Shares

Definition Ordinary share represent the ownership position in the company. The holders of ordinary shares are called the shareholders and they are the legal owners of the company.

By a share it also means right to participate in the profits made by a company, while it is a going concern and declares dividend, and in the assets of the company when it is wound up.

A stock is defined as consolidated value of fully paid up shares of a member.

Types of shares capitalEquity shares capital

Preference shares capital: Preference share is the one which satisfies the following criteria-With respect to dividend it carries a preferential right to be paid which may be a fixed amount or a fixed rate-On winding up or on repayment of capital a preferential right to be repaid the amount .

Features of Preference Share

Claims on income and assets

Fixed Dividend

Cumulative dividend

Redemption

Sinking fund

Call feature

Participation feature

Hybrid Security

Ordinary share

• Non payment of dividend does not force the company to insolvency

• Dividends are not deductible for tax purpose

• In some cases there is no fixed maturity date.

Debenture

•Dividend rate is fixed

•Pref shareholders do not share in the residual earnings

•They have claim on income andassets prior to ordinary shareholders

Types of Preference Shares

Participating preference shares.:- they carry a right to participate in the surplus profit along with equity shareholders after dividend at certain rate has been paid to equity shareholders.

Cumulative and non-cumulative shares

Redeemable preference shares

Fully or partly convertible preference shares.

Voting rights for preference shareholders

Every member of a company holding any preference shares has a right to vote only on resolutions placed before the company which directly affect attached to his preference shares

Apart from this preference shareholders are entitled to vote if dividend has remain unpaid in case of cumulative as well as non cumulative for two years.

Pros

•Risk less leverage advantage

•Dividend postpondability

•Fixed dividend

•Limited voting right

Cons

•Non tax deductibility of dividend

•Commitment to pay dividend

Equity shares

Types of Equity Shares

Authorized share capital

Issued share capital

Subscribed share capital

Paid up share capital

Issue price of shares: the price at which share is issued in the market.

Paid up share capital = issue price * no. of ordinary shares. Issue price has two components1. Par value 2. Share premiumPar value is the price per ordinary share stated in the

memorandum of association.Generally they are in the denomination of 10 or 100.Any amount in excess of par value is called the share premium.Shareholders equity = paid up share capital + share premium +

reserves and surplus = Net worthBook value per share = Net worth / no. of ordinary sharesMarket value of a share is the price at which it trades in the

market. It is generally based upon the expectations about the performance of the economy in general and company in particular.

Features of Equity Shares

Residual claim to income

Residual claim on assets

Right to control

Voting system

Pre-emptive right

Limited liability

Evaluation Merits-it is a permanent source of fund without any repayment liability-It does not involve any obligatory dividend payment

Demerits-high cost of fund reflecting the high required rate of return of investors as a compensation for higher risk-High floatation cost in terms of underwriting, brokerage and other issue expenditure-Dilution of control

Method of Raising Capital

By issue of prospectus

Rights issue of equity shares.

Private placement of shares

Issuing of securities

Filing of offer documentApplication for listingIssue of securities in dematerialized formBook building: It is a process undertaken by which demand for securities proposed to be issued is elicited and built up and price for such issue is assessed for determination of quantum of such securities to be issued.

Issue of share at a discount

Issue of share at a premium

Call on shares: application, allotment and other calls

Forfeiture of shares

Initial Public OfferBenefits of going public-Access to capital-Respectability-Investors recognition-Liquidity-Signals from the market

Costs of going public-Adverse selection-Dilution-Disclosures-Accountability-Public pressure

ISSUE TYPE OFFER PRICE

DEMAND PAYMENT RESERVATIONS

Fixed Price Issues

Price at which the securities are offered and would be allotted is made known in advance to the investors

Demand for the securities offered is known only after the closure of the issue

100 % advance payment is required to be made by the investors at the time of application.

50 % of the shares offered are reserved for applications below Rs. 1 lakh and the balance for higher amount applications.

Book Building Issues

A 20 % price band is offered by the issuer within which investors are allowed to bid and the final price is determined by the issuer only after closure of the bidding.

Demand for the securities offered , and at various prices, is available on a real time basis on the BSE website during the bidding period..

10 % advance payment is required to be made by the QIBs along with the application, while other categories of investors have to pay 100 % advance along with the application.

50 % of shares offered are reserved for QIBS, 35 % for small investors and the balance for all other investors.

Eligibility for an IPOA company can make 100% retail issues provided it satisfies all the following conditions

1.It has a net tangible asset of at least Rs 3 crore in each of the preceding three years.

2.It has a track record of distributable profit for at least three out of immediately proceeding 5 years.

3.It has a net worth of at least Rs1 crore in each of the preceding 3 financial years.

4.The issue size (offer through offer document + firm allotment + promoters contribution through offer document) does not exceed five times the pre-issue net worth

Cost of Public IssueUnderwriting Expenses

Brokerage

Fees to the managers to the issue

Fees for registrars to the issue

Printing expenses

Postage expenses

Advertising and publicity expenses

Listing fees

Stamp duty

Green Shoe optionA provision contained in an underwriting agreement that gives the underwriter the right to sell investors more shares than originally planned by the issuer. This would normally be done if the demand for a security issue proves higher than expected. Legally referred to as an over-allotment option.

It provides additional price stability to a security issue because the underwriter has the ability to increase supply and smooth out price fluctuations if demand surges.   Greenshoe options typically allow underwriters to sell up to 15% more shares than the original number set by the issuer.

However, some issuers prefer not to include greenshoe options in their underwriting agreements under certain circumstances, such as if the issuer wants to fund a specific project with a fixed amount of cost and does not want more capital than it originally sought.

The term is derived from the fact that the Green Shoe Company was the first to issue this type of option.

Allotment

size of public offer: 2,00,000 equity shares of Rs 10 each

no. of times over subscribed: 3 timestotal no. of shares applied for: 6,00,000 equity shares

S.No

No. of shares applied for category wise

No. of applicants

Total no. of shares applied

Proportionate allocation

No. of shares allocated by rounding

No of successful applicant

Total no of shares allocated

1 100 1500 150000 50,000 100 500 50,000+3300

2 200 400 80,000 26,700 100 267 26700

3 300 300 90,000 30,000 100 300 30,000

4 400 300 1,20,000

40,000 100 300 30,000

5 500 200 1,00,000

33,300 200 200 40,000

6 600 100 60,000 20,000 200 100 20,000

6,00,000

2,00,000

2,00,000

Rights Issue of Equity Share

It involves selling of ordinary shares to the existing shareholders.

Law in India requires that the new ordinary shares must be first issued to the existing shareholders on a prorata basis

No. of rights = existing share/ new share

Private placement of shares

It involves sale of shares (or other securities) by a company to few selected investors, particularly the Institutional Investors like the Unit Trust of India (UTI), the Life Insurance Corporation of India (LIC), IDBI etc.

Private placement has the following advantages-It is helpful to raise small amount of fund-It is less expensive-It is a much faster way of raising fund.

Shareholder A shareholder (or stockholder) is an individual or company (including a corporation) that legally owns one or more shares of stock in a joint stock company.

Shareholders are granted special privileges depending on the class of stock, including the right to vote (usually one vote per share owned) on matters such as elections to the board of directors, the right to share in distributions of the company's income, the right to purchase new shares issued by the company, and the right to a company's assets during a liquidation of the company. However, shareholder's rights to a company's assets are subordinate to the rights of the company's creditors.

Preferential Allotment, An issue of equity or equity related instruments by a listed company to pre-identified investors who may or may not be the existing shareholders of the company at a pre-determined price is referred to as a preferential allotment.

Made to promoters, strategic investors, venture capitalist, financial institutions and suppliers

Rationale- to secure equity participation of those that the company considers desirable, but who may otherwise find it very costly or impractical to buy large chunk of shares in the market.

Regulations Special resolution

- company must pass special resolution- government must grant special approval

under section 81(1A)Pricing – price should not be lower than the higher of the average of the weekly high and low of the closing price of the shares quoted on the stock exchange during six months before the relevant date or two weeks before the relevant date.Open offer- a preferential allotment of more than 15% of equity necessitates an open offer.Lock-in-period – one year lock-in-period

Internal Accruals

Depreciation Charges

Retained earnings

Advantages & Disadvantages of Internal Accruals

Advantages Retained earnings are easily available internally.

It eliminates issue and transaction cost.

No dilution of control

DisadvantagesAmount that can be raised by way of retained earning is limited.

Opportunity cost is quite high

Term Loan

Term Loan

Term loan is a loan made by bank/financial institution to a

business having an initial maturity of more than one year.

Features of a term loan Maturity

Negotiated

Security:- primary security/secondary security (collateral)

Covenantsrestrictive covenants are contractual clauses in the loan agreement that place certain operating and financial constraints on the borrower.these covenants are both positive as well as negative in the sense of what borrowers should do and should not do in the conduct of its operation.

Covenants Asset-related covenants-maintenance of working capital position in terms of

minimum current ratio-ban on sale of fixed asset without the lenders approval Liability related covenant-restrain on incurrence of additional debt-reduction in debt equity ratio by issue of additional

capital Cash flow related covenant-limitation on dividend payment to a certain amount or

rate-ceiling on managerial salary or perks Control related covenant-appointment of nominee director to represent the

financial institution and safeguard their interest

Repayment schedule/Loan Amortization

Year Beginning loan

Payment installment

Interest (0.14)

Principal repayment[3-4]

Ending loan [2-5]

1 2 3 4 5 6

1 60,000 12,934 8,400 4,535 55,466

2 55,466 12,934 7,776 5,168 50,298

3 50,298 12,934 7,042 5,896 44,406

4 44,406 12,934 6,216 6,718 37,688

5 37,688 12,934 5,276 7,658 30,030

6 30,030 12,934 4,204 8,730 21,300

7 21,300 12,934 2,982 9,952 11,348

8 11,348 12,934 1,588 11,346 0

Obtaining a term loan An application form containing comprehensive information

about the project is submitted to the financial institution It contains details like promoters background, particulars of

the industrial concern, particulars of the industrial project, cost of the project, means of financing etc.

After the application is received a flash report is generated which is a summarization of the loan application. On the basis of this report detailed appraisal of the project is done.

In the detailed analysis marketing, technical, financial, management and economic feasibility of the project is tested.

If on appraisal is the project is found feasible then the loan is sanctioned by the bank.

Debentures

Debenture/bond is a debt instrument indicating that a company has borrowed certain sum of money and promises to repay it in future under clearly defined

terms.

Attributes

Trust indenture: it is a complex and lengthy legal document stating the conditions under which a bond has been issued.

It provides the specific terms of agreement such as description of debenture, rights of debenture holder, rights of the issuing company and responsibilities of the trustees.

Trustees is a bank or financial institution that acts as a third party to the bond to ensure that the issue does not default on its contractual responsibilities to the bond holders.

Interest: the debenture carries a fixed rate of interest, payment of which is legally binding

Maturity: It indicates the length of time for redemption

Debenture redemption reserve: It is a requirement in the debenture indenture to provide for systematic retirement of debenture on maturity.

Call and put provision: the call/buyback provides an option to the issuing company to redeem the debenture at a specified price before maturity. The put option is the right to the debenture holder to seek redemption at a specified time at a predetermined price.

Security

Convertibility

Credit rating

Claim on income and assets

Innovative debt Instruments

Zero Interest Bond- They do not carry any explicit rate of interest- They are sold at a discount from their maturity value- The difference between face value of the bond and the

acquisition cost is the gain.

Deep Discount bond- It is issued at a deep/steep discount at its face value- It appreciates to its face value during the maturity period

IDBI in 1992 had come up with a deep discount bond of face value Rs 1,00,000 at a deep discount price of Rs 2,700 with a maturity period of 25 years. If the investors hold it for 25 years the annualized return comes out to be 15.54%. The investor had the option to withdraw at the end of every five years with a specified maturity and face value ranging between Rs 5,700 (after 5 years) and Rs 50,000 after 20 years, the implicit annual rate of interest being 16.12 and 15.71 respectively

Secured premium notes- It is a secured debenture redeemable at premium over

the face value/ purchase price

- There is a lock in period during which no interest is paid

- The redemption is made in installment

Floating rate bond- Interest is linked to some benchmark rate such as

treasury bill, bank rate etc

Callable and puttable bonds

Other new sources of finance Leasing and hire purchase- leasing: It is a process by which a firm can obtain

the use of certain fixed assets for which it must make a series of contractual, periodic, tax-deductible payments.

- Hire purchase:- It is a type of financial transaction in which goods are let on hire with an option to the hirer to purchase them.

Venture capital financing: It is a type of finance available for investors looking for high potential returns and entrepreneurs who need capital as they are yet to go to the public

Qualified Institutional Buyer (QIB)

The Securities and Exchange Board of India has defined a Qualified Institutional Buyer as follows

"Qualified Institutional Buyers are those institutional investors who are generally perceived to possess expertise and the financial muscle to evaluate and invest in the capital markets.

In terms of clause 2.2.2B (v) of DIP Guidelines, a ‘Qualified Institutional Buyer’ shall mean:

"a) Public financial institution as defined in section 4A of the Companies Act, 1956;"b) Scheduled commercial banks;"c) Mutual funds;"d) Foreign institutional investor registered with SEBI;"e) Multilateral and bilateral development financial institutions;"f) Venture capital funds registered with SEBI."g) Foreign Venture capital investors registered with SEBI."h) State Industrial Development Corporations."i) Insurance Companies registered with the Insurance Regulatory and Development

Authority (IRDA)."j) Provident Funds with minimum corpus of Rs.25 crores"k) Pension Funds with minimum corpus of Rs. 25 crores"These entities are not required to be registered with SEBI as QIBs. Any entities falling

under the categories specified above are considered as QIBs for the purpose of participating in primary issuance process."

Factors affecting choice of financing

Sales stability

Asset structure

Profitability

Control

Taxes

Growth rate

Management attitude

Firm’s internal conditions

Financial flexibility

Market conditions

Prices