Sources of Long-Term Finance:

Equity Capital and Preference Capital -

Debenture Capital - Term Loans and Deferred Credit, Leasing and Hire-Purchase –

Deferred Credit

A deferred credit is cash received that is not initially reported as income.

In most cases, a deferred credit is caused by the receipt of a customer advance. This is a
situation where a customer pays the seller before the seller has provided it with an offsetting
amount of services or merchandise.

Since the seller has not yet earned the corresponding amount of revenue, it should instead
record the payment as a current liability.
A deferred credit can also be classified as a long-term liability if it will take more than one
year to provide services or merchandise to the customer that provided the payment (as may
be the case under a multi-year subscription service). However, this is a rare situation.

If the seller is unable to provide the services or merchandise for which the customer advance
was paid, the correct transaction (subject to the terms of the contract) is to pay the customer
back, which results in a debit to the liability account and a credit to the cash account. This
situation arises when a prepaid customer order is placed on backorder status, and the
backordered item cannot subsequently be filled.

Term Loan
Definition: The Term Loan is the primary source of long-term debt raised by the companies
to finance the acquisition of fixed assets and working capital margin. It is also called as a
term finance which means the money raised through the term loans is generally repayable in
regular payments i.e. fixed number of installments over a period of time.

Advantages of Term Loan

 Interest on debt is tax-deductible, whereas the equity or preference dividends are paid out
of profit after tax.
 There is no dilution of control of the management, since, in the debt financing, the lenders
have no right to vote.
 The lenders are not entitled to the profits of the firm as they are only paid the principal and
the interest amount.
 An issue cost of debt is less expensive as compared to the preference and equity capital.
 The maturity of the debt instrument can be altered with respect to the funds requirements
in the firm.
 Generally, it is easier for the management of the firm to communicate the proprietary
details to the private lenders than to a public capital market.

Disadvantages of Term Loan

 The firm is legally obliged to pay the fixed interest and principal amount to the lenders,
the failure of which could lead to its bankruptcy.
 The debt financing, especially the term loans, raises the financial leverage of the firm,
which in turn raises the cost of equity to the firm.
 If the inflation rate touches the extremely low levels, then the real cost of debt will be
more than expected.
Now the question may arise, that how the term loan is different from the bank’s short-term
loan? Well, the bank’s short-term loans are employed to finance the short-term working
capital requirements, and it recovers its full cost in less than a year. The banks or financial
institutions give rupee loans as well as a foreign currency term loan.

The rupee term loan is generally given directly to the organizations for setting up new
projects or buying new capital assets. Whereas, the currency loan is given to meet the
expenses incurred in importing the machinery or equipment or paying the fees against the
foreign technical know-how. The term loan is typically a secured borrowing, as the assets
against which the loan is raised is called the prime security while the other assets may serve
as a collateral security.

Raising Long-term Finance: Venture Capital, Initial Public Offering, Public

Issue by listed companies, Rights Issue, Preferential allotment, Private
placement and Term Loans.

Initial Public Offering was happen due the following reasons:-

 To promote a new company

 To expand an existing company

 To diversify the production

 To meet the regular working capital requirements

 To Capitalise the reserves

CAPITAL MARKET
Comparison Chart

BASIS FOR
PRIVATE PLACEMENT PREFERENTIAL ALLOTMENT
COMPARISON

Meaning Private Placement refers to the offer or Preferetial Allotment, is the allotment of
invitation to offer made to specified shares or debentures to a selected group
investors, for inviting them to subscribe of persons is made by a listed company,
for shares, so as to raise funds. to raise funds.

Governed by Section 42 of the Companies Act, 2013 Section 62 (1) of the Companies Act,
2013

Offer letter Private placement offer letter No such document

Consideration Payment is made by way of cheque, Cash or consideration other than cash.
demand draft or other modes except
cash.

Bank account To keep the application money, Not required.

separate bank account in a scheduled
commercial bank is required.

Articles of Articles of association of the company No authorization is required.

association must authorize it.

Definition of Private Placement

The private placement implies selling of securities, i.e. debentures or equity

shares, to private investors, with the aim of raising funds for the company.
According to section 42 of the Companies Act 2013, the private placement is
one in which a company makes an offer to selected persons such as mutual
funds or insurance companies by issuing a Private Placement Offer Letter and
satisfying the conditions thereon.

The offer or invitation to subscribe for securities can be made up to 200

persons or less, in a financial year, not including qualified institutional buyers
and securities issued to employees by way of Employees Stock Option Plan
(ESOP). If a company makes an offer or invitation to offer to issue or enters
into an agreement to issue shares to persons more than the limit prescribed
then it will be considered as a public issue and regulated accordingly.
The company making private placement has to make allotment of securities to
the investors within 60 days from the date of receipt of the application
amount, or else it has to refund the same within 15 days to the investors. If
the company defaults in refunding the money to the subscribers within 15
days, then the company is liable to pay the entire sum with interest @ 12
% right from the 60th day.

Definition of Preferential Allotment

Preferential Allotment is used to mean the issue of specified securities by a

company listed on a recognized stock exchange, to any select person or group
of persons, on preferential basis. The offer is subject to the rules and
regulations made by Securities and Exchange Board of India, in this regard.
However, when an unlisted company goes for preferential allotment the rules
of the Companies Act, 2013 will apply.

The offer can be made to any person whether they are equity shareholders and
employees of the company or not. Following regulations must be complied
with, in relation to preferential allotment:

 The allotment is authorized by the company’s articles of association.

 The company’s members must pass a special resolution, or it is
approved by Central Government.
 The securities issued through preferential allotment should be fully
paid, when the issue is made.
 As per SEBI takeover code, a preferential allotment exceeding 25% of
equity constitutes an open offer to the existing shareholders.
 Shares issued to promoters as preferential allotment are subject to a
lock in period of three years, and so they cannot transfer such shares.
Nevertheless, the securities issued to other investors are subject to lock-
in period of one year only

Comparison Chart

BASIS FOR PREFERENTIAL

PRIVATE PLACEMENT
COMPARISON ALLOTMENT

Meaning Private Placement refers to Preferetial Allotment, is the

the offer or invitation to
offer made to specified
investors, for inviting them
to subscribe for shares, so
as to raise funds.
allotment of shares or
debentures to a selected group
of persons is made by a listed
company, to raise funds.
 BASIS FOR PREFERENTIAL
PRIVATE PLACEMENT
COMPARISON ALLOTMENT

Governed by Section 42 of the Section 62 (1) of the

Companies Act, 2013 Companies Act, 2013

Offer letter Private placement offer No such document

letter

Consideration Payment is made by way of Cash or consideration other

cheque, demand draft or than cash.
other modes except cash.

Bank account To keep the application Not required.

money, separate bank
account in a scheduled
commercial bank is
required.

Articles of Articles of association of the No authorization is required.

association company must authorize it.

Definition of Private Placement

The private placement implies selling of securities, i.e. debentures or equity

shares, to private investors, with the aim of raising funds for the company.
According to section 42 of the Companies Act 2013, the private placement is
one in which a company makes an offer to selected persons such as mutual
funds or insurance companies by issuing a Private Placement Offer Letter and
satisfying the conditions thereon.

The offer or invitation to subscribe for securities can be made up to 200

persons or less, in a financial year, not including qualified institutional buyers
and securities issued to employees by way of Employees Stock Option Plan
(ESOP). If a company makes an offer or invitation to offer to issue or enters
into an agreement to issue shares to persons more than the limit prescribed
then it will be considered as a public issue and regulated accordingly.

The company making private placement has to make allotment of securities to

the investors within 60 days from the date of receipt of the application
 amount, or else it has to refund the same within 15 days to the investors. If
the company defaults in refunding the money to the subscribers within 15
days, then the company is liable to pay the entire sum with interest @ 12
% right from the 60th day.

Rights Issue of Shares

 1 Features of Rights Issue of Shares
 2 Why Does a Company Issue Rights Shares?
 3 Right Issue Example
 4 Market Price Action Post Rights Issue
 5 Accounting Treatment for Rights Issue
A rights issue is one of the ways by which a company can raise equity share capital among the
various types of equity share capital sources available. These are slightly different from the standard issue
of shares. Right shares mean the shares where the existing shareholders have the first right to subscribe the
shares.
In layman terms, rights issue gives a right to the existing shareholders to purchase additional new shares in
the company. Rights shares are usually issued at a discount as compared to the prevailing traded price in
the market. The existing shareholders are allowed a prescribed time limit/date within which need to
exercise the right or the right will thereafter be forgone.

Let us have a look at the features of the rights issue, reasons why rights shares are
issued, accountingtreatment of rights issue and how market price reacts post rights issue. This will help us
understand the concept better.
FEATURES OF RIGHTS ISSUE OF SHARES
 The rights shares allow preferential treatment to existing shareholders, where existing shareholders have
the right to purchase shares at a lower price on or before a specified date. The shares are issued at a
discount as a compensation for the stake dilution that will take place post issue of additional shares.
 The existing shareholders can trade the rights to other interested market participants until the date at which
the new shares can be purchased. The rights are traded in a similar way as the normal equity shares.
 The amount of rights issue to the shareholders is usually at a proportion of existing holding.
 The existing shareholders can also choose to ignore the rights; however, one may not do so as existing
shareholding will be diluted post issue of additional shares and will result in a loss (in valuation) for
existing shareholder.
WHY DOES A COMPANY ISSUE RIGHTS SHARES?
 A company may look to raise a large amount of capital for expansion projects which may have a longer
gestation period.
 A project where debt/loan funding may not be available/suitable or expensive usually makes company to
raise capital via this route.
 Companies looking to improve debt to equity ratioor looking to buy a new company may opt for funding
via rights issue route.
 Sometimes troubled companies may issue rights shares to pay off debt to ease the financial strain.
Having looked at the features, let us look at an example of a rights issue.
Public issues or Initial public offering (IPO)

The issuing company directly offers to the general public/institutions a fixed number of securities at
a stated price or price band through a document called prospectus. This is the most common
method followed by companies to raise capital through issue of the securities

 Public Issue- It is an invitation by a company to public to subscribe to the securities offered

through a prospectus

 Initial Public Offer (IPO) - When an unlisted company makes either a fresh issue of securities
or offers its existing securities for sale or both for the first time to the public, it is called IPO.

 Further Public Offer (FPO) - When an already listed company makes either a fresh issue of
securities to the public or an offer for sale to the public, it is called an FPO.