LONG TERM SOURCES OF FINANCE INDIAN CAPITAL AND STOCK MARKET INTRODUCTION Capital markets are a sub-part of the

financial system. Conceptually, the financial system includes a complex of institutions and mechanisms which affects the generation of savings and their transfer to those who will invest. It may be said to be made of all those channels through which savings become available for investments. The main elements of the financial system are a variety of (i financial

instruments!assets!securities, (ii financial intermediaries!institutions and (iii financial markets. FINANCIAL ASSETS " financial asset!Instrument!security is a claim against another economic unit and is held as a store of value and for the return that is expected. #hile the value of a tangible!physical asset depends on its physical properties such as buildings, machines, furniture vehicles and so on, a financial asset represents a claim to future cash flows in the form of interest, dividends and so on. They are a claim on a stream of income and!or particular assets. The entity!economic unit that offers the future cash flows is the issuer of the financial instrument$ and the owner of the security is the investor$. %epending upon the nature of claim!return, an instrument may be (i debt (security such as bonds, debentures, term loans, (ii e&uity (security shares and (iii hybrid security such as preference shares and convertibles, 'ased on the type of issuer, the security may be (( direct () indirect and (* derivative. The securities issued by manufacturing companies are direct assets (e.g. shares!debentures . Indirect assets are claims against financial intermediaries (e.g. units of mutual funds . The derivative instruments include options and futures. The prevalence of a variety of securities to suit the investment re&uirements of heterogeneous investors, offers differentiated

investment choice to them and is an important element in the maturity and sophistication of the financial system. Financial Intermediaries +inancial Intermediaries are institutions that channelise the savings of investors into investments!loans. "s institutional source of finance, they act as a link between the savers and the investors, which results in institutionalisation of personal savings. Their main function is to convert direct financial assets into indirect securities. The indirect securities offer to the individual investor better investment alternative than the direct!primary security by pooling which it is created, for example, units of mutual funds. The main consideration underlying the attractiveness of indirect securities is that the pooling of funds by the financial intermediary leads to a number of benefits to the investors. The services!benefits that tailor indirect financial assets to the re&uirements of the investors are (i convenience, (ii lower risk, (iii expert management and (iv lower cost. Convenience +inancial intermediaries convert direct!primary securities into a more convenient vehicle of investment. They divide primary securities of higher denomination into indirect securities of lower denomination. They also transform a primary security of certain maturity into an, indirect security of a different maturity. +or instance, as a result of the redemption!repurchase facility available to unitholders of mutual funds, maturities on units would conform more with the desires of the investors than those on primary securities. Lo er Ris! The lower risk associated with indirect securities results from the benefits of diversification of investments. In effect, the financial intermediaries transform the small

investors in matters of diversification into large institutional investors as the former shares proportionate beneficiary interest in the total portfolio of the latter. E"#ert Mana$ement Indirect securities give to the investors the benefits of trained, experienced and specialised management together with continuous supervision. In effect, financial intermediaries place the individual investors in the same position in the matter of expert management as large institutional investors. Lo Cost

,ow cost is the benefits of investment through financial intermediaries are available to the individual investors at relatively lower cost due to the economies of scale. The ma-or financial intermediaries are banks, insurance organisations, both life and non-life! general, mutual funds, non-banking financial companies and so on. Financial Mar!ets +inancial markets perform a crucial function in the financial system as facilitating organisations. .nlike financial intermediaries, they are not a source of funds but are a link and provide a forum in which suppliers of funds and demanders of loans!investments can transact business directly. #hile the loans and investments of financial intermediaries are made without the direct knowledge of the suppliers of funds (i.e. investors , suppliers in the financial market know where their funds are being lent!invested. The two key financial markets are the money market and the capital market. Mone% Mar!et The money market is created by a financial relationship between suppliers and demanders of short-term funds which have maturities of one year or less. It exists because investors (i.e. individuals, business entities, government and financial institutions have temporarily idle funds that they wish to place in some type of li&uid

asset or short-term interest-earning instrument. "t the same time, other entities! organisations find themselves in need of seasonal! temporary financing. The money market brings together these suppliers and demanders of short- term li&uid funds. The broad ob-ectives of money market are three-fold/ "n e&uilibrating mechanism for evening out short-term surplus and deficiencies in the financial system0 " focal point of intervention by the central bank (e.g. 1eserve 'ank of India intervention for influencing li&uidity in the economy0 and " reasonable access to the users of short-term funds to meet their re&uirements at realistic! reasonable cost and temporary deployment of funds for earning returns to the suppliers of funds. Ca#ital Mar!et The capital market is a financial relationship created by a number of institutions and arrangements that allows suppliers and demanders of long-term funds (i.e. funds with maturities exceeding one year to make transactions. It is a market for long-term funds. Included among long-term funds are securities issues of business and 2overnment. The backbone of the capital market is formed by the various securities exchanges that provide a forum for e&uity (e&uity market and debt (debt market transactions.

3echanisms for efficiently offering and trading securities contribute to the functioning of capital markets which is important to the long-term growth of business. Thus, the capital market comprises of (I stock!security exchanges!markets (secondary markets and () new issue!primary market 4initial public offering (I56 market7. Relations&i# 'et een Ne Iss(e Mar!et )NIM* and Stoc! E"c&an$e

The industrial securities market is divided into two parts, namely, 8I3 and stock market. The relationship between these parts of the market provides an insight into its organisation. 6ne aspect of their relationship is that they differ from each other

organisationally as well as in the nature of functions performed by them. They have some similarities also. Di++erences The differences between 8I3 and stock exchanges pertain to (i Types of securities dealt, (ii 8ature of financing and (iii 6rganisation. Ne vs Old Sec(rities

The 8I3 deals with new securities, that is, securities which were not previously available and are, therefore, offered to the investing public for the first time. The market, therefore, derives its name from the fact that it makes available a new block of securities for public subscription. The stock market, on the other hand, is a market for old securities which may be defined as securities which have been issued already and granted stock exchange &uotation. The stock exchanges, therefore, provide a regular and continuous market for buying and selling of securities. The usual procedure is that when an enterprise is in need of funds, it approaches the investing public, both individuals and institutions, to subscribe to its issue of capital. The securities thus floated are subse&uently purchased and sold among the individual and institutional investors. There are, in other words, two stages involved in the purchase and sale of securities. In the first stage, the securities are ac&uired from the issuing companies themselves and these are, in the second stage, purchased and sold continuously among the investors without any involvement of the companies whose securities constitute the stock-intrude except in the strictly limited sense of registering the transfer of ownership of the securities. The section of the industrial securities market dealing with the first stage is referred to as the 8I3, while secondary market covers the second stage of the dealings in securities. Nat(re o+ Financin$

"nother aspect related to the separate functions of these two parts of the securities market is the nature of their contribution to industrial financing. 9ince the primary market is concerned with new securities, it provides additional funds to the issuing companies either for starting a new enterprise or for the expansion or diversification of the existing one and, therefore, its contribution to company financing is direct. In contrast, the secondary markets can in no circumstance supply additional funds since the company is not involved in the transaction. This, however, does not mean that the stock markets have no relevance in the process of transfer of resources from savers to investors. Their role regarding the supply of capital is indirect. The usual course in the development of industrial enterprise seems to be that those who bar the initial burden of financing a new enterprise, pass it on to others when the enterprise becomes well established. The existence of secondary markets which provide, institutional facilities for the continuous purchase and sale of securities and, to that extent, lend li&uidity and marketability, play an important part in the process. Or$anisational Di++erences The two parts of the market have organisational differences also. The stock exchanges have, organisationally speaking, physical existence and are located in a particular geographical area. The 8I3 is not rooted in any particular spot and has no geographical existence. The 8I3 has neither any tangible form any administrative organisational set up like that of stock exchanges, nor is it sub-ected to any centralised control and administration for the consummation of its business. It is recognised only by the services that it renders to the lenders and borrowers of capital funds at the time of any particular operation. The precise nature of the specialised institutional facilities provided by the 8I3 is described in a subse&uent section. Similarities

8evertheless, in spite of organisational and functional differences, the 8I3 and the stock exchanges are inseparably connected. Stoc! E"c&an$e Listin$ 6ne aspect of this inseparable connection between them is that the securities issued in the 8I3 are invariably listed on a recognised stock exchange for dealings in them. In India, for instance, one of the conditions to which a prospectus is to conform is that it should contain a stipulation that the application has been made, or will be made in due course for admitting the securities to dealings on the stock exchange. The practice of listing of new issues on the stock market is of immense utility to the potential investors who can be sure that should they receive an allotment of new issues, they will subse&uently be able to dispose them off any time. The absence of such facilities would act as some sort of psychological barrier to investments in new securities. The facilities provided by the secondary markets, therefore, encourage holdings of new securities and, thus, widen the initial!primary market for them. Control The stock exchanges exercise considerable control over the organisation of new issues. In terms of regulatory framework related to dealings in securities, the new issues of securities which seek stock &uotation!listing have to comply with statutory rules as well as regulations framed by the stock exchanges with the ob-ect of ensuring fair dealings in them. If the new issues do not conform to the prescribed stipulations, the stock exchanges would refuse listing facilities to them. This re&uirement obviously enables the stock exchange to exercise considerable control over the new issues market and is indicative of close relationship between the two. Economic Interde#endence The markets for new and old securities are, economically, an integral part of a single market:the industrial securities market. Their mutual interdependence from the

economic point of view has two dimensions. 6ne, the behavior of the stock exchanges has a significant bearing on the level of activity in the 8I3 and, therefore, its responses to capital issues/ "ctivity in the new issues market and the movement in the prices of stock exchange securities are broadly related/ new Issues increase when share values are rising and vice versa.( This is because the two parts of the industrial securities market are susceptible to common influences and they act and react upon each other. The stock exchanges are usually the first to feel a change in the economic outlook and the effect is &uickly transmitted to the new issue section of the market. F(nctions o+ Stoc! E"c&an$es )Secondar% Mar!ets 9tock exchanges discharge three vital functions in the orderly growth of capital formation/ (i 8exus between savings and investments, (ii 3arket place and (iii Continuous price formation. Ne"(s ,et een Savin$s and Investment +irst and foremost, they are the nexus between the savings and the investments of the community. The savings of the community are mobilised and channelled by stock exchanges for investment into those sectors and units which are favoured by the community at large, on the basis of such criteria as good return, appreciation of capital, and so on. It is the preference of investors for individual units as well as industry groups, which is reflected in the share price, that decides the mode of investment. 9tock exchanges render this service by arranging for the preliminary distribution of new issues of capital, offered through prospectus, as also offers for sale of existing securities, in an orderly and systematic manner. They themselves administer the same, by ensuring that the various re&uisites of listing (such as offering at least the prescribed minimum percentage of capital to the public, keeping the subscription list open for a minimum period of days, making provision for receiving applications at least at the prescribed

centres, allotting the shares against applications on a fair and unconditional basis are duly complied with 3embers of stock. Mar!et Place The second important function discharged by stock markets!exchanges is that they provide a marker place for the purchase and sale of securities, thereby enabling their free transferability through several successive stages from the original subscriber to the neverending stream of buyers, who may be buying them today to sell them at a later date for a variety of considerations like meeting their own needs of li&uidity, shuffling their investment portfolios to gear up for the ever changing market situations, and so on. 9ince the point of aggregate sale and purchase is centralised, with a multiplicity of buyers and sellers at any point of time, by and large, a seller has a ready purchaser and a purchaser has a ready seller at a price which can he said to be competitive. This guarantees saleability to one who has already invested and surety of purchase to the other who desires to invest. Contin(o(s Price Formation The third ma-or function, closely related to the second, discharged by the stock exchanges is the process of continuous price formation. The collective -udgement of many people operating simultaneously in the market, resulting in the emergence of a large number of buyers and sellers at any point of time, has the effect of bringing about changes in the levels of security prices in small graduations, thereby evening out wide swings in prices. The ever changing demand and supply conditions result in a continuous revaluation of assets, with today$s prices being yesterday$s prices, altered, corrected, and ad-usted, and tomorrow$s values being again today$s values altered, corrected and ad-usted. The process is an unending one. 9tock exchanges thus act as a barometer of ;the state of health of the nations economy, by constantly measuring its progress or otherwise. "n investor can always have his eyes turned towards the stock

exchanges to know, at any point of time, the value of the investments and plan his personal needs accordingly. F(nctions o+ Ne Iss(es-Primar% Mar!et

The main function of 8I3 is to facilitate the transfer of resources from savers to entrepreneurs seeking to establish new enterprise or to expand!diversify existing ones. 9uch facilities are of crucial importance in the context of the dichotomy of funds available for capital uses from those in whose hands they accumulate, and those by whom they are applied to productive uses. Conceptually, the 8I3 should not, however, be conceived as exclusively serving the purpose of raising finance for new capital expenditure. In fact, the organisation and facilities of the market are also utilised for selling concerns to the public as going concerns through the conversion of existing proprietary enterprises or private companies into public companies. The 8I3 is a complex of institutions through which funds can be obtained directly or indirectly by those who re&uire them from investors who have savings. 8ew issues can be classified in various ways. The first of new issues are by new companies and old companies. This classification was first suggested by 1.+. <enderson. The distinction between new also called initial and old also known as further, does not bear any relation to the age of the company. The securities issued by companies for the first time either after the incorporation or conversion from private to public companies are designated as initial issues, while those issued by companies which already have stock exchange &uotation, either by public issue or by rights to existing shareholders, are referred to as further or old. The general function of the 8I3, namely, the channelling of investible funds into industrial enterprises, can be split from the operational stand-point, into three services (i 6rigination,(ii .nderwriting, and (iii %istribution. The institutional set-up dealing with these can be said to constitute the 8I3 organisation. In other words, the 8I3 facilitates

the transfer of resources by providing specialist institutional facilities to perform the triple-service function. Ori$ination The term origination refers to the work of investigation and analysis and processing of new proposals. These two functions are performed by the specialist agencies which act as the sponsors of issues. These services include advice on such aspects of capital issues as/ (i determination of the class of security to be issued and price of the issues in the light of market conditions, (ii the timing and magnitude of issues, (iii methods of 1otation, and (iv techni&ue of selling, and so on. The importance of the specialised services provided by the 8I3 organisation in this respect can hardly be overstressed in view of its pivotal position in the process of flotation of capital in the 8I3. 6n the thoroughness of investigation and soundness of -udgement of the sponsoring institutions depends, to a large extent, the allocative efficiency of the market. Under ritin$ The origination howsoever thoroughly done, will not, by itself, guarantee the success of an issue. To ensure success of an issue, therefore, the second specialist service: underwriting:provided by the institutional setup of the 8I3 takes the form of a guarantee that the issues would be sold by eliminating the risk arising from uncertainty of public response. That ade&uate institutional arrangement for the provision of underwriting is of crucial significance both to the issuing companies as well as the investing public cannot be overstressed. Distri,(tion .nderwriting, however, is only a stopgap arrangement to guarantee the success of an issue, in the ultimate analysis, depends on the issues being ac&uired by the investing public. The sale of securities to the ultimate investors is referred to as distribution. It is a

specialist -ob, which can best be performed by brokers and dealers in securities, who maintain regular and direct contact with the ultimate investors. Iss(e Mec&anism The success of an issue depends, partly, on the issue mechanism. The methods by which new issues are made are/ (i 5ublic issue through prospectus, (ii Tender!'ook building, (iii 6ffer for sale (iv 5lacement and (v 1ights issue. P(,lic Iss(e t&ro($& Pros#ect(s " common method followed by corporate enterprises to raise capital through the issue of securities is by means of a prospectus inviting subscription from the investing public. .nder this method, the issuing companies themselves offer directly to the general public a fixed number of shares at a stated price, which in the case of new companies is invariably the face value of the securities, and in the case of existing companies, it may sometimes include a premium amount, if any. "nother feature of public issue method is that generally the issues are underwritten to ensure success arising out of unsatisfactory public response. The foundation of the public issue method is a prospectus, the minimum contents of which are prescribed by the Companies "ct, (=>?. It also provides both civil and criminal liability for any misstatement in the prospectus. "dditional disclosure re&uirements are also mandated by the 9@'I. The contents of the prospectus, inter alia, include/ (i 8ame and registered office of the issuing company0 (ii @xisting and proposed activities0 (iii 'oard of directors0 (iv ,ocation of the industry0 (v "uthorised, subscribed and proposed issue of capital to public0 (vi %ates of opening and closing of subscription list0 (vii 8ame of broker, underwriters, and others, from whom application forms along with copies of prospectus can be obtained0 (viii 3inimum subscription0 (ix 8ames of underwriters, if any, along with a statement that in the opinion of the directors, the resources of the underwriters are sufficient to meet the underwriting obligations0 and

(x " statement that the company will make an application to stock exchange(s for the permission to deal in or for a &uotation of its shares and so on. Tender-'oo! '(ildin$ Met&od The essence of the tender!book building method is that the pricing of the issues is left to the investors. The issuing company incorporates all the details of the issue proposal in the offer document on the lines of the public issue method including the reserve!minimum price. The investors are re&uired to &uote the number of securities and the price at which they wish to ac&uire. O++er +or Sale "nother method by which securities can be issued is by means of an offer for sale. .nder this method, instead of the issuing company itself offering its shares directly to the public, it offers through the intermediary of issue houses!merchant banks!investment banks or firms of stockbrokers. The modus operandi of the offer of sale is akin to the public issue method in that the prospectus with strictly prescribed minimum contents which constitutes the foundation for the sale of securities, and a known &uantity of shares are distributed to the applicants in a nondiscriminatory manner. 3oreover, the issues are underwritten to avoid the possibility of the issue being left largely in the hands of the issuing houses. 'ut the mechanism adopted is different. The sale of securities with an offer for sale method is done in two stages. Placement Met&od Aet another method to float new issues of capital is the placing method defined by ,ondon 9tock @xchange as Bsale by an issue house or broker to their own clients of securities which have been previously purchased or subscribedB. .nder this method, securities are ac&uired by the issue houses, as in offer for sale method, but instead of being subse&uently offered to the public, they are placed with the clients of the issue houses, both individual and institutional investors. @ach issue house has a list of large

private and institutional investors who are always prepared to subscribe to any securities which are issued in this manner. Thus, the flotation of the securities involves two stages/ In the first stage, shares are ac&uired by the issuing houses and in the second stage, they are made available to their investor-clients. The issue houses usually place the securities at a higher price than the price they pay and the difference, that is, the turn is their remuneration. "lternatively, though rarely, they may arrange the placing in return for a fee and act merely as an agent and not principal. Placin$ o+ sec(rities 9ecurities that are un&uoted is known as private placing. The securities are usually in small companies but these may occasionally be in large companies. #hen the securities to be placed are newly &uoted, the method is officially known as stock exchange placing. The main advantage of placing, as a method of issuing new securities, is its relative cheapness. This is partly because, many of the items of expenses in public issue and offer for sale methods like underwriting commission, expense relating to applications and allotment of shares, and so on are avoided. 3oreover, the stock exchange re&uirements relating to contents of the prospectus and its advertisement are less onerous in the case of placing. Its weakness arises from the point of view of distribution of securities. "s the securities are offered only to a select group of investors, it may lead to the concentration of shares into a few hands who may create artificial scarcity of scrips in times of hectic dealings in such shares in the market. Ri$&ts Iss(e The methods discussed above can be used both by new companies as well as by established companies. In the case of companies whose shares are already listed and widely held, shares can be offered to the existing shareholders. This is called rights

issue. .nder this method, the existing shareholders are offered the right to subscribe to new shares in proportion to the number of shares they already hold. This offer is made by circular to ;existing shareholders$ only. In India, 9ection C( of the Companies "ct, (=>? provides that where a company increases its subscribed capital by the issue of new shares, either after two years of its formation or after one year of first issue of shares whichever is earlier, these have to be first offered to the existing shareholders with a right to renounce them in favour of a nominee. " company can, however, dispense with this re&uirement by passing a special resolution to the same effect.

LONG . TERM SOURCES OF FINANCE INTRODUCTION ,ong-term capital is capital with maturity exceeding one year. ,ong-term capital is used to fund the ac&uisition of fixed assets and part of current assets. 5ublic limited companies meet their long-term financial re&uirements by issuing shares and debentures and through borrowing and public deposits. The re&uired fund is to be mobiliDed and utiliDed systematically by the companies. SOURCES OF CAPITAL 'roadly speaking, a company can have two main sources of funds. Internal and external, Internal sources refer to sources from within the company @xternal sources refer to outside sources. Internal sources consist of depreciation provision, general reserve fund or free reserve : retained earnings or the saving of the company. @xternal sources consists of share capital, debenture capital, loans and advances (short term loans from commercial banks and other creditors, long term loans from finance corporations and other creditors . 9hare capital is considered as ownership or e&uity capital whereas debentures and

loans constitute borrowed or debt capital. 1aising capital through issue of shares, debentures or bonds is known as primary capital sourcing. 6therwise it is called new issues market. ,ong-term sources of finance consist of ownership securities y shares and preference shares and creditor-ship securities (debentures, towing from the financing institutions and lease finance . 9hort-term sources of finance consists of trade credit, short-term loans from banks and financial institutions and public deposits. Lon$.Term Ca#ital Instr(ments Corporate securities also known as company securities are said to be the documentary media of raising capital by the -oint stock companies. These are of two classes/ 6wnership securities0 and Creditor-ship securities. O ners&i# Sec(rities 6wnership securities consist of shares issued to the intending investors with the right to participate in the profit and management of the company. The capital raised in this way is called ;owned capital$. @&uity shares and securities like the irredeemable preference shares are called ownership securities. 1etained earnings also constitute owned capital. Creditor.s&i# Sec(rities Creditor-ship securities consist of various types of debentures which are

acknowledgements of corporate debts to the respective holders with a right to receive interest at specified rate and refund of the principal sum at the expiry of the agreed term. Capital raised through creditor-ship securities is known as ;borrowed capital$. %ebentures, bonds, notes, commercial papers etc. are instruments of debt or borrowed capital. E/(it% S&ares @&uity shares are instruments to raise e&uity capital. The e&uity share capital is the backbone of any company$s financial structure. @&uity capital represents ownership

capital. @&uity shareholders collectively own the company. They en-oy the reward of ownership and bear the risk of ownership. The e&uity share capital is also termed as the venture capital on account of the risk involved in it. The e&uity shareholders$ liability, unlike the liability of the owner in a proprietary concern and the partners in a partnership concern, is limited to their capital subscription and contribution. Advanta$es o+ E/(it% S&are Ca#ital (. @&uity share capital constitutes the ;corpus$ of the company. It is the ;heart$ to the business. ). It represents permanent capital. <ence, there is no problem of refunding the capital. It is repayable only in the event of company$s winding up and that too only after the claims of preference shareholders have been met in full. *. @&uity share capital does not involve any fixed obligation for payment of dividend. 5ayment of dividend to e&uity shareholders depends on the availability of profit and the discretion of the 'oard of %irectors. E. @&uity shares do not create any charge on the assets of the company and the assets may be used as security for further financing. >. @&uity capital is the risk-bearing capital, unlike debt capital which is riskburdening. ?. @&uity share capital strengthens the credit worthiness and borrowing or debt capacity of the company. In general, other things being e&ual, the larger the e&uity base, the higher the ability of the company to secure debt capital. F. @&uity capital market is now expanding and the global capital market can be accessed. Disadvanta$es o+ E/(it% S&ares ca#ital (. Cost of issue of e&uity shares is high, as the limited group of risk- seeking investors need to be attracted and targeted. @&uity shares attract only those

classes of investors who can take risk. Conservative and cautious investors do not subscribe for e&uity issues, underwriting commission, brokerage costs and other issue expense$ are high for e&uity capital, rising up issue cost. ). The cost of servicing e&uity capital is generally higher than the cost of issuing preference shares or debenture since on account of higher rise, the expectation of the e&uity shareholders is also high as compared preference shares or debentures. *. @&uity dividend is payable from post-tax earnings. .nlike interestB paid on debt capital, dividend is not deductible as an expense from the profit for taxation purposes. <ence cost of e&uity is high 9ometimes, dividend tax is paid, further rising cost of e&uity share capital. E. The issuing of e&uity capital causes dilution of control of the e&uity holders.In times of depression, dividends on e&uity shares reach low be which leads to drastic fall in their market values. >. @xcessive reliance on financing through e&uity shares reduces the capacity of the company to trade on e&uity. The excessive use of e&uity shares is likely to result in over capitaliDation of the company. Pre+erence S&ares 5reference shares are those which catty priority rights in regard to the payment of dividend and return of capital and at the same time are sub-ect to certain limitations with regard to voting rights. The preference shareholders are entitled to receive the fixed rate of dividend out of the net profit of the company. 6nly after the payment of dividend at a fixed rate is made to the preference shareholders, the balance of it will be used for paying dividend to ordinary shares. The rate of dividend preference shares is mentioned in the prospectus. 9imilarly in the event of li&uidation the assets remaining after payment of all debts of the

company are first used for returning the capital contributed by the preference shareholders. T%#es o+ Pre+erence S&ares There are many forms of preference shares. These are/ (. Cumulative preference shares ). 8on-Cumulative preference shares *. 5articipating preference shares E. 8on-participating preference shares >. Convertible preference shares ?. 8on-convertible preference shares F. 1edeemable preference shares C. Ir-redeemable preference shares =. Cumulative convertible preference shares Merits o+ Pre+erence s&ares (. The preference shares have the merits of e&uity shares without their limitations. ). Issue of preference shares does not create any charge against the assets of the company. *. The promoters of the company can retain control over the company by issuing preference shares, since the preference shareholders have only limited voting rights. E. In the case of redeemable preference shares, there is the advantage that the amount can be repaid as soon as the company is in possession of funds flowing out of profits. >. 5reference shares are entitled to a fixed rate of dividend and the company may declare higher rates of dividend for the e&uity shareholders by trading on e&uity and enhance market value.

?. If the assets of the company are not of high value, debenture holders will not accept them as collateral securities. <ence the company prefers to tap market with preference shares. F. The public deposit of companies in excess of the maximum limit stipulated by the 1eserve 'ank can be li&uidated by issuing preference shares. C. 5reference shares are particularly useful for those investors who want higher rate of return with comparatively lower risk. =. 5reference shares add to the e&uity base of the company and they strengthen the financial position of it. "dditional e&uity base increases the ability of the company to borrow in future. (G. 5reference shares have variety and diversity, unlike e&uity shares0 Companies thus have flexibility in choice. Demerits o+ Pre+erence S&ares (. .sually preference shares carry higher rate of dividend than the rate of interest on debentures. ). Compared to debt capital, preference share capital is a very expensive source of financing because the dividend paid to preference shareholders is not, unlike debt interest, a tax-deductible expense. *. In the case of cumulative preference shares, arrears of dividend accumulate. It is a permanent burden on the profits of the company. E. +rom the investor$s point of view, preference shares may be disadvantageous because they do not carry voting rights. Their interest may be damaged by e&uity shareholders in whose hands the control is vested. >. 5reference shares have to attraction. 8ot even (H of total corporate capital is raised in this form.

?. Instead of combining the benefits of e&uity and debt, preference share capital, perhaps combines the benefits of e&uity and debt. De,ent(res " debenture is a document issued by a company as an evidence of a debt due from the company with or without a charge on the assets of the company. It is an acknowledgement of the company$s indebtedness to its debenture-holders. %ebentures are instruments for raising long-term debt capital. %ebenture holders are the creditors of the company. In India, according to the Companies "ct, (=>?, the term debenture includes Bdebenture stock, bonds and any other securities of company whether constituting a charge on the assets of the company or notB %ebenture-holders are entitled to periodical payment of interest agreed rate. They are also entitled to redemption of their capital as per the terms. 8o voting rights are given to debenture-holders. .nder section ((F of the companies "ct, (=>?, debentures with voting rights cannot be issued. .sually debentures are secured by charge on or mortgage of the assets of the company. T%#es o+ de,ent(res %ebentures can be various types. They are/ (. 1egistered debentures ). 'earer debentures or unregistered debentures *. 9ecured debentures E. .nsecured debentures >. 1edeemable debentures ?. Irredeemable debentures F. +ully convertible debentures C. 8on-convertible debentures

=. 5artly convertible debentures (G. @&uitable debentures ((. ,egal debentures (). 5referred debentures (*. +ixed rate debentures (E. +loating rate debentures (>. Iero coupon debentures (?. +oreign currency convertible debentures Re$istered de,ent(res/ 1egistered debentures are recorded in a register of debenture-holders with full details about the number, value and types of debentures held by the debenture-holders. The payment of interest and repayment of capital is made to the debenture-holders whose names are entered duly in the register of debenture-holders. 1egistered debentures are not negotiable. Transfer of ownership of these types of debentures cannot be valid unless the regular instrument of transfer is sanctioned by the %irectors. 1egistered debentures are not transferable by mere delivery. 'earer or Unre$istered de,ent(res / The debentures which are payable to the bearer are called bearer debentures. The names of the debenture-holders are not recorded in the register of debenture-holders. 'earer debentures are negotiable. They are transferable by mere delivery and registration of transfer is not necessary. Sec(red de,ent(res/ The debentures which are secured by a mortgage or change on the whole or a part of the assets of the company are called secure debentures. Unsec(red de,ent(res/ .nsecured debentures are those, which do not have charge on the assets of the company.

Redeema,le de,ent(res/ The debentures which are repayable after a certain period are called redeemable debentures. 1edeemable debentures may be bullet repayment debentures (i.e. one time be payment or periodic repayment debentures. Irredeema,le de,ent(res/ The debentures which are not repayable during lifetime of the company are called irredeemable debentures. They are al known as perpetual debentures. Irredeemable debentures can be redeemed in the event of the company$s winding up. F(ll% converti,le de,ent(res/ Convertible debentures can be converted into e&uity shares of the company as per the terms of their issue. Convertible debenture-holders get an opportunity to become shareholders and to take part the company management at a later stage. Convertibility adds a ;sweetner$ to debentures and enhances their appeal to risk seeking investors. Non0converti,le de,ent(res1 8on-convertible debentures are not convertible They remain as debt capital instruments. Partl% converti,le de,ent(res/ 5artly convertible debentures appeal to investors who want the benefits of convertibility and non-convertibility in one instrument. E/(ita,le de,ent(res/ @&uitable debentures are those which are secured by deposit of title deeds of the property with a memorandum in writing to create a charge. Le$al De,ent(res/ ,egal debentures are those in which the legal ownership of property of the corporation is transferred by a deed to the debenture holders, security for the loans. Pre+erred de,ent(res/ 5referred debentures are those which are paid first in the , time of winding up of the company. The debentures have priority over other debentures Fi"ed rate de,ent(res/ +ixed rate debentures carry a fixed rate of interest 8ow a days this class is not desired by both investors and issuing institutions.

Floatin$ rate de,ent(res/ +loating rate debentures carry floating interest rate coupons. The rates float over some benchmark rates like bank rate, ,I'61 etc. 2ero.co(#on de,ent(res/ Iero-coupon debentures are merest coupons. Interest on these is paid on maturity called as deep-discount debentures. Forei$n C(rrenc% converti,le de,ent(res / +oreign currency convertible debentures are issued in overseas market in the currency of the country where the flotation takes place. ,ater these are converted into e&uity, either 2%1. "%1 or plain e&uity. Merits o+ de,ent(res (. %ebentures provide funds to the company for a long period without diluting its control, since debenture holders are not entitled to vote. ). Interest paid to debenture-holders is a charge on income of the company and is deductible from computable income for income tax purpose whereas dividends paid on shares are regarded as income and are liable to corporate income tax. The post-tax cost of debt is thus lowered. *. %ebentures provide funds to the company for a specific period. <ence, the company can appropriately ad-ust its financial plan to suit its re&uirements. E. 9ince debentures are generally issued on redeemable basis, the company can avoid over-capitalisation by refunding the debt when the financial needs are no longer felt. >. In a period of rising prices, debenture issue is advantageous. The burden of servicing debentures, which entail a fixed monetary commitment for interest and principal repayment, decreases in real terms as the price level increases. ?. %ebentures enable company to take advantage of trading on e&uity and thus pay to the e&uity shareholders a dividend at a rate higher than overall return on investment.

F. %ebentures are suitable to the investors who are cautious and who particularly prefer a stable rate of return with no risk. @ven institutional investors prefer debentures for this reason. Demerits o+ De,ent(res (. %ebenture interest and capital repayment are obligatory payments. +ailure to meet these payment -eopardiDes the solvency of the firm. ). In the case of debentures, interest has to be paid to the debenture holders irrespective of the fact whether the company earns profit or not. It becomes a great burden on the finances of the company. *. %ebenture financing enhances the financial risk associated with the firm. This may increase the cost of e&uity capital. E. #hen assets of the company get tagged to the debenture holders the result is that the credit rating of the company in the market comes down and financial institutions and banks refuse loans to that company. >. %ebentures are particularly not suitable for companies whose earnings fluctuate considerably. In case of such company raising funds through debentures, may lead to considerable fluctuations in the rate of dividend payable to the e&uity shareholders. Financin$ T&ro($& E/(it% S&ares and De,ent(res Com#arison " company may prefer e&uity finance (i if long gestation period is involved, (ii if e&uity is preferred by the market forces, (iii if financial risk perception is high, (iv if debt capacity is low and (v dilution of control isn$t a problem or does not rise. " company may prefer debenture financing compared to e&uity shares financing for the following reasons/ i. 2enerally the debenture-holders cannot interfere in the management of the company, since they do not have voting rights.

ii. iii.

Interest on debentures is allowed as a business expense and it is tax- deductible. %ebenture financing is cheaper since the rate of interest payable on it is lower than the dividend rate of preference shares.

iv.

%ebentures can be redeemed in case the company does not need the funds raised through this source. This is done by placing call option in the debentures.

v.

2enerally a company cannot buy its own shares but it can buy its own debentures.

vi.

%ebentures offer variety and in dull market conditions only debentures help gaining access to capital market.

Converti,le Iss(es " convertible issue is a bond or a share of preferred stock that can be converted at the option of the holder into common stock of the same company. 6nce converted into common stock, the stock cannot be estranged again for bonds or preferred stock. Issue of convertible preference shares and convertible debentures are called convertible issues. The convertible preference shares and convertible debentures are converted into e&uity shares. The ratio of exchange between the convertible issues and the e&uity shares can be stated in terms of either a conversion price or a conversion ratio. Si$ni+icance o+ converti,le iss(es/ The convertible security provides the investor with a fixed return from a bond (debenture or with a specified dividend from preferred stock (preference shares . In addition, the investor gets an option to convert the security (convertible debentures or preference shares into e&uity shares and thereby participates in the possibility of capital gains associated with, being a residual claimant of the company. "t the time of issue, the convertible security will be priced higher than its conversion value. The difference between the issue price and the conversion value is known as conversion premium. The convertible facility provides a measure of flexibility to the capital structure

of the company to company which wants a debt capital to start with, but market wants e&uity. 9o, convertible issues add sweeteners to sell debt securities to the market which want e&uity issues. Converti,le #re+erence s&ares1 The preference shares which carry the right of conversion into e&uity shares within a specified period, are called convertible preference shares. The issue of convertible preference shares must be duly authoriDed by the articles of association of the company. Converti,le de,ent(res1 Convertible debentures provide an option to their holders to convert them into e&uity shares during a specified period at a particular price. The convertible debentures are not likely to have a good investment appeal, as the rate of interest for convertible debentures is lesser than the non-convertible debentures. Convertible debentures help a company to sell future issue of e&uity shares at a price higher than the price at which the company$s e&uity shares may be selling when the convertible, debentures are issue. 'y convertible debentures, a company gets relatively cheaper financial resource for business growth. %ebenture interest constitutes tax deductible expenses. 9o, till the debentures are converted, the company gets a tax advantage. +rom the investors$ point of view, convertible debentures prove an ideal combination of high yield, low risk and potential capital appreciation. Di++erent Modes o+ Ca#ital Iss(es Capital instruments, namely, shares and debentures can be issued to the market by adopting any of the four modes/ 5ublic issues, 5rivate placement, 1ights issues and 'onus issues. ,et us briefly explain these different modes of issues. P(,lic Iss(es 6nly public limited companies can adopt this issue when it wants to raise capital from the general public. The company has to issue a prospectus as per re&uirements of the corporate laws in force inviting the public to subscribe to the securities issued, may be

e&uity shares, preference shares or debentures!bonds. " private company cannot adopt this route to raise capital. The prospectus shall give an account of the prospects of investment in the company. Convinced public apply to the company for specified number of shares!debentures paying the application money, i.e., money payable at the time of application for the shares!debentures usually )G to *GH of the issue price of the shares!debentures. " company must receive subscription for at least =>H of the shares!bonds offered within the specified days. 6therwise, the issue has to be scrapped. If the public applies for more than the number of shares!debentures offered, the situation is called over subscription. In under subscription public subscribes for less number of shares!debentures offered by the company. +or good companies coupled with better market conditions, over :subscription results. 5rior to issue of shares!debentures and until the subscription list is open, the company goes on promoting the issue. In the western countries such kind of promoting the issue is called ;road-show$. #hen there is over-subscription a part of the excess subscription, usually upto (>H of the offer, can be retained and allotment proceeded with. This is called as green-shoe option. #hen there is over-subscription, pro-rata allotment (proportionate basis allotment, i.e., say when there is )GGH subscription, for every )GG share applied (GG shares allotted may be adopted. "lternatively, pro-rata allotment for some applicants, fill scale allotment for some applicants and nil allotment for rest of applicants can also be followed. .sually the company co-opts authorities from stock-exchange where listing is done, from securities regulatory bodies (9@I*J in Indian, 9@C in .9" and so on etc. in finaliDing mode of allotment. 5ublic issues enable broad-based share-holding. 2eneral public$s savings directed into corporate investment. @conomy, company and individual investors benefit. The company management does not face the challenge of dilution of control over the affairs

of the company. "nd good price for the share$ and competitive interest rate on debentures are &uite possible. Ri$&t S&ares #henever an existing company wants to issue new e&uity shares, the existing shareholders will be potential buyers of these shares. 2entrally the "rticles or 3emorandum of "ssociation of the Company gives the right to existing shareholders to participate in the new e&uity issues of the company. This right is known as ;pre-emptive right$ and such offered shares are called ;1ight shares$ or ;1ight issue$. " right issue involves selling securities in the primary market by issuing rights to the existing shareholders. #hen a company issues additional share capital, it has to be offered in the first instance to the existing shareholders on a pro-rata basis. This is re&uired in India under section C( of the Companies "ct, (=>?. <owever, the shareholders may by a special resolution forfeit this right, partially or fully, to enable the company to issue additional capital to public. .nder section C( of the Companies "ct (=>?, where at any time after the expiry of two years from the formation of a company, or at any time after the expiry of one year from the allotment of shares being made for the first lime after its formation, whichever is earlier, it is proposed to increase the subscribed capital of the company by allotment of further shares, then such further shares shall be offered to the persons who, at the date of the offer, are holders of the e&uity shares of the company, in proportion as nearly as circumstances admit, to the capital paid on those shares at that date. Thus the existing shareholders have a pre-emptive right to subscribe to the new issues made by a company. This right has at its root in the doctrine that each shareholder is entitled to participate in any further issue of capital by the company e&ually, so that his interest in the company is not diluted.

Si$ni+icance o+ ri$&ts iss(e (. The number of rights that a shareholder gets is e&ual to the number of shares held by him. ). The number rights re&uired to subscribe to an additional share is determined by the issuing company. *. 1ights are negotiable. The holder of rights can sell them fully or partially. E. 1ights can be exercised only during a fixed period which is usually less than thirty days. >. The price of rights issues is generally &uite lower than market price and that a capital gain is &uite certain for the share holders. ?. 1ights issue gives the existing shareholders an opportunity for the protection of their pro-rata share in the earning and surplus of the company. F. There is more certainty of the shares being sold to the existing shareholders. If a rights issue is successful it is e&ual to favourable image and evaluation of the company$s goodwill in the minds of the existing shareholders. 'on(s Iss(es 'onus issues are capital issues by companies to existing shareholders whereby no fresh capital is raised but capitaliDation of accumulated earnings is done. The shares capital increases, but accumulated earnings fall. " company shall, while issuing bonus shares, ensure the following/ (. The bonus issue is made out of free reserves built out of the genuine profits and shares premium collected in cash only. ). 1eserves created by revaluation of fixed assets are not capitaliDed *. The development rebate reserves or the investment allowance reserve is considered as free reserve for the purpose of calculation of residual reserves only.

E. "ll contingent liabilities disclosed in the audited accounts which have bearing on the net profits, shall be taken into account in the calculation of the residual reserve. >. The residual reserves after the proposed capitalisation shall be at least EG per cent of the increased paid up capital. ?. *G percent of the average profits before tax of the company for the previous three years should yield a rate of dividend on the exp capital base of the company at (G percent. F. The capital reserves appearing in the balance sheet of the company as a result of revaluation of assets or without accrual of cash resources are capitaliDed nor taken into account in the computation of the residual reserves of EG percent for the purpose of bonus issues. C. The declaration of bonus issue, in lieu of dividend is not made. =. The bonus issue is not made unless the partly paid shares, if any existing, are made fully paid-up. (G. The company : a has not defaulted in payment of interest or principal in respect of fixed deposits and interest on existing debentures or principal on redemption thereof and (b has sufficient reason to believe that it has not defaulted in respect of the payment of statutory dues of the employees such as contribution to provident fund, gratuity or bonus. ((. " company which announces its bonus issue after the approval of the board of directors must implement the proposals within a period of six months from the date of such approval and shall not have the option of changing the decision. (). There should be a provision in the "rticles of "ssociation of the Company for capitalisation of reserves, etc. and if not the company shall pass a resolution at

its general body meeting making decisions in the "rticles of "ssociation for capitalisation. (*. Conse&uent to the issue of bonus shares if the subscribed and paid-up capital exceed the authoriDed share capital, a resolution shall be passed by the company at its general body meeting for increasing the authoriDed capital. (E. The company shall get a resolution passed at its generating for bonus issue and in the said resolution the management$s intention regarding the rate of dividend to be declared in the year immediately after the bonus issue should be indicated. (>. 8o bonus shall be made which will dilute the value or rights of the holders of debentures, convertible fully or partly. Se,i General G(idelines +or P(,lic Iss(es (. 9ubscription list for public issues should be kept open for at least * working days and disclosed in the prospectus. ). 1ights issues shall not be kept open for more than ?G days. *. The &uantum of issue, whether through a right or public issue, shall not exceed the amount specified in the prospectus!letter of offer. 8o retention of over subscription is permissible under any circumstances, except the special case of exercise of green-shoe option. E. #ithin E> days of the closures of an issue a report in a prescribed form with certificate from the chartered accountant should be forwarded to 9@'I to the lead managers. >. The gap between the closure dates of various issues eg., 1ights and Indian public should not exceed *G days. ?. 9@'I will have right to prescribe further guidelines for modifying the existing norms to bring about ade&uate investor protection, enhance the &uality of disclosures and to bring about transparency in the primary market.

F. 9@'I shall have right to issue necessary clarification to these guidelines to remove any difficulty in its implementation. C. "ny violation of the guidelines by the issuers!intermediaries will be punishable by prosecution by 9@'I under the 9@'I "ct =. The provisions in the Companies "ct, (=>? and other applicable laws shall be complied in connection with the issue of shares and debentures. LENDING PROCEDURES OF T3E TERM LENDING FINANCIAL INSTITUTIONS INTRODUCTION .nder this head we shall see the lending procedure practiced by long-term finance ESSENTIAL RE4UIREMENTS1 The essential re&uirements insisted upon by the financial institutions before taking up a re&uest for financial assistance for consideration are/ (. The applicant concerned include the following should have obtained industrial license or should have made some kind of commitment, where necessary ). The applicant should have obtained!applied for permission of the 9ecurities and @xchange 'oard of India to issue capital, wherever necessary *. The applicant should have obtained the approval of the 2overnment regarding the terms of technical and!or financial collaboration agreement, if any. E. The applicant should have a clearance from the Capital 2oods Committee in respect of the machinery proposed to be imported >. The applicant should have selected a site for the location of the factory and has prepared a detailed ;pro-ect report$. "fter the receipt of the filled up application in triplicate in the case of non-corporate units and &uadruplicate in the case of corporate bodies, the pro-ect is appraised by a team of technical, financial and economic officers of the Corporation from several angles : technical, financial, economic, managerial and social.

APPRAISAL '5 FINANCIAL INSTITUTION1 67Tec&nical A##raisal The technical appraisal of the pro-ect involves a critical analysis of the following/ (. +easibility of the selected technical pro-ect and its suitability in Indian conditions. ). ,ocation of the pro-ect in relation to the sources and availability of inputs : raw materials, water, power, transport, skilled and unskilled labour and in relation to the market to be served by the product!service. *. "de&uacy of the plant and machinery and their specifications E. "de&uacy of the plant layout >. "rrangements for securing technical know-how, if necessary ?. "vailability of skilled and unskilled labour and arrangements for training for the labourers. F. 5rovision for the disposal of factory effluents and utilisation of byproducts if any. C. #hether the process proposed for selection is technically sound up-to-date etc. "nother important feature of technical appraisal relates to the technology to be adopted for the pro-ect. In case of new technical processes adopted from abroad, attention is to be paid to the terms and conditions. 87Economic A##raisal The economic appraisal of a pro-ect involves/ (. Consideration of natural and industrial property of the pro-ect and contribution to the national economy of the country in terms of contribution to 2%5, down stream and upstream pro-ects. ). 9avings in foreign exchange or prospects of exports. *. @mployment potential, direct and indirect E. " critical study of the existing and future demand for the products proposed to be manufactured, the licensed and installed capacity, the level of competition etc.

>. 9crutiny of the pro-ect in relation to the import and export policies of the 2overnment and various other factors like regulatory controls, if any, in regard to production, prices and raw materials. 97Financial A##raisal +inancial appraisal of the existing concern deals with an analysis of its working results, balance sheets and cash flow for the past years!pro-ected future years and an examination of the following aspects in all cases. (. @stimated cost of the pro-ect ). +inancial plan with reference to capital structure, promoter$s contribution, debte&uity ratio and the availability of other resources. *. Crucial examination of the investments made outside the business and -ustification therefore. E. 5ro-ections of cash flow, both during the construction and the operation periods. >. 5ro-ects break-even level of operation and time re&uired to reach that level of operation. ?. @stimation of future profitability in the light of competition and product service obsolescence. F. Internal rate of return, debt-service coverage and pro-ected dividends on share capital, payback period, abandonment value at the end of different levels of milestones or years of operation. :7Mana$erial A##raisal The confidence of the lending institution in the repayment prospects of a loan is largely conditioned by its opinion of the borrowing unit$s management. Therefore, it has been remarked that appraisal of management is the touch stone of term credit analysis. #here the technical competence, administrative ability, integrity and resourcefulness of the management are well established, the loan application gets the most favourable

consideration. The expertise, experience and earnestness of the management tells in the efficiency, effectiveness and excellence of the pro-ect. ;7Social A##raisal The social ob-ectives of the pro-ect are considered keeping in view the interest of the general public. The pro-ects, which provide large employment opportunities and canaliDe the income of the agricultural sector for productive use, pro-ects located in totally less developed areas and pro-ects that stimulated small scale industries are considered to serve the society well. The social benefits are more. The social cost of pollution consumption of scarce resources, etc. is also to be weighed. Conditions +or Assistance +rom Financial Instit(tions %ifferent financial institutions stipulate different kinds of conditions depending on the nature of the pro-ect, the borrower etc. The main conditions of a term loan are as follows/ (. The borrower (applicant has to obtain all relevant 2overnment clearances such as licensing, capital goods clearance for imported machines, import license, clearance from pollution control board, etc. ). +or consortium loan, the borrower has to satisfy all the institutions participating in lending *. Concurrence of the financial institution is necessary for repayment of any existing loan or long-term liabilities. E. The term loan agreement may stipulate the debt-e&uity ratio to be followed by the company. >. "s long as the loan is outstanding, the declaration of dividend is made sub-ect to the institution$s approval. ?. The term lending institution reserves the right to nominate one or more directors in the management of the company.

F. 6nce the loan agreement is signed, any ma-or commercial agreements such as orders for e&uipment, consultancy, collaboration agreement, selling agency agreement etc. and further expansion need the concurrence of the term lending institution. C. The borrower is not permitted to create any additional charge on the assets without the knowledge of the financial institutions. =. The financial institutions may appoint suitable personnel in the areas of marketing, research and development, depending upon the nature of the pro-ect. (G. The promoters cannot dispose their shareholders without the consent of the lending institutions. This is stipulated for keeping the promoters involved as long as the institutions are involved in the business. P(#lic De#osits %eposits with companies have come into prominence in r cent years. 6f these the more important one are the deposits accepted by trading and manufacturing companies. The Indian Central 'anking @n&uiry Committee in (=*( recogniDed the importance of public deposits in the financing of cotton textile industry in India in general and at "hmedabad in particular. The growth of public deposits has been considerable. +rom the company$s point of view, public deposits are a ma-or source of finance to meet the working capital needs. %ue to the credit s&ueeDe imposed by the 1esearch 'ank of India on bank loans the corporate sector during (=FGs (=CGs and also due to the recommendations of the Tandon Committee, restricting credit, many companies were not getting as much money in the (=CGs as they are used to getting in the past, from the banks. 9o, public deposits came handy as working capital funds for the businesses. #hile to the depositor the rate offered is higher than that offered by banks, the cost of deposits to the company is less than the cost of borrowings from bank. 3oreover, the availability and volume of bank credit are restricted by considerations of margin, security offered, periodical submission

of statements etc. The credit available to companies through public deposits is not affected by such consideration. There is no problem of margin or security. 9ince, the fixed deposits from the public are unsecured, the borrowing company need not mortgage or hypothecate any of its assets to raise loans in this form. These deposits are available for comparatively longer terms than bank credit. Merits o+ P(,lic De#osits The merits of public deposits are as follows/ (. There is no need of creation of any charge against any of the assets of the company for raising funds through public deposits. ). The company can get advantage of trading on e&uity since the rate of interest and the period for which the public deposits have been accepted are fixed. *. 5ublic deposit is a less costly method for raising short-term as well as medium term funds re&uired by the companies, because of less restrictive covenants governing this as against bank credits. E. 8o &uestions are asked about the uses of public deposits. >. Tax leverage is available as interest on public deposits is a charge on revenue. Demerits o+ P(,lic De#osits The main demerits of the public deposits are as follows/ i. This mode of financing, sometimes, puts the company into serious financial difficulties. @ven a slight rumour about the inefficiency of the company may result in a rush of the public to the company for getting premature payments of the deposits made by them. ii. iii. @asy availability of fund encourages lavish spending. 5ublic deposits are unsecured deposits and in the event of a failure of the company, depositors have no assurance of getting their money back.

<ENTURE CAPITAL FINANCING INTRODUCTION In present day economy, finance is defined as the provision of money at the time when it is re&uired. +inance is re&uired for all types of pro-ect and non-profit organiDations, to carry out their regular activities to achieve their ob-ectives. <ence, it is considered as lifeblood of economic activities. The success of any organiDation mainly depends on how well financial resources are being used. ,iberaliDation in industrial licensing, foreign investment, foreign technology agreements, disinvestment of public sector units and 31T5 "ct amendments were introduced. The new import and export policy brought series of changes in the economic environment. "ll these attracted the financial sector. 'oth primary and secondary markets started functioning as per the re&uirements of the market. 8ew financial products were introduced. Technology in banks and customer service have improved. Competitive financial market was created focusing on needs of customers. This resulted in the witnessing of new financial instruments in the market KiD., ,easing, <ire-purchase +actoring, +orfeiting, 2lobal %epository 1eceipts, Kenture capital etc., DEFINITION <ent(re Ca#ital It is defined as long-term funds in e&uity or semi-e&uity form to finance hi-tech pro-ects involving high risk and yet having strong potential of high profitability. The term ;Kenture Capital$ refers to capital investment made in a business or industrial enterprise, which carries elements of risk and insecurity and the probability of business haDards. Capital investment may assume the form of either e&uity or debt or both as a derivative instrument, The risk associated with the enterprise could be so high as to entail total loss or be so insignificant as to lead high gains. 2enerally, the investment is

made in the form of e&uity with the prime ob-ective being capital gains as the business prospers. @&uity investment enables the investor to the investment into cash when re&uired. Meanin$ Kenture Capital means many things to many people Jane Loloski 3orris, editor of the well known industry publication, Kenture @conomics, defines Kenture capital as ;providing seed, start-up and first stage financing$ and also funding the expansion of companies that have already demonstrated their business potential but do not yet have access to the public securities market or to credit oriented institutional funding sources Kenture capital also provides management in leveraged buy out financingB. The @uropean venture capital association describes it as risk finance for entrepreneurial growth oriented companies. It is investment for the medium or long-term seeking to maximiDe medium or long-term return for both parties. It is a partnership with the entrepreneur in which the investor can add value to the company because of his knowledge experience and contract base. 9teven James ,ee, defines it as actual or potential e&uity investments in companies through the purchase of stock, warrants, options or convertible securities. Kenture capital is a long-term investment discipline that often re&uires the venture capitalist to wait five or more years before realising a significant return on the capital resource. The (==> +inance 'ill, defines Kenture capital as long-term e&uity investment in novel technology, based pro-ects which display potential for significant growth and financial returns. <ence, venture capital implies an investment in the form of e&uity for high risk pro-ects with the expectation of higher returns. The investment is made through the private placement with the expectation of risk of total loss or huge returris. 1isk is associated with such capital investment and as such it is termed as venture capital.

<igh technology industry is more attractive to venture capital because of high returns. The main ob-ect of investing e&uity is to get high capital profits at saturation stage. C&aracteristic Feat(res M Investments are made in e&uity in high tech. Industry and wait for >- F years to reap the benefit of capital gains. M Investments are made in innovative pro-ects with new technology with a view to commercialise the know how through new productsNservices M The claim over the management is decided on the basis of proportion to investments. M Kenture capital investor does not interfere in the day-to-day business affairs but closely watch the performance of the business unit. M Kenture capital funds need not be repaid in the course of business units, but they are realised through exist route, (stock exchange . <ent(re Ca#ital Investment Process +inancing of a <igh tech., pro-ect under venture capital has following steps. They are/ 67 Esta,lis&ment o+ contact ,et een t&e entre#rene(r and t&e vent(re ca#italist1 The 5rospective entrepreneur, with his know how prepares a pro-ect report establishing there in the possibility of marketing a commercial product. This can be done with the help of auditor, professional or a merchant banker. The business consists of five important feasibility reports namely, Technical, +inancial, 3anagerial, 3arketing and 9ocio-economic feasibility. The formal application in duplicate will be submitted to venture capital investor. 87 Preliminar% Eval(ation1 "fter the preliminary evaluation of the report is completed, venture capital investor normally discusses the investment plan for the pro-ect with the banker. %uring this stage close net work is expected from the management team, to implement the pro-ect. 97 Detailed A##roval / In addition to the close discussion with the management team, a detailed appralOal of pro-ect is undertaken. Techno-economic feasibility will be

examined by involving the executives of the Kenture capital Investor and the management professional. If re&uired they may even consult the experts In the similar field to take a decision. :7 Sensitivit% Anal%sis1 The +orecasted results of sales and profits are tested and analysed. The risks and threats will be evaluated by using sensitivity analysis. 9ensitivity analysis helps the evaluators to predict the probable risks and returns associated with the pro-ect. This formally clears the pro-ect for investment. ;7 Investment in t&e #ro=ect1 The terms and conditions of venture capital assistance will be finalised according to the re&uirement of the pro-ect. The amount of funds re&uired, profile of the business, the life time technology and the possible competition in the business will be looked into. " formal agreement is entered between the technocrat and investor stating therein the role of and share of management in the new pro-ect. >7 Monitorin$ t&e Pro=ect and #ost investment s(##ort1 The venture capitalist role begins with financing the pro-ect. It is a general practice of the Investor to appoint an executive director to have closer look in to the pro-ect. The executive director assists the pro-ect in developing strategies, decision-making and planning. The process of interaction with the technocrat increases the healthy environment in carrying the day-today business affairs. Sta$es o+ <ent(re Ca#ital Financin$ The financing of high-tech., pro-ect in the form of venture capital financing is done in several stages. They may ;be in the form of/ (. @arly-stage financing ). ,ater stage financing )6* Earl%.sta$e +inancin$

This stage of financing is done to the new pro-ect or to the new technocrat who wishes to commercialiDe his research talents. "s the technocrat is well versed only with know how and not with capital, going for debt at this stage increases the risk of entrepreneur and affect the health of the business unit. In, other means of financing, the obligation to repay the loans along with interest starts immediately with lending. <ence, it is not advisable for young entrepreneurs to go in for such loans. They have depend mainly on e&uity stoke so that the risk of repayment does not arise e&uity financing permits the young entrepreneurs to commercialiDe and earns profits out of the investment. The main instruments used for such financial assistance would be in the form of e&uity contribution, unsecured loans and optionally convertible securities. 6nce the financing is done, venture capitalists assists the firm in general administrative activities and allow the technocrat to concentrate on production and marketing. This stage of venture capital financing consists of seed capital, start-ups and second round financing. )a* Seed ca#ital1 9eed capital financing includes the implementation of research pro-ect, starting from all initial conceptual stage. This stage re&uires more time to complete the process. 'ecause the entrepreneur made an effort to the maximum to meet the market potentiality. Therefore external e&uity in preferred. The key factors that influence e&uity financing at this stage are/ The technology used in the pro-ect, possible threats of new technology in the near future. %ifferent aspects of the product life cycle. The total investment re&uired commercialiDing the product and time re&uired to get suitable returns etc., ),* Start.(# sta$e +inancin$ / "t this stage innovator re&uires finance to commercialiDe the product. This stage is not simple to execute, it re&uires more time in getting different elements ie., (patent rights, trade marks, design and copy rights which are very essential to bring the product in the market. "ll these components are very essentially

needed to launch the product effectively. <ence, time and finance is needed. 6n the other hand, the research must also be done to evaluate the probable opportunities to exploit the market. Therefore, venture capital investor evaluates the pro-ects carefully and negotiate the terms and conditions with the entrepreneur with regard to sharing the management. )c* Second ro(nd o+ +inancin$1 This type of financing is re&uired when the pro-ect incurs loss or inability to yield sufficient profits. The reasons could be due to internal or external factors. "t this stage, if the venture capitalists is fully aware of the genuine reasons for the loss, he should decide on second round financing, or he may seek the support of new investor. This is a complex process as the original investor may express his inability to further finance the pro-ect or entrepreneur must have lost the confidence with the original investor or he may wishes to broad base the investment pattern. ,ot of bargaining has be done to coordinate the financing with original investor and with the technocrat or promoter. )8* Later Sta$e Financin$ ,ater stage financing is considered to be the easy means of assistance. The reason being, the product launched has not only reached the boom period but also indicator further expansion and growth. <ence it is a easy means of financing with low risk profile. The real problem associated at this stage is entrepreneur not be willing to give ma-ority of his stake to the venture capitalists but may accept for more number of executive directors in the board. This means of is also known as expansion finance, replacement capital, management buy out and turn around capital. )a* E"#ansion +inance/ ,ater stage financing is executed to expand the market, production or to establish warehouses etc., @xport trade activities may also be considered for financing the pro-ect.

),* Re#lacement ca#ital*1 .nder this stage, the promoter may prefer to buy the entire e&uity stake of the pro-ect by approaching some other financiers. <e may also wish to increase his holding by buying more number of e&uity shares. 1eplacement capital is normally preferred at the time of public issues. If the company is unlisted, getting capital gains on the fresh issues needs more time, tilt then replacement capital can be obtained in the form of convertible preference shares from the second financier. )c* Mana$ement '(% o(t )M'O*1 This may be offered in two ways namely. ;3anagement buy out$ or ;3anagement buy int. In management buy out, venture capitalist help the management of a company to buy or take over the ownership of the business. This would help the management to reshuffle or reengineer the entire pro-ect. In management buy in strategies, outsides prefers to buy the existing business. This means of financing is less risky, it is not considered as venture capital and has wide criticism. )d* Resc(e Ca#ital/ 1escue capital is also known as turnaround capital offered with a view to help the technocrat or the business unit to come out of difficulties. This means of financing is risky in nature and the investor may ask for ma-or changes in the management. In India, venture capital financing for 3'6 and turnout are rarely seen, as the ma-ority of the investor prefers to invest only in later stages. T%#es o+ <ent(re Ca#ital Or$ani?ations 6n the basis of ownership, management and rising of funds, venture capital organiDation are categorised on the following groups/ Ca#tive <ent(re Ca#ital F(nds1 These organiDations are wholly owned by financial institutions and are operated as subsidiaries. The parental institutions supply funds for venture capital assistance e.g.. (%'I used captive funds to assist venture capital, T%IC uses the funds for venture capital which is supplied by .TI and ICICI. 1CTC used the funds of .TI and I+CI. "ll these venture capital investors perform their activities

independently. Inde#endent <ent(re Ca#ital F(nds1 "ll these funds are raised by group individuals venture capitalists. These funds are close-ended with minimum capital base and e&uity oriented instruments. The investor in such contribution expects huge capital gains, rather than regular income of dividends. The amount invested in the pro-ect will be realised through the exist route. (5romoter and venture capitalists prefers to go for primary market to sell the shares and distributes the realised amount as per the terms and conditions of the agreement. Government F(nds1 These venture capital organiDations are wholly owned by the government. The assistance will be given to promoter at the initial stages to complete research and developmental activities. To avail such benefits the product innovated should be of national importance. 2overnment of Larnataka through the Central 2overnment scheme, provides 1s. )>,GGG for the technocrat who commercialiDes his know how by obtaining a patent right, the Commissioner of industrial development is authorised to release this fund through Larnataka Council of Technological upgradation scheme. E"it Ro(te o+ <ent(re Ca#ital The main aim of venture capitalist is to realise the investment with huge profit after the completion of successful efforts with the promoter in launching or commercialising the product. The exit route will be well thought by the investor at the stage of marking investments. @xit means realiDation of investment through the issue of e&uity shares to the public. The main motto of venture capitalist is find exit at ;maximum profit or if it is unavoidable with ;minimum loss$. There are alternative routes of disinvestment practiced in a real life situation. They are/ 2oing public 9ale of shares to entrepreneurs 9ale of the company to another company

+inding a new investor ,i&uidation )a* Goin$ P(,lic1 3ost of the venture capital assisted firms prefers to go in for public issue to recover their investments with profits. This process not only help the entrepreneur but also the investor in different ways. The main benefit of going public increases the li&uidity of the business firm. This li&uidity will increase the percentage returns over the private placements. (If it were sold through private placements . The public issues provides another opportunity for the business firm to list its shares in the stock market. 6nce the shares are listed, it increases the image of the organiDation. In addition to this, it increases and attracts efficient persons to work in the organiDation. In addition to this, the commercial banks and financial institutors will forward to offer different types of loans. If the firm wishes to raise additional capital for expansion and growth, it could be done easily through the public issue. <owever, going public is not an easy route to exit or venture capital assisted units because, it has to observes several legal for$ of stock exchange. The company must also disclose part a considerable ar(t of information at the time of issuing the shares0 this could be a sales threat with the global competition. @mployees may ask for better comfort with huge hike in the salaries and perks. The expenditure incurred during the course of the issue in also substantially high, which may affect the profitability. "s the company is going for public issue, its social responsibility increases and they have to be accountable to all the organs of the society, which burdens the financial affairs of the company. #ith all these demerits or bottlenecks going public for exit route is widely used in seal life situations. ),* Sale o+ s&ares to entre#rene(r1 9ome times, promoter may prefers to have exit route through, 6ver The Counter @xchange by entering into bought out deals with the member of 6.T.C. <e may purchase the shares with a view of entering in to the primary market at the later stage.

In certain circumstances, an entrepreneur himself prefers to buy the entire shares. <e may even buy the shares with the help of his own group-even the employees are allowed to do so at an agreed price for buying such shares. If necessary, the entrepreneur may approach financial institutions for loans. The price at which the stake of the K. C. assisted may be done as several methods. KiD., )i* 'oo! val(e met&od1 "ccording to this method, the price is fixed on the basis of book value method or a predetermined multiple applied to determine the book value (ii* Price.earnin$ ratio1 This method is widely in practice. The price of the share is determined as the basis of multiplying the price earning ratio to earning per share. )iii* Percenta$e o+ sales met&od1 5ricing under 5!@ ratio is popular only when the earnings are low or the company anticipated losses in the coming years 5I@ ratio is not suitable. 6n such circumstance, percentage of sale method is used. If the sales figures are highly volatile, the total average sale of the industry is taken into consideration. )iv* M(lti#le o+ cas& +lo met&od1 "ccording to this method, the value of the business

is determined by multiplying the cash flow of the business by a multiplies which is similar to the industry. <ence it is considered to be a better method when compared to 5I@ ratio and percentage on sales method. (v* Inde#endent <al(ation1 9ometimes, the task of determining the value of business is assigned to professionals like C"s or 3erchant 'ankers. They may use either p!eratio method or a traditional method for assessing the value of the assets. (1ealisable value )vi* A$reed to t&is met&od1 Kenture capitalist and the entrepreneur follow the price that was determined mutually at the time of launching business. This is a traditional and simple method. (c* Sale o+ a com#an% to anot&er com#an% / 6n many occasions, venture capitalist and the entrepreneur may agree together to sell the business unit to some other

company. The reasons could be many viD., the entrepreneurs may prefer to undertake some other new company. <e may find it difficult to operate the business profitably. "t the time of managerial difficulties he may search for a new company which is having similar line of business. The modalities of such a sale will be made on the basis of level of operations and, the nature of venture, which may be acceptable to both the parties. )d* Findin$ a ne investor1 .nder this method, the venture capitalists and the investor

may decide to sell the unit to another new investor who may be a venture capitalist or a corporate who is having similar line of business. 'ut buying venture from others and buying company may increase their operation and profitability. This provides an opportunity to exploit and can have economies of large scale operations )e* Li/(idation/ This is a lender of last resort, when a firm performs very badly, in other words if it incurs continuous cash loss over the years, venture capitalist and the entrepreneur decides to close down the operations. <ence, it takes the firm to li&uidation. The reason for such a exercises would be many viD., stiff competition, technological failure, poor management by the entrepreneur etc.,

(. %iscuss the main elements of the financial system. ). @xplain briefly financial assets!instruments. *. %escribe briefly the functions of financial intermediaries. E. @xplain briefly the two key financial markets. >. #rite a brief note on the differences between the new issue market and the stock exchanges. ?. #hat are the similarities between the 8I3 and the stock marketP F. #hat are the functions of the stock exchangesP C. 'riefly discuss the functions of the 8I3. =. #hat are the different methods of flotation of issues in the primary marketP (G. %iscuss the sources of long-term finance of a company. ((. Critically evaluate e&uity shares a source of finance both the point of (i the company and (ii investing public. (). %iscuss the features of preference shares and evaluate preference share capital from the company$s point of view. (*. #hat are right sharesP @xplain the significance of the same from the company$s and investors$ view point. (E. %efine ;debenture$ and bring out its salient features as an instrument of corporate financing. (>. @xplain the different types of debentures that may be issued by a company. (?. #hat are the advantages and disadvantages of debenture finance to a companyP (F. ,ist out the 9@'I guidelines for issuing bonus shares. (C. #hat do you mean by 5ublic %epositsP @xplain their merits and demerits. (=. @xplain the types of appraisal to be made in sanctioning pro-ect finance.

)G. %efine the term ;Kenture Capital$ )(. @xplain the process Kenture Capital investment. )). 3ention the different characteristic features of Kenture Capital )*. #hat is early stage financingP @xplain. )E. #hat is later stage financingP @xplain.