CHAPTER 20

FINANCING OPTIONS

I NTRODUCTION

Choosing the most suitable sources of debt/equity financing is of significant importance in financial management. A finance manager must be aware of the various long-term and short-term financing options available and the terms and conditions of their availability.

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R OLE O F F INANCIAL M ARKETS

Financial markets channelize the resources from the surplus units to the deficit units.
Such a transfer enables the surplus units to park their funds fruitfully.

The deficit units get the necessary funds to meet their investment requirements
A well-functioning and efficient financial market benefits the economy by channelizing the funds towards the most productive avenues of investments.

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R OLE O F F INANCIAL M ARKETS

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F INANCIAL M ARKETS S EGMENTS , P RODUCTS A ND S ERVICES

Financial markets are an assemblage of players, and the various financing instruments and services. They can be segmented based on the duration and the purpose of financing.

Broadly they could be segmented into capital market and money market.

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F INANCIAL M ARKETS S EGMENTS , P RODUCTS A ND S ERVICES

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L ONG T ERM S OURCES

Equity capital Domestic

IPOs, Rights Book Building

Foreign

ADRs and GDRs

Venture Capital and Private Equity

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C APITAL M ARKETS

Capital market is the market for long-term financing. It can be categorized as

domestic and international.

Domestic capital market constitutes of

Primary market and Secondary market.

Primary market is the new issue market. Previously issued securities get traded in the Secondary market.
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E QUITY C APITAL

IPO is the first sale of stock by a firm (company) to the public. All public issues of equity made after the IPO are termed as follow-on public offer. IPOs generally involve one or more investment banks as underwriters. The investment bank that leads the syndicate in the IPO is called lead manager.
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CAPITAL MARKETS I NVESTMENT B ANKER

Investment bankers provide a wide array of preand post-capital issue services to the firms.
They are termed as financial intermediaries Are an important link between the investors and issuers of the capital. Due to their intermediation and facilitation in the funds transfer they often referred to as merchant bankers. Investment bankers advise the issuing firm on the pricing of the IPO.
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CAPITAL MARKETS I NVESTMENT B ANKER

Investment banker, besides other responsibilities like road shows, book building etc., have to compulsorily underwrite the issue that they are managing.
Underwriting guarantees the public issue against any under-subscription Book building is a price discovery mechanism in an IPO.
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INTERNATIONAL CAPITAL MARKETS: GDR S AND ADR S

GDRs are the receipts issued

By international banks acting as depository. GDRs are issued against the shares of a foreign firm and deposited with the depository.

They are freely tradable like equity shares.

ADRs are American Depository Receipts issued against domestic shares for investors in USA.

ADRs are same as GDRs.

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V ENTURE C APITAL

Venture capital is the initial capital infused in a new venture/product to meet the needs of people with bright ideas but limited financial resources. This is also called start-up financing A venture capitalist is expected to fulfill the gap in funding and is characterized by:
Sharing of risk of the new venture Compliment the financial needs by sharing of profits, Exiting from the firm once it reaches the self sustaining growth with relatively less risk, Add strategic value to the firm, May participate in management .

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V ENTURE C APITAL E XIT O PTIONS

Venture capital is the risk bearing capital. When the risk of the projects is expected to come down to a reasonable level to be assumed by normal investors, venture capitalists needs to make an exit. Three exit routes available are:

Buyback by promoters Selling to another investor Offer for sale in the IPO

An important feature in all exit routes is the valuation of the firm at the time of exit.
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P RIVATE E QUITY

As the name implies it is non-public equity placed with select investors who are willing to assume risk of the project for a longer time. Private equity seeks greater returns than the normal investor in the capital markets. Venture capital is a form of private equity. Private equity is the capital that bears lesser risk than venture capital but higher risk than the what the project would have once it matures to have steady cash flows.
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L ONG T ERM S OURCES B ONDS

Bonds are borrowing instruments for a firm that promised fixed rate of return to the investors not linked to the performance of the firm.
The bonds are usually a source of long term capital that enhances the returns for equity holders. The tenure of bonds has been increasing and off late perpetual bonds are also being placed with select investors with longer time for resetting of coupon rates.
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L ONG T ERM S OURCES D EBT

Basic vanilla commercial loans that carry a fixed rate of interest and maturity period.
Can be classified into intermediate-term loans and long-term loans.

Traditionally, Development Financial Institutions (DFIs) have been extending term loans to Indian industry. Due to their cost and other disadvantages they are not the preferred source of financing for Indian industry
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C APITAL M ARKETS P ROJECT F INANCE

Financing option available to large capital intensive projects with huge capital requirements and involving high risks. Risk identification and allocation is a key component of project financing.

Project financing may be done in BOT, BLT, or PPP format.

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I NTERNATIONAL C APITAL

MARKETS

ECB S

ECBs are the foreign currency denominated loans raised by Indian firms.

They are just like term loans or bond in the domestic markets.
Mobilization of loans from international markets is governed by regulations by Reserve Bank of India involving foreign exchange inflows and outflows.
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I NTERNATIONAL C APITAL

MARKETS

FCCB S

FCCBs are foreign currency denominated bonds issued by Indian companies. Carry a fixed coupon rate and are convertible into a fixed number of ordinary shares at a preferred price. Are listed and traded abroad and subscribed to by a non-resident.

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S HORT T ERM S OURCES OF F INANCE

DOMESTIC

Lines of credit Commercial papers Factoring Bill Discounting Forfaiting

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INTERNATIONAL

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M ONEY M ARKET

Money market consists of players and instruments related to working capital financing Several non-conventional sources of short-term financing such as Commercial Papers and Factoring have evolved over the years.

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L INE

OF

C REDIT

Line of credit is the source of meeting the working capital requirements of businesses.

Extended by firms banks with a preset credit limit.

The interest paid is on the amount of credit availed and not on the entire credit limit approved.

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MONEY MARKET: C OMMERCIAL PAPERS

Commercial Paper is an unsecured money market instrument with a fixed maturity period (7 days-1 year)

Issued by highly rated corporate borrowers to meet their working capital.

Stringent requirements, as per the guidelines, in terms of net worth and credit rating for issuing companies.
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FACTORING

Factoring refers to sale of accounts receivables by the client (a firm) to the factor (a bank).
It unlocks firms cash that gets tied up in receivables. Factoring can be with recourse or without recourse.

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FACTORING

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FACTORING

Factoring, though similar to bill discounting, has some distinguishing features

While bill discounting is a pure fund based activity, factoring has both, fee based and fund based features In addition to the funds provided, the factor offers certain other services, such as collection of receivables, sales ledger administration, etc., to the client.
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F ORFAITING

Forfaiting is the discounting of international trade receivables on a without recourse basis.

It involves purchasing of an exporter's receivables (the amount importers owe the exporter) by the forfaiter at a discount. The forfaiter pays cash to the exporter, and the importer is obliged to pay its debt to the forfaiter. What factoring is to a domestic credit sale transaction, forfaiting is to an international transaction.
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