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LESSON
14
SOURCES OF LONG TERM FINANCE
CONTENTS
14.0 Aims and Objectives 14.1 Introduction 14.2 Equity Shares 14.2.1 Sweat Security 14.2.2 Non Voting Shares 14.2.3 Bonus Issue 14.3 Preference Shares 14.3.1 Cumulative Preference Shares 14.3.2 Non Cumulative Preference Shares 14.4 Debentures 14.5 Bonds 14.6 Warrants 14.7 Let us Sum up 14.8 Lesson-end Activity 14.9 Keywords 14.10 Questions for Discussion 14.11 Suggested Readings
14.1 INTRODUCTION
The sources of long-term finance could be classified into the following categories:
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The combination of the sources of long-term finance is known as capital structure. From the above classification, we will discuss one after the another.
To vote To control the management To share the profits To claim on the residual portion during the winding up To exercise pre-emptive To apply the court To receive the copy of the statutory report, copy of the annual accounts To apply the central government for AGM - failure on the part of the company To apply company law board for Extraordinary general meeting
It is one kind of Equity share, which was introduced in the Ordinance 1998, facilitating the companies to acquire the technical know-how, intellectual property through the issue of equity shares. Definition The equity shares which are issued at discount to employees and directors and consideration other than cash for Technical know-how, intellectual property are known as sweat security.
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Normally the sweat security is issued by the companies in two different categories:
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Sweat security which is issued at preferential pricing more specifically for employees Sweat security which is issued at face value, that may be either at par or above par
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Right to receive the dividend prior to the equity shareholders in any particular year. The repayment of share capital normally takes place only at the moment of winding of the companies. Convertible preference shares: These types of shares are issued by the company along with the right of conversion to convert the holding into equity shares at the specified period. Normally, during the process of conversion, the companies charge higher premium from the shareholders. The voting powers, bonus issue, higher dividends and so on are subject to the availability of rights out of the conversion. Redeemable preference shares: Under this category, the amount of raised capital is subject to redemption/repayment, which means that when any preference shares are revealing the definite time period of repayment is known as redeemable preference shares. Non redeemable preference shares: These types of preference share never carry any definite period of repayment but at the moment of winding up the repayment is made immediately after the creditors. Participating preference shares: The type of preference shares facilitates the holders to share the surplus benefits immediately after declaring the dividend benefits to preference shareholders and equity shareholders.
Non Participating preference shares: Except the earlier, all are nothing but non participating preference shares in category.
14.4 DEBENTURES
Sec 2(12) of the Companies Act defines "Debenture includes debenture stock, bonds and any other securities of a company whether constituting a charge on the assets of the company". Debenture is an evidencing document i.e., long-term promissory note.
Debentures are issued on indebtedness It is an instrument which indicates the time/date schedule of repayment of principal or interest The Charge is created on the assets of the company ; to protect the interest of lenders. If any default arises - the due amount of either principal or interest will be claimed through direct or debenture trustees action for the realization assets in order to secure the debt
On the basis of security On the basis of holding On the basis of redemption On the basis of convertibility
On the basis of Security: Under this type the debentures are further classified into two categories viz secured and unsecured debentures: Secured/Naked Debentures: There is no charge on the assets of the company which means that there is no claim on the company at the moment of default. These debentures are normally issued by the company through their well built good will during the past. Secured or Mortgage Debenture: The type of the debentures bearing the security through the creation of charge either whole or part of the assets of the company are known as secured or mortgage debentures. These types of debentures warrant registration and finally immediately after the registration process the title deeds should be deposited under the custody of the lender. On the basis of holding: These types of debentures are further divided into two categories viz Bearer and Registered Debentures.
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Bearer Debenture: The interest periodical is payable to the bearer and transferable by mere delivery. It never requires registration to enter in the books. The holder is simply having the eligibility for redemption Registered Debentures: The holders are required to register in the register in accordance with the Sec 152 of the Companies Act.
On the basis of redemption: This classification has two types viz Redeemable and Irredeemable: Redeemable Debentures: Redeemable after the expiry period - Re issuance is possible with reference to Sec 121 of the companies act 1956 Irredeemable Debentures: These debentures are issued to redemption of specific event which is non happening in nature for indefinite period for e.g. Winding up of the company.
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On the basis of Conversion: This type of debentures are trifurcated into the following viz Fully convertible, Partly convertible and Non convertible: Fully Convertible Debentures This type of debentures are fully converted into Equity shares with premium or without premium. The Conversion is normally takes after expiry of the period. The conversion is optional purely left with the discretion of the debentureholders which normally ranges in between 18 and 36 months. The interest periodical is payable till the process of conversion is over. Non Convertible Debentures: This type of debentures never carry any option of conversion to avail the equity shares of the company immediately after conversion. In other words, these debentures are denial of option of conversion. Partly Convertible Debentures: Under this category, there are Two parts involved, one part is meant for conversion; second part is non convertible portion:
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Convertible portion is the portion which can be availed for conversion at or after 18 months upto 36 months, it is at the optional right of the debentureholders. Non convertible portion - It does not carry any convertible portion instead it bears the redeemable portion for redemption after the expiry period.
The next important classification under the long-term sources of finance is Bonds
14.5 BONDS
It is a long-term debt instrument issued by the company to raise the financial resources from the market, for specific period and it carries fixed rate of interest which has its own salient features
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Issued at face value i.e Par value and Par or Discount. Rate of interest is fixed or flexible i.e. variable / floating rate of bond - coupon rate of bond. Maturity date is specified but not in the case of perpetual bonds. Redemption value - in the bond certificate - may be par or premium - terms of the issue. Bonds are traded in the market.
Type of Bonds
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Secured Bond: Issued on the assets of the issuer. Unsecured Bond: Issued by the issuer on the basis of name and fame. Perpetual bond: Bonds do not have maturity. Redeemable bond: Redemption or Repayment of the principal is specified by the issuer. Fixed rate bonds: Rate of Interest is fixed at. Flexible/Floating rate bonds: Rate of interest is subject to prefixed norms.
The further more classification of bonds are available. They are following: Zero Coupon bonds: These bonds are sold at discounted value and will be given at the face value after the maturity period.
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Deep discount bonds: It is another kind of zero coupon bond. Large discount is made on their nominal value. Interest is paid only at the time of maturity - 3-25 years. Pay in kind bonds: This another kind of long-term instrument of raising funds. During the First three years, these bonds need not pay any interest to the holders of the bonds, in stead the interest bonds are issued which are known as additional bonds. These additional bonds are called as baby bonds or kid bonds which are derived out of the parent bond. It is identified by the many of the companies as wonderful instrument to raise the capital from the market at the early stage of commencement of business. The next type long-term instrument is that Warrants.
14.6 WARRANTS
These are nothing but Bearer documents which are title to buy the specified number of equity shares at specified price during the future period. The life period of the warrants are normally too long. The warrants are normally issued by the company only in order to attract the issue of fixed bearing securities viz preference shares and debentures. The following are the various type of warrants:
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Detachable warrants: Warrants which are issued along with the host securities; detachable Puttable warrants: The warrants issued are sold back to company before expiry date Naked warrants: Warrants issued without any host securities
Advantages of the warrants l Making other host securities more attractive l It facilitates the companies to stand on its own leg and reduces the rate to depend on the intermediaries l The exercise of the warrants only during the future period which fosters better planning for the company l Lower cost of debt due to greater attraction towards warrants - denominated in terms of equity shares - which are at later date l Warrants are highly liquid which means they are traded in the Stock Exchanges provided the warrants should not be exercised.
Check Your Progress
2.
Preferential share is
(a) (b) (c) (d) Issued at preferential price Preferential rights over the debentures Preferential rights over the equity shares None of the above Contd....
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3.
4.
5.
6.
Warrants are
(a) (c) Title to buy the preference shares Title to buy the equity shares (b) (d) Title to buy debentures Title to buy bonds
Sweat security which is issued at preferential pricing more specifically for employees Sweat security which is issued at face value, that may be either at par or above par
The unpaid preference dividends are paid before anything paid to equity share holders. The unpaid preference dividends are called in other words as Arrearages. Debentures are classified on the following basis:
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On the basis of security On the basis of holding On the basis of redemption On the basis of convertibility
Bond is a long-term debt instrument issued by the company to raise the financial resources from the market, for specific period and it carries fixed rate of interest which has its own salient features. Warrants are nothing but Bearer documents which are title to buy the specified number of equity shares at specified price during the future period. The life period of the warrants are normally too long.
14.9 KEYWORDS
Share: smaller unit of the share capital of the company
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Preference share: Preferential rights are pegged with this type of a share to share anything from the company prior to the equity shareholders
Bond: Long-term debt instrument Debenture: Long-term debt instrument floated by the company with or without charge on the assets of the company. Security: The amount of lending is secured through the charge on the assets Redemption: Time period of repayment and payment of the principal and interest respectively are known Warrants: Title to buy equity shares at the specified price in the future date Host securities: These are the securities which are normally issued by the company along with the warrants viz preference share and debenture Naked warrants: Without any host securities, if any warrants are issued
10. Explain the advantages of issuing the warrants. 11. Elucidate the various classifications of warrants.
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