SOURCES OF FINANCE

TOPICS COVERED Venture Capital Financing Retained Earning Equity Share Preference Share Deep Discount Bond Certificate of Deposit  Trade Credit Debenture Commercial Paper Bank Advances

VENTURE CAPITAL

VENTURE CAPITAL

A risky undertaking

Money/asset to run a business

MeaningA venture capital financing facilitates funds for startup and

highly risky venture promoted by entrepreneurs who lack experience and funds to give a shape to their ideas.

VC Firms IDBI ICICI SBI Capital market etc.

Methods of VC FinancingEquity FinancingConditional Loan Income NoteParticipating Debenture

Factors Influencing VC Finan…Level of expertise of company’s managementLevel of expertise in productionNature of new product/serviceFuture prospectsCompetitionRisk borne by entrepreneur

RETAINED EARNING

RETAINED-EARNINGS

DEFINITIONRetained earnings refer to the percentage

of net earnings not paid out as dividends, but retained by the company

A debit balance in retained earnings is called deficit

FEATURESSource of internal financingNet income increases retained earnings and net loss

decreases itNo compulsory maturity like term loans and debentures. It is taxed under income tax

CALCULATIONRetained Earnings (RE) = Beginning RE + Net Income -

Dividends

PROS-CONS

No cost of investmentNo dilution of control and

ownership No fixed obligation of

interest or installment payments.

They are very flexible

Negative balanceOpportunity cost of these

earnings is highThe earnings made will be

taxed Management can misuse

the retained earnings.

Advantages Dis-advantages

SHARES

SHARESMeaning: The capital of a company is divided into shares.

Each share forms a unit of ownership of a companyShares can be broadly divided into two categories - equity

and preference shares

EQUITY SHARESAn equity share represents the form of ownership in which a

shareholder, as a fractional owner, undertakes the maximum risk associated with a business venture.

Equity shares give their holders the power to share and vote.

They are also called ordinary shares.

FEATURES1. They are permanent in nature.2. Equity shareholders are the actual owners and they bear the

highest risk.3. Equity shares are transferable.4. Equity shareholders do not get fixed rate of dividend.5. The liability of equity shareholders is limited to the extent of

their investment.

MERITS Company need not have the forced obligation to pay

dividend to equity shareholders.

The obligation to repay the equity capital arises only at the time of liquidation of the company.

The shareholders can participate in the management of the company through voting rights.

Equity shares can be issued without creating any charge over the assets.

DEMERITS Equity shares always associated with the expectations of the

investors. It is practically a difficult task to fulfill the expectations of the investors.

Equity shareholders have to bear all the losses at the time of liquidation.

Original investment is not guaranteed.

Investors who have a desire to invest in safe or fixed returns have no attraction of such shares.

PREFERENCE SHARESPreference shares earn their holders only dividends, which

are fixed, giving no voting rights.Preference shares carries certain priority rights.At the time of winding up of the company, capital is paid to

preference shareholders prior to the return of equity capital.

FEATURES Preference shares are long-term source of finance The dividend payable on preference shares is generally

higher than debenture interest Preference shareholders get fixed rate of dividend

irrespective of the volume of profit. Preference shareholders do not have any voting rights Preference shareholders have the preferential right for

repayment of capital in case of winding up of the company.

TYPES Cumulative and Non cumulative.

Participating and Non Participating.

 Convertible and Non Convertible.

Redeemable and Non Redeemable.

ADVANTAGES The earnings per share of existing preference shareholders

are not diluted if fresh preference shares are issued. Preference shareholders do not have any voting rights and

hence do not affect the decision making of the company. Preference dividend is payable only if there is profit.

It can be redeemed after a specified period.

DISADVANTAGES Preference dividend is not tax deductible and hence it is

costlier than a debenture. In case of cumulative preference share, arrear dividend is

payable when the company earns profit, which creates a huge financial burden on the company.

Redemption of preference share again creates financial burden on the company.

Preference shareholders get dividend at a constant rate and it will not increase even if the company earns a huge profit.

Preference shareholders do not enjoy the voting rights.

DEEP DISCOUNT BOND

DEEP DISCOUNT BOND Deep Discount Bond is technically called a Zero Coupon Bond. This

means the deposit does not give any interest payouts. Instead the interest is accumulated and paid out at the time of

maturity. Deep discount bonds were a rage India during the early 1990s. Example 1:- There was the Narmada bond, which on an investment of

Rs 3600 promised to give Rs 1.10 lakhs, 20 years after 1993. The ICICI Children's Bond promised Rs 1 lakh on an investment of Rs 7,000/-, 18 years after 1995. These bonds were at very attractive interest rates of 18% and 16% respectively.

CONT…..The Deep Discount Bond is however different from a

cumulative deposit in the much longer tenure. Example 2:- The deep discount bond issued by NABARD is a

first of sorts for this decade. The bond is being issued at Rs 9,750/- for a maturity value of Rs 20,000/- after 10 years. This gives it a return of 7.45%. The bond issue opens on March 23rd 2010. The bond can be traded on the BSE. This means that the bond holder can also make some capital gains in case the interest rate during the period drops below 7.45%.

ADVANTAGES One can invest upto Rs. 20,000 per annum 

One can get a tax exemption in addition to 1,00,000 u/s 80C.

Compared to the regular bonds, the interest rates are linked to the rise and fall of the interest rates in the market.

Recently Indian Railway Finance Corporation (IRFC) and the National Bank of Agriculture & Rural Development(NABARD) were issued these kind of bonds.

DISADVANTAGESA company or government issuing zero

coupon bonds is at a high risk of repayment because the amount to be paid is very huge. 

Market prices of zero coupon bonds are prone to higher fluctuation compared to other coupon paying bonds.

Conservation of Cash: Company can preserve the cash with them in the case of ZCBs. If they would have issued normal bonds, interest payment every year would have been compulsory

CERTIFICATE OF DEPOSIT

CERTIFICATE OF DEPOSIT The Certificate of Deposit indicates that the investor has

deposited a sum of money for specified period of time and at a specified rate of interest.

Certificate of Deposit is beneficial for a risk averse investor who is looking to save and will not need funds until the instrument reaches maturity.

MERITS AND DEMERITS MERITS

Safe and Secure

Easy to get

DEMERITS

Funds tied up

Price of Safety

TRADE CREDIT

MEANING Trade credit is the credit extended by one business firm to

another as incidental to sale or purchase of goods and services.

It is also known as mercantile credit.

DEFINITION- It may be defined as credit extended by sellers to buyers at all levels of the production and distribution process down to the seller.

Features It does not include consumer credit or installment creditArises out of transfer of goods Is unsecuredGranted for periods ranging from 15 days to 3 monthsBuying firm receives supplies without paying immediately

Features Cont....Reflects the buyer’s power to purchase now and pay later Indicates the seller’s faith in the buyer Is available in the ordinary course of businessNo securities required for getting trade credit

DEBENTURES

DEBENTURES / BONDS

DEFINITION It is a promissory note for raising long term loan capital It is a long term, fixed income, financial asset It is a type of debt instrument They are the most common form of long-term loansThese loans are normally repayable on a fixed date and pay

a fixed rate of interest

FEATURES

Contractual rate of interest Specific maturity Debenture interest is tax deductible Availability of indenture Security: Can be secured or unsecured

Rated by rating companies Interest is paid before dividends Can be traded in secondary capital markets

TYPES

Convertible debentures; which can be converted in to

shares

1. Fully convertible2. Partially convertible Non-convertible debentures; which can not

PROS-CONS

Less costly than equity financing

No ownership dilutionFixed payment Reduced real obligations

Obligatory paymentsFinancially risky Indenture may contain

restricted covenants

Advantages Dis-advantages

COMMERCIAL PAPER

COMMERCIAL PAPERCommercial Paper is an unsecured money measurement

instrument issued in form of a promissory note.The Reserve Bank Of India introduced the commercial

paper scheme in the year 1989. Subsequently, in addition to Corporate, Primary dealers

and All India Financial Institutions have also been allowed to issue commercial paper.

Commercial Papers are issued in denominations of Rs 5 lakhs or above.

CONT….All eligible issuers are required to get the credit rating from

Credit Rating Information Services of India Ltd (CRISIL). Investment Information and Credit Rating Agency of India

Ltd (ICRA), (CARE) or FITCH Ratings India Pvt Ltd or any other credit rating agency as if specified by Reserve Bank of India (RBI).

ADVANTAGES OF COMMER… It is quick and cost effective way of raising working capital. It provides the exit option to the investors to quit the

investment. They are cheaper than a bank loan. The companies which issue commercial paper get two

benefits out of it.

DISADVANTAGES It is available only to a few selected blue chip

and profitable companies. By issuing commercial paper, the credit

available from the banks may get reduced. Issue of commercial paper is very closely

regulated by the RBI guidelines. Commercial papers are expensive for general

public to buy

BANK ADVANCES

BANK ADVANCES

Amount that is lent as a limit for a running account is generally termed as Bank Advances.

MERITS AND DEMERITS MERITS

Flexibility

Speed

DEMERITS

Difficulty

Credit

Curated And Presented By

Nandan

Aviral

Sahil

Kartik