independent information, opinions and

solutions that help them make better informed business and investment decisions,
improve the efficiency of markets and market participants, and help shape infrastructure

policy and projects. Its integrated range of capabilities includes credit ratings; research

on India's economy, industries and companies; investment research outsourcing; fund

services; risk management and infrastructure advisory services.

CRISIL's majority shareholder is Standard & Poor's, the world's foremost provider of

independent credit ratings, indices, risk evaluation, investment research and data.
 Investment Information and Credit Rating Agency of India (ICRA)

Head Office:

4th Floor, Kailash Building

26, Kasturba Gandhi Marg

New Delhi 110 001, India.

E-mail: vivek_m@icra.mailserve.net

ICRA Limited (formerly Investment Information and Credit Rating Agency of India

Limited) was set up in 1991 by leading financial/investment institutions, commercial

banks and financial services companies as an independent and professional Investment

Information and Credit Rating Agency. The international Credit Rating Agency Moody’s

Investors Service is ICRA’s largest shareholder. The participation of Moody’s is

supported by a Technical Services Agreement, which entails Moody’s providing certain

high-value technical services to ICRA. Specifically, the agreement is aimed at benefiting

ICRA’s in-house research capabilities, and providing it with access to Moody’s global

research base. Today, ICRA and its subsidiaries together form the ICRA Group of

Companies (Group ICRA). ICRA is a Public Limited Company, with its shares listed on

the Bombay Stock Exchange and the National Stock Exchange.

ICRA information products, Ratings, and solutions reflect independent, professional and

impartial opinions, which assist businesses enhance the quality of their decisions and help

issuers access a broader investor base and even lesser known business entities approach

the money and capital markets.

We strongly believe that quality and authenticity of information are derivatives of an

organisation’s research base. We have dedicated teams for Monetary, Fiscal, Industry and

Sector research, and a panel of Advisors to enhance our in-house capabilities. Our

research base enables us to maintain the highest standards of quality and credibility.

The focus of ICRA in the coming years will continue to be on developing innovative

concepts and products in a dynamic market environment, generating and promoting wider

investor awareness and interest, enhancing efficiency and transparency in the financial

market, and providing a healthier environment for market participants and regulators.
ICRA’s Ratings Scale and Definitions

Long-Term rating Scale: All Bonds, NCDs, and other debt instruments

(excluding Public Deposits) with original maturity exceeding one year.

LAAA The highest-credit-quality rating assigned by ICRA. The rated instrument

carries the lowest credit risk

LAA The high-credit-quality rating assigned by ICRA. The rated instrument

carries low credit risk.

LA The adequate-credit-quality rating assigned by ICRA. The rated instrument

carries average credit risk.

LBBB The moderate-credit-quality rating assigned by ICRA. The rated

instrument carries higher than average credit risk.

LBB The inadequate-credit-quality rating assigned by ICRA. The rated

instrument carries high credit risk.

LB The risk-prone-credit-quality rating assigned by ICRA. . The rated instrument

carries very high credit risk.

LC The poor-credit-quality rating assigned by ICRA. The rated instrument has

limited prospects of recovery.

LD The lowest-credit-quality rating assigned by ICRA. The rated instrument has

very low prospects of recovery.

Credit Analysis & Research Limited (CARE)

Head Office:

5th Floor, Mahindra Towers

Dr G. M. Bhosale Marg

Worli, Mumbai 400 018, India.

Tel: (91 22) 492 5242 / 44, 493 2588 / 5627, 497 5574 / 75

Fax: (91 22) 497 3243

E-mail: care@careratings.com

Website: http://www.careratings.com

Credit Analysis & Research Ltd. (CARE Ratings) is a full service rating company that

offers a wide range of rating and grading services across sectors. CARE has an unparallel

depth of expertise. CARE Ratings methodologies are in line with the best international

practices.

CARE Ratings has completed over 5307 rating assignments having aggregate value of

about Rs.14801 billion (as at December 2008), since its inception in April 1993. CARE

is recognised by Securities and Exchange Board of India (Sebi), Government of India

(GoI) and Reserve Bank of India (RBI) etc.

CARE was promoted by major Banks/FIs (financial institutions) in India. The three

largest shareholders of CARE are IDBI Bank, Canara Bank and State Bank of India.

CARE, is set-up with two divisions:

 REFERENCES

Books

Capital Markets in the EEC: The Sources and Uses of Medium-and Long-term

Finance by Edward Victor Morgan, Richard Harrington - Business &

Economics - 1977

Web

1. www.wikipedia.org

2. www.google.com

3. www.yahoo.com

4. www.scribd.com