Sources of Long term

finance
&
Raising Long Term Funds

1
 Agenda
• Meaning and purpose of long
term finance
• Various sources of long term
finance
• Raising share capital – Equity finance &
Debt finance
•
 Types of Finance
There are three types of finance which might
be needed:
1. Short term: for up to one year

2. Medium term: for one to ten years

3. Long term: for more than ten years

There are two main sources:

1. Internal to the business

2.External to the business
There are two main reasons for raising funds:

a)The purchase of fixed assets

b)The need for more working capital
4.
 Meaning of Long term
Finance
Long term finance: Funds required
for fixed capital and part of
working capital is called long
term finance.
Purpose of long term finance

i. To Finance fixed assets

ii.To finance the permanent part of
working capital
iii.To finance growth and
expansion of business

 Factors determining long-
term financial requirements

i. Nature of Business
ii.Nature of goods produced
iii.Technology used
 Funding a firm depends on?
• Financial Strategy
• Leverage
• Business expectations affect investment
• Different products require different stock
levels
• Large firms can regulate stocks more
readily
• Government grants & tax allowances will
influence the asset structure of a
business
Which source of funds to choose ?
1. Cost: interest rates vary, but share issues
carry high administration costs
2. Size of loan: large amounts are less likely to

be found from internal resources

3. Gearing: the ratio between owners’ equity &

borrowed money will affect creditworthiness

4. Risk: the likely profitability of the investment

will affect whether owners or lenders are

willing to invest
5. Collateral: where firms have assets as

guarantees against loans, institutions are

more willing to lend
6. Status: reputable firms will find fund raising
 The need for each type of
finance
Short term:
1. To cover time lags between producing & selling

2. To cover seasonal fluctuations in cash flow

3. To buy equipment with a life of under one year

Medium term:

1. For small scale expansion

2. To cover more persistent cash flow problems

3. To buy equipment & assets with lives of 1-10 yrs

Long term:

1. For starting up, or large scale expansion

2. To finance takeovers or mergers

3. To buy long term assets like buildings

 Sources of Long Term Finance
External:
Loan from financial institutions

Issue of Debenture

Public Deposits

Term loans from banks

Internal:

1. Shares Owners’ Funds

 Issues of shares by companies
 Owners’ injections of money
for small businesses
2. Retained profits
3. Reserves
 Different kinds of Shares
1. Ordinary shares: carry one vote per share,
but receive their dividend last
2. Ordinary non-voting shares

3. Preference shares: receive a fixed dividend

& has priority over ordinary share for

dividends
4. Cumulative preference shares: will be paid

arrears of dividends when profits are

ultimately made
5. Redeemable preference shares: the

company has the right to buy these shares

back, at a fixed date
 Owners’ Equity
Advantages:
1. Dividends payable when profits are made

2.Ordinary shareholders have voting rights

3.Borrowing Capacity
Disadvantages:

1. Capital is tied up in the business

2. Might be difficult to sell shares, or the

business
3. Share issues are expensive to administer
 Borrowing
Advantages:
1. Interest on loans is tax deductible
2. Real value of debt falls during inflation

3. Limited liability protects companies

4. Debentures can be sold on the Stock

Exchange
Disadvantages:

1. Borrowed funds have to be repaid

2. Limited liability does not protect businesses

3.Some loans will require collateral

4.Highly geared firms are vulnerable in
 Euro Issues
• Issue of GDRs : Global Depository
Receipts
• A GDR is a dollar denominated
instrument tradeable on a stock
exchange in Europe or in the USA
• E.g. A GDR of $60 = 4 equity shares
of $15 each, equivalent to Rs. 600/-
(if exchange rate is $1=Rs.40)
 SUMMING UP
•

• Equity capital represents ownership

capital
•

• Internal accruals consist of depreciation,

amortisation,
 and retained earnings
•
•

• Preference capital represents a hybrid

form of financing
•

• Term loans and debentures are the most

important
 sources of long-term debt finance
•

• Cost, dilution of control, risk, and

restraint on
 managerial
used for freedom are the key criteria

termevaluating
finance the various sources of long-
 Assignment-2

 What are the criteria applied by

Financial institutions in India
while sanctioning term finance to
industrial units ?
RAISING LONG – TERM
FINANCE
 Methods

1. Venture Capital
2. Initial Public Offer
3. Secondary Public Offer
4. Rights Issue
5. Private Placement
 VENTURE CAPITAL

VENTURE CAPITAL REPRESENTS FINANCIAL

INVESTMENT IN A HIGHLY RISKY PROPOSITION

MADE IN THE HOPE OF EARNING A HIGH RATE OF

RETURN
 FEATURES OF VENTURE CAPITAL

• The venture capitalist ( VC ) subscribes

to equity or
quasi - equity instruments .

• The VC takes an active interest in

guiding the assisted
firm .

• The VC normally plans to liquidate its

investment in the
assisted firm after 3 to 7 years .
 GUIDELINES FOR PREPARING A BUSINESS PLAN

• Use simple and clear language

• Focus on four basic elements , viz .,
people , product ,
market , and competition .
• Give projections for about two years
with emphasis on
cash flows .
• Identify risks and develop a strategy to
cope with the
same .
• Convince that the management team is
talented ,
committed , and determined .
BENEFITS OF GOING PUBLIC

• Access to Capital

• Respectability

• Investor Recognition

• Window of Opportunity

• Liquidity

• Diversification
 COSTS OF GOING PUBLIC
• Adverse Selection
• Dilution
• Loss of Flexibility
• Disclosures
• Accountability
• Public Pressure
• Costs
 BOOK BUILDING

Book building is a method of offering

shares to investors in which the issue

price is not fixed in advance ( as is done

in a fixed price offer ) but is determined

through a bidding process .

ROLE OF THE LEAD
MANAGER
OF THE ISSUE
The lead manager of a public issue may
be likened to the ‘ conductor ’ of an opera .
His principal tasks are to :
• Structure the issue
• Coordinate the appointment of various
intermediaries
• Prepare the draft prospectus and
finalise the same
• Market the issue
• Monitor the issue during the
subscription period
• Finalise the allotment
• Secure stock exchange listing .
 RIGHTS ISSUE

A rights issue is an issue of capital to

the existing shareholders of a company on a
pro rata basis through a Letter of Offer .

Rights are negotiable and can be exercised

only during a fixed period which is usually
about 30 days .
 VALUE OF A SHARE
The value of a share , after the rights
issue , is expected to be :

NP 0 + S
N + 1
where : N = number of existing shares
required for a rights share
P 0 = cum - rights market price per
share
S = subscription price at which
the rights share are issued
 VALUE OF A RIGHT

The theoretical value of a right is :

P0 – S

N + 1
 KEY POINTS ABOUT A RIGHTS ISSUE

• The wealth of existing shareholders , per

share , is not
affected by the rights offering ,
provided , of course , the
existing shareholders exercise their
rights in full or sell
their rights .

• Theoretically , the subscription price is

irrelevant
because the wealth of a shareholder who
subscribes to
the rights shares or sells the rights
remains unchanged ,
irrespective of what the subscription
price is .
PRIVATE PLACEMENT AND
PREFERENTIAL
ALLOTMENT

• Private placement and preferential

allotment involve
sale of securities to a limited number
of sophisticated
investors such as financial
institutions , mutual funds ,
venture capital funds , banks , and so on .

• In a preferential allotment , the

identity of investors is
known when the issuing company seeks
the approval of
the shareholders , whereas in a private
placement , the
identity of investors is not known when
the offer
 PRIVATE PLACEMENT AND PREFERENTIAL
ALLOTMENT

In the Indian context we find broadly

(i) private placement refers to sale of

equity or equity related instruments of an
unlisted company or sale of debentures of a
listed or unlisted company and

( ii ) preferential allotment refers to sale

of equity or equity related instruments of
a listed company .
 DILUTION

When a firm plans to sell securities ,

dilution is an issue that often comes up

for discussion . We can think of dilution in

terms of proportionate ownership or market

value or book value or earnings per share .

 SUMMING UP
• Venture capital funds seek to support promising firms
during their initial
stages
offering of before they are ready to make a public
securities
• The decision to go public is a complex one which calls
for carefully weighing
the benefits against costs .
• An Indian company can make an IPO if it satisfies
certain conditions .
• A series of steps is involved in a public issue ,
whether it is an IPO or a
secondary offer .
• The manager of a public issue may be likened to the
‘ conductor ’ of an
opera .
• A rights issue involves selling securities in the
primary market to the existing
shareholders .
• Private placement and preferential allotment involve
sale of securities to a
small number of sophisticated investors .
 Additional Readings

ising Finance for African Gas - Related Projects : Lessons from Nigeria

- Victor E . Eromosele
 Assignment -3
A.Procedure to Raise funds through public deposits
B.
D.Problems in raising finance for small firms
E.
 C. A firm is thinking of a rights issue to raise Rs. 5
 Crore. It has 5 lakhshares outstanding and current
 market price is Rs. 170. The subscription price on
the
 new share will be Rs. 125 per share.

i)How many shares should be sold to
raise the required funds?=400000
 ii) How many rights are needed to