Sources of Finance:

Equity vs Debt Capital

Equity capital: represents the personal investment of the owner (s) of a company Debt capital: the financing that a small business owner has borrowed and must repay with interest

Sources of Equity Capital

Equity Capital Personal savings Preference CapitalFriends and family members Internal Accurals. Venture capital

Equity Capital

Ownership Capital Equity shareholders collectively own the company They enjoy the rewards and bear the risks of ownership.

Rights to Equity shareholders

Right to INCOME
Right to CONTROL PRE-EMPTIVE rights Right in LIQUIDATION

Advantages of Equity Capital

No compulsion to pay dividends No maturity date Enhances creditworthiness of the compant Equity dividends are tax exempt in the hand of investors

Disadvantages

Dilution of Control Rate of return reqd by equity shareholders is generally higher Equity dividends are paid out of profit after tax Cost of issuing equity shares is high

PREFERENCE CAPITAL

Hybrid form of Financing partakes some characteristics of equity & debentures.

Resembles Equity:

Preference dividend is payable only out of profits. Preference dividend is not a obligatory payment. Preference dividend is not a taxdeductible payment.

Resembles Debentures:

The dividend rate is usually fixed. Claim of preference shareholders is prior to the claim of equity shareholders. No roght to vote.

Types of Preference Capital:

Cumulative & Non Cumulative.

Participating & Non- Participating. Redeemable & Non-Redeemable. Convertible & Non-Convertible.

Advantages of Preference shares

No legal obligation to pay didvidend No redemption liability No dilution of control under normal circumstances

Disadvantages

Not tax deductible Skipping preference dividend can adversely affect the image of the firm Preference share holders have prior claim to equity holders on the assets n earnings of the firm If a firm skips preference dividends for 3 yrs, it has to grant voting right to the preference share holders

INTERNAL ACCURALS

Depreciation charges Retained Earnings.

Advantages

Readily available Eliminate issue costs & losses No dilution of control

Disadvantages

Amount available may be limited Oppurtunity cost is high

Debt Financing

Bonds Term loans Working Capital advance Miscellaneous

DEBENTURES (Bonds)

A document or a certificate issued by a company under its seal as an acknowledgement of its debt

It is a viable alternative for Term loans. Debenture holders are the creditors of the company. Debenture holders have the right to receive their interest payments before any dividend is payable to shareholders and, most importantly, even if a company makes a loss, it still has to pay its interest charges.

Characteristics of Debentures:

Borrowed Fund Fixed rate of interest Compulsory Payment of interest Security Redeemable No voting Rights Appointment of Trustee.

Types of Debentures:

Secured Debentures Unsecured Debentures Convertible Debentures Non convertible Debentures

Advantages of Debentures

Low cost No dilution of Control Intrest is treated as an expense Low rate of Interest Flexibility Attract large number of investors

Disadvantages

Fixed obligation Reduction in Creditability Charge on assets No voting rights

TERM LOANS

A loan is for a fixed amount with a fixed repayment schedule and may appear on a balance sheet with a specific name telling the reader exactly what the loan is and its main details. It is generally repayable in less than 10yrs.

Features of Term Loans:

Currency
Security Interest Payment & Principal Repayment Restrictive Covenants

Term loan procedure:

Submission of Loan application Initial Processing of Loan Appraisal of the Proposed Project Issue of the Letter of Sanction Acceptance of the Terms & Conditions by the Borrower Unit

Execution of Loan agreement Creation of Security Disbursement of Loans Monitoring Syndicated Loans

Working Capital Advance

Amount needed to meet seasonal or cyclical demand Like Short term loans

Forms

Cash credits/ Overdrafts

Loans Purchase/ Discount of bills Letter of Credit

Miscellanous

Deferred Credit Lease Finance & Hire purchase Unsecured Loans Special Scheme of institutions Subsides & Sales tax deferments & exemptions

Short term loans from financial institution Commercial paper Factoring Securitisation

Venture Capital
capital contributed at an early stage in the development of a new enterprise, which may have a significant chance of failure but also a significant chance of providing above average returns and especially where the provider of the capital expects to have some influence over the direction of the enterprise. Venture Capital can be a high risk strategy.

Use more Equity when:

Tax rate applicable is negligible Buisness risk exposure is high Dilution of control is not an important issue Assets of the project are mostly intangiable Project have many valuable growth options

Use of Debt when:

Tax rate applicable is high Buisness risk exposure is low Dilution of control is an issue The assets of the project are mostly tangiable Project has few growth options

Key Factors in Determining The Debt- Equity ratio:

Cost Nature of Assets Buisness risk Norms of Lenders Control Considerations Market conditions