TYPES OF CAPITAL

Gayatri Mohanty Asst. Professor Dr. J K Patel Institute of Management

Types of Capital
Basically two types of securities for raising capital: Shares -Equity Shares -Preference Shares Debentures Long term capital can also be obtained through term loans or borrowings through banks and financial institutions.

EQUITY SHARES
Also called ordinary shares or common shares They represent the ownership position in a company Source of permanent capital Entitled to dividends Variable income security Ownership risks
claims on income claims on assets

EQUITY SHARES
Authorized capital: Maximum amount of capital which a company can raise from shareholders. The authorized capital can be changed by altering the MoA. Issued capital: That portion of the authorized capital which have been offered to the shareholders. Subscribed share capital: That part of the issued share capital which have been accepted by the shareholders.

EQUITY SHARES
Paid up share capital: The part of subscribed capital which have been actually paid up by the shareholders of the company. Issue Price = Par Value + Share Premium Share premium: Any amount in excess of the par value of an equity share is called the share premium.

Net Worth of Equity Shares

Net Worth comprises of: Paid up share capital Share premium Reserves & Surplus (undistributed profits of the company which ultimately belong to the equity shareholders) Therefore, Book value per share = net worth number of ordinary shares Book value and market value of a share are two different things
Book value of a share is based on historical data whereas market value of a share is based on the demand and supply of the share in the stock market. It is based on expectations about the performance of the economy in general and the company in particular

Features of Equity Shares

Residual claim on income Dividends Retained earnings Claim on assets Dividend paid on equity shares is not tax-deductible Right to control Voting rights (in person or proxy votes) Election of directors Alteration of MoA of the company Pre-emptive rights (right to maintain proportionate share in ownership-rights issue, right during FPO) Limited liability (once share is fully paid-up)

Advantages of Equity Shares (From company point of view)

Permanent capital Borrowing base Dividend payment discretion

Disadvantages of Equity Shares (From company point of view)

Cost - dividends are not tax-deductible - high floatation costs Risk (for investor and hence a higher return expectation) Earnings dilution Ownership dilution

Some terminologies:
Public Issue Underwriting Private Placement Rights Issue

PREFERNCE SHARES
It is also called Hybrid Security as it has combined features of equity shares and debentures. Similarity to Equity Shares: Non payment of dividends doesnt force the company to insolvency Dividends paid on preference shares are not tax-deductible In certain cases preference shares have no maturity

PREFERNCE SHARES
Similarity to Debentures: Rate of dividend is fixed No share in residual earnings Claim on assets and income prior to equity shareholders Usually do not have voting rights

Features of Preference Shares

Claims on assets and income (senior security) Fixed dividend (but not legally binding, fixed income security) Cumulative dividends Redemption (Redeemable & Irredeemable preference shares) Sinking fund Call feature (buy-back of preference shares at call premium) Participation feature (in extraordinary profits and in some cases with voting rights) Voting rights (Contingent Voting Rights) Convertibility (Convertible & Non-convertible preference shares)

Advantages of Preference Shares

Risk less leverage Dividend postponability (financial flexibility) Fixed dividends (no participation in extra ordinary profits) Limited voting rights

Disadvantages of Preference Shares

Non tax-deductibility of dividends from tax (costlier than debentures) Commitment to pay dividends Substantial cash outflows during redemption

DEBENTURES
It is a long term promissory note for raising loan capital. The firm promises to pay the periodic interest and principal upon maturity as specified. The rate of interest on debentures is fixed and it is legally binding on the company to pay interest on debentures. Public sector debentures in India are also called bonds.

Features of Debentures
Interest rate (coupon rate)
legally binding tax deductible

Maturity Sinking fund Buy-back (call) provision Indenture (Debenture Trust Deed) Security and Credit Rating (secured unsecured debentures) Yield (Current Yield, Yield to Maturity) Priority in claims on income and assets

or

Types of Debentures
Non-convertible Debentures (Pure Debentures) Convertible Debentures
Fully Convertible Debentures Partly Convertible Debentures

Zero-coupon Bonds (Deep Discount Bonds)

Advantages of Debentures
Less costly
low expected rate of return interest on debentures are tax-deductible

No ownership dilution Fixed payments of interest means no claims on extraordinary profits Reduced real obligation during times of high inflation

Disadvantages of Debentures
Obligatory payments Financial risks ( for firms with seasonal business) Cash outflows Restrictive covenants

TERM LOANS
It is a source of long term capital for companies wherein a debt in the form of loan is obtained from a bank or financial institutions. Term loans are generally obtained for expansion, modernization or diversification projects. So, they are often referred to as Project Financing.

Features of Term Loans

Fixed and long term maturity Direct negotiation Security Asset-related covenants (credit-worthiness) Liability-related covenants (restrictions on further heavy borrowings) Cash flow related covenants (restrictions on too much cash outflows) Control related covenants Convertibility

Depository Receipts
A depository receipt (DR) is a type of negotiable (transferable) financial security that is traded on a local stock exchange but represents a security, usually in the form of equity, that is issued by a foreign publicly listed company. The DR, which is a physical certificate, allows investors to hold shares in equity of other countries. Depository receipts are an indirect way of raising equity capital from foreign markets. An Indian company can issue American Depository Receipts in USA and raise capital there. On the other hand if an American investor wants to invest in the shares of an Indian company he can do so with ADRs. The ADR investor holds privileges like those granted to shareholders of ordinary shares, such as voting rights and cash dividends. The rights of the ADR holder are stated on the ADR certificate. The Indian firms can also issue GDRs in many other companies.