#1 Long Term Financing

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Prof. Kulbir Singh (IMT-Nagpur)Jan 2012

Corporate Finance II (2012)

Session#1:

Long-term Financing:

An Introduction

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What is Debt?

An obligation to pay a specific amount of money to another

party.

Characteristics of debt:

short-term vs long-term

fixed vs floating interest rate loans

secured vs unsecured

domestic vs foreign


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Types of Long-term Debt

Debentures

Secured and unsecured

notes

Convertible notes

Fixed deposit loans

Mortgages

Eurobonds

Eurocurrency term loans

Leasing

Project finance

Transferable loan

certificates

Derivative debt products



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Sources of Long-term Financing

Debenturessecure, fixed-term loan instruments issued bycompanies.

Secured notessame as debentures with lower security.

Unsecured notesshorter-term loans to a company offeringno assets as security.

Convertible notesdebt that provides an option to convert toequity at maturity.

Fixed depositsunsecured loans at fixed rates for definite

terms.



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Sources of Long-term Financing

Mortgagesthe conveyance of property for the security ofdebt.

Eurobondsunsecured fixed-interest borrowingsdenominated in a currency of a country other than its country

of issue.

Eurocurrency FRNsa foreign currency borrowing whoserates adjust to reflect market interest rates.

Leasingpurchaser of equipment leases the asset to anotherparty.

Project financingsyndicate financing of very large (andexpensive) projects.



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Different Types of Debentures

Zero coupon debenturesinitially priced at a deep discountas they make no coupon payments.

Floating-rate debenturescoupon payments are tied to aninterest rate index and are therefore adjustable. Usually

contain a put provision, together with coupon ceilings and

floors.

Income debenturescoupons dependent on companyincome.

Put debenturesholder can force the buy back of debt at astated price.



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Debt Market in India



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Debt Market in India.



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Debt Market in India.



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Debt versus Equity

Corporations try to create debt securities that are really equity

to get the tax benefits of debt and the bankruptcy benefits of

equity.

Interest on debt is fully tax deductible, so the distinction is

important for tax purposes.

Hybrid securities have characteristics of both debt and equity:

convertible notes

subordinated debt

preference shares.



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Reasons for Issuing CallableDebentures

Superior interest rate forecastingcompany insiders maythink they know more about interest rate decreases than

debtholders.

Taxescall provisions provide tax advantages to bothdebtholders and the company.

Future investment opportunitiesallows the company to buy

back debentures to take advantage of superior investmentopportunities.



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Financial Distress

The disadvantage of using debt is the possibility of financial

distress, which can be defined as:

business failure

legal bankruptcy

technical insolvency

accounting insolvency.


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Securitisation

The process of transforming financial institutions assets such

as mortgages, into marketable securities, by pooling and

selling the rights to the income streams.

Advantages: Investornegotiable security provides both regular

income and final payout.

Mortgage agencyconversion of an illiquid asset into a

marketable security.



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Securitization in India.



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Preference Shares

Shares with dividend priority over ordinary shares, normally

with a fixed dividend rate, sometimes without voting rights.

Cumulative vs non-cumulative dividends.

Irredeemable vs redeemable shares.

Non-participating vs participating shares.

Most preference shares issued are cumulative, irredeemableand non-participating.



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Reasons for Issuing PreferenceShares

Redeemable preference shares can be used to enhance the

balance sheet by increasing the equity base.

As subordinate debt, they can be included in a banks capital

base.

They can be used to avoid the threat of bankruptcy that exists

for debt.

Companies unable to take advantage of the tax deductibility

of debt favour preference shares.

A means of raising equity without surrendering control.



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Resource Mobilization ThroughPrimary Market in India



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Ordinary Shares

Equity without priority for dividends or in bankruptcy.

Types of companies:

companies limited by shares

companies limited by guarantee companies limited by both shares and guarantee

unlimited companies

no liability companies.



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Private Placement

Private Placement means an offer or invitation to less thanfifty persons to subscribe to the debt securities in terms of

sub-section (3) of section 67 of the Companies Act, 1956

(1 of 1956)



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Private Equity

Private equity, consists of equity securities operatingcompanies that are not publicly traded on a stock exchange.

Generally made by a private equity firm, a venture capital firm

or an angel investor.

Each has its own set of goals, preferences and investment

strategies to nurture expansion, new product development,or restructuring of the companys operations, management, or

ownership.

Most common investment strategies - leveraged

buyouts, venture capital, growth capital, distressed

investments and mezzanine capital. Mezzanine:subordinated debt or preferred equity securities often

represent the junior portion of a company's capital structure



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Private Equity in India.



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Private Equity in India.



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Classes of Ordinary Shares

Different classes of ordinary shares may be distinguished by:

voting rights

dividend entitlement

priority to dividend payment

priority to capital repayment and surplus assetdistribution in the event of liquidation.

Reasons for different classes:

debt characteristics for some shares

retain control in small/newly listed firms taxation issues

nature of company (e.g. home units).


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Indian Capital Markets: Challenges



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Sources

http://www.dbresearch.com/PROD/DBR_INTERNET_EN-

PROD/PROD0000000000206002.pdf

http://www.pwc.be/en_BE/be/publications/pdf/Indian-Capital-Market-

2011.pdf

http://www.kpmg.com/CN/en/IssuesAndInsights/ArticlesPublications/Do

cuments/private_equity_india_O_0805.pdf


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http://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000206002.pdfhttp://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000206002.pdfhttp://www.pwc.be/en_BE/be/publications/pdf/Indian-Capital-Market-2011.pdfhttp://www.pwc.be/en_BE/be/publications/pdf/Indian-Capital-Market-2011.pdfhttp://www.kpmg.com/CN/en/IssuesAndInsights/ArticlesPublications/Documents/private_equity_india_O_0805.pdfhttp://www.kpmg.com/CN/en/IssuesAndInsights/ArticlesPublications/Documents/private_equity_india_O_0805.pdfhttp://www.kpmg.com/CN/en/IssuesAndInsights/ArticlesPublications/Documents/private_equity_india_O_0805.pdfhttp://www.kpmg.com/CN/en/IssuesAndInsights/ArticlesPublications/Documents/private_equity_india_O_0805.pdfhttp://www.pwc.be/en_BE/be/publications/pdf/Indian-Capital-Market-2011.pdfhttp://www.pwc.be/en_BE/be/publications/pdf/Indian-Capital-Market-2011.pdfhttp://www.pwc.be/en_BE/be/publications/pdf/Indian-Capital-Market-2011.pdfhttp://www.pwc.be/en_BE/be/publications/pdf/Indian-Capital-Market-2011.pdfhttp://www.pwc.be/en_BE/be/publications/pdf/Indian-Capital-Market-2011.pdfhttp://www.pwc.be/en_BE/be/publications/pdf/Indian-Capital-Market-2011.pdfhttp://www.pwc.be/en_BE/be/publications/pdf/Indian-Capital-Market-2011.pdfhttp://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000206002.pdfhttp://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000206002.pdfhttp://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000206002.pdf

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