3 Sources of L

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Accounting and Finance for

Managers 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 Issue14.3 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

14.0 AIMS AND OBJECTIVES

In this lesson we will study about long term finances of companies. After studying this

lesson you will be able to:

(i) describe the concepts of equity share, sweat security, non-voting shares and bonus

issues.

(ii) distinguish between cumulative and non-cumulative preference share.

(iii) explain the features of debentures, bonds and warrants.

14.1 INTRODUCTION

The sources of long-term finance could be classified into the following categories:

l Equity shares

l Preference shares

l Debentures

l Bonds

l Warrants


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Sources of Long Term FinanceThe combination of the sources of long-term finance is known as capital structure. From

the above classification, we will discuss one after the another.

14.2 EQUITY SHARES

Shares and Stock are synonymous in usage. Shares are the expression of smaller units

of Share capital of the organization. The raising of equity share capital from the investorsin various segments viz Application money, First call money and Subsequent calls money

are collected subject to the capital clause of the Memorandum of Association of the

organization.

After the issue, the share certificates are issued which normally depicts the expression

of right of shares.

Right of Equity Shares:

Sec. 85(2) of the Companies Act, 1956 expresses the right of the equity shareholders

who hold the equity shares

l To vote

l To control the management

l To share the profits

l To claim on the residual portion during the winding up

l To exercise pre-emptive

l To apply the court

l To receive the copy of the statutory report, copy of the annual accounts

l To apply the central government for AGM - failure on the part of the company

l To apply company law board for Extraordinary general meeting

14.2.1 Sweat Security

l 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.

l Definition

l 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.

Normally the sweat security is issued by the companies in two different categories:

l Sweat security which is issued at preferential pricing more specifically for employees

l Sweat security which is issued at face value, that may be either at par or above par

14.2.2 Non Voting Shares

These type of equity shares never carry any voting rights. These type of shares are also

eligible to enjoy the bonus issue and exclusive listing for the holding of the shares. When

Two year Dividends are continuously missing, the nature of the non voting shares will

automatically become as Voting shares. The Non voting shares are to be declared 20%

dividend more than the ordinary dividend. The issue size of the Non voting shares should

not exceed the maximum limit of the voting stock i.e. 25%.


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Managers14.2.3 Bonus Issue

This type of issue is merely considered as book entry in between the two different

sources of long term finance viz Free Reserves and Equity Share capital. This type of

issue is normally restricted to the companies which are having the partly paid equity

shares. The bonus issue is permitted by making the partly paid up shares into fully paid

shares. The bonus issue is normally decided in the board meeting.

14.3 PREFERENCE SHARES

These type of shares are annexed with preferential rights over the equity shares in

sharing the benefits organization at the moment of declaration. It is nothing but the

combination of both equity shares and debentures; why ? It has some features of equity

shares and debenture through redemption. The dividends are normally paid only to the

tune of fixed rat which was agreed only at the moment of issue in between the issuing

company and investors. The dividends are normally declared by them only subject to the

availability of profits.

Type of Preference Shares: The following are the various type of preference shareswhich the company normally issues:

14.3.1 Cumulative Preference Shares

The unpaid preference dividends are paid before anything paid to equity shareholders.

The unpaid preference dividends are called in other words as Arrearages. The arrearages

should not go beyond three years. The arrearages never carry any interest rate. If any

provision is available in the Articles of Association, the arrearages are paid to preference

shareholders at the moment of liquidation.

14.3.2 Non Cumulative Preference Shares

The dividends are paid subject to the availability of profits. If the availability of profits

are not sufficient for the declaration of preference dividend, which do not bear any right

to receive. Due to non declaration of dividends during the previous years, these types of

shareholders are not entitled to share in the surplus benefits of the company, but they are

having the right to receive the dividend prior to the equity shareholders in any particular

year.

No Rights to Share in the Surplus Profits

l 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 windingof the companies.

l Convertible preference shares: These types of shares are issued by the companyalong with the right of conversion to convert the holding into equity shares at thespecified period. Normally, during the process of conversion, the companies chargehigher premium from the shareholders. The voting powers, bonus issue, higherdividends and so on are subject to the availability of rights out of the conversion.

l Redeemable preference shares: Under this category, the amount of raised capitalis subject to redemption/repayment, which means that when any preference sharesare revealing the definite time period of repayment is known as redeemablepreference shares.

l Non redeemable preference shares: These types of preference share nevercarry any definite period of repayment but at the moment of winding up the

repayment is made immediately after the creditors.l Participating preference shares: The type of preference shares facilitates the

holders to share the surplus benefits immediately after declaring the dividend benefitsto preference shareholders and equity shareholders.


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Sources of Long Term Financel Non Participating preference shares: Except the earlier, all are nothing but nonparticipating 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 thecompany". Debenture is an evidencing document i.e., long-term promissory note.

Unique Features of the Debentures

l Debentures are issued on indebtedness

l It is an instrument which indicates the time/date schedule of repayment of principal

or interest

l 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

Debentures are classified on the following basis:

l On the basis of security

l On the basis of holding

l On the basis of redemption

l 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 whichmeans 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.

l 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

l 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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ManagersOn 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 inbetween 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:

l 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.

l 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

l Issued at face value i.e Par value and Par or Discount.

l Rate of interest is fixed or flexible i.e. variable / floating rate of bond - coupon rate

of bond.

l Maturity date is specified but not in the case of perpetual bonds.

l Redemption value - in the bond certificate - may be par or premium - terms of the

issue.

l Bonds are traded in the market.

Type of Bonds

l Secured Bond: Issued on the assets of the issuer.

l Unsecured Bond: Issued by the issuer on the basis of name and fame.

l Perpetual bond: Bonds do not have maturity.

l Redeemable bond: Redemption or Repayment of the principal is specified by the

issuer.

l Fixed rate bonds: Rate of Interest is fixed at.

l 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 theface value after the maturity period.


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Sources of Long Term FinanceDeep 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 capitalfrom 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:

l Detachable warrants: Warrants which are issued along with the host securities;

detachable

l Puttable warrants: The warrants issued are sold back to company before expiry

date

l Naked warrants: Warrants issued without any host securities

Advantages of the warrants

l Making other host securities more attractive

lIt facilitates the companies to stand on its own leg and reduces the rate to dependon 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

Select the most appropriate one:

1. Equity share means

(a) Equal share in the volume

(b) Equal share in the assets claim

(c) Equal and Small units of the share capital

(d) None of the above

2. Preferential share is

(a) Issued at preferential price

(b) Preferential rights over the debentures

(c) Preferential rights over the equity shares

(d) None of the aboveContd....


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Managers3. When non voting share will become as a voting shares

(a) For the continuous payment of dividends

(b) For the continuous non payment of dividends for the period of 3 years

(c) For the continuous payment of dividends

(d) None of the above

4. In which case the bond are issued instead of interest payment

(a) Naked bonds (b) Pay in kind bonds

(c) Cumulative bonds (d) Secured bonds

5. Non convertible portion of the debenture is

(a) Convertible at later date (b) Irredeemable

(c) Redeemable (d) None of the above

6. Warrants are

(a) Title to buy the preference shares (b) Title to buy debentures

(c) Title to buy the equity shares (d) Title to buy bonds

14.7 LET US SUM UP

Shares and Stock are synonymous in usage. Shares are the expression of smaller unitsof Share capital of the organization. The raising of equity share capital from the investorsin various segments. Normally the sweat security is issued by the companies in two

different categories:

l Sweat security which is issued at preferential pricing more specifically for employees

l Sweat security which is issued at face value, that may be either at par or above parThe 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:

l On the basis of security

l On the basis of holding

l On the basis of redemption

l 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 ownsalient features. Warrants are nothing but Bearer documents which are title to buy thespecified number of equity shares at specified price during the future period. The lifeperiod of the warrants are normally too long.

14.8 LESSON-END ACTIVITY

Distinguish between preference and non-preference shares. What are the advantages

of preference share?

14.9 KEYWORDS

Share: smaller unit of the share capital of the company

Preference share: Preferential rights are pegged with this type of a share to share

anything from the company prior to the equity shareholders


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Sources of Long Term FinanceBond: 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

14.10 QUESTIONS FOR DISCUSSION

1. Define equity share.

2. Define debentures.

3. Briefly explain the sweat security.

4. What is meant by preference shares?

5. Explain various types of preference shares.

6. Explain the various types of debentures.

7. Define bonds.

8. Explain the various types of bonds.

9. Define warrants.

10. Explain the advantages of issuing the warrants.11. Elucidate the various classifications of warrants.

12. Why warrants are issued?

14.11 SUGGESTED READINGS

R.L. Gupta and Radhaswamy, Advanced Accountancy.

V.K. Goyal, Financial Accounting, Excel Books, New Delhi.

Khan and Jain, Management Accounting.

S.N. Maheswari, Management Accounting.S. Bhat, Financial Management, Excel Books, New Delhi.

Prasanna Chandra, Financial Management Theory and Practice, Tata McGraw

Hill, New Delhi (1994).

I.M. Pandey, Financial Management, Vikas Publishing, New Delhi.

Nitin Balwani, Accounting & Finance for Managers, Excel Books, New Delhi.

Documents

3 Sources of L