Chapter 11 FINANCING A BUSINESS

Outline the ways in which share capital may be issued LEARNING OUTCOMES You should be able to: Identify the main sources of finance available to a business and explain the advantages and disadvantages of each Outline the ways in which share capital may be issued Explain the role and nature of the Stock Exchange Discuss the ways in which smaller businesses may seek to raise finance

The major sources of internal finance Total internal finance Tighter credit control Delayed payment to trade payables Reduced inventories levels Long-term Short-term Retained profits Figure 11.1 Major internal sources of finance

Hire purchase agreements Securitisation of assets The major external sources of finance Preference shares Ordinary shares Bank overdrafts Debt factoring Total finance Long- term Short- term Finance leases Hire purchase agreements Invoice discounting Securitisation of assets Borrowings Figure 11.2 Major external sources of finance

The risk/return characteristics of long-term funds Borrowing Preference shares Ordinary shares Figure 11.3 The risk/return characteristics of sources of long-term finance

Loan capital and risk Lenders may reduce the risk of lending by Requiring security (fixed or floating charge on assets) Including covenants in the loan contract Lenders may reduce the risk of lending by

Loan covenants Financial statements Other borrowings Dividend payments May deal with such matters as: Other borrowings Dividend payments Financial statements Liquidity

Types of loan capital Term loans Loan notes Eurobonds Convertible loans Eurobonds Mortgages

Finance leases Main benefits Cost Improved cash flows Ease of borrowing Flexibility Figure 11.4 Benefits of finance leasing

The hire purchase process Supplier Financial institution Customer Regular payments made over time (5) H P agreement (1) Asset delivered (4) Asset purchased and paid for immediately (3) Initial deposit (2) Figure 11.5 The hire purchase process

The securitisation process SPV Income from assets Assets transferred Asset–backed bonds issued Interest paid on bonds

The debt-factoring process Client business Credit customer Factor Goods supplied on credit (1) Customer pays amount owing to factor (4) Factor invoices credit customer (2) Factor pays 80% to client immediately (3) Factor pays 20% balance to client (less fees) when credit customer pays amount owing (5) Figure 11.6 The debt-factoring process

Long-term versus short-term borrowing Issues that should be taken into account include: Flexibility Refunding risk Matching Interest rates

Short-term and long-term financing requirements Short-term finance Long-term finance Total funds (£) Time Permanent current assets Fluctuating current assets Non-current assets Figure 11.7 Short-term and long-term financing requirements

Common methods of share issue Rights issue Offer for sale Bonus issue Common issue methods Placing Public issue Figure 11.8 Common methods of share issue

Reasons for a rights share issue Costs are lower when offering shares to existing shareholders There is no dilution of control

The Stock Exchange Secondary market Primary market Two important roles

Stock Exchange listing – advantages Advantages for a business Enables other businesses to be acquired by shares rather than cash Shares valued in an efficient manner Broadens investor base Raises profile Funds acquired at lower cost Easier to raise funds Can help attract and retain employees (share incentives)

Stock Exchange listing – disadvantages Increased vulnerability to takeover Close monitoring of actions and decisions Increased regulatory burden Cost (including management time) Disadvantages for a business

Ownership of UK listed shares, end of 2012 Private non-financial companies Insurance companies 10 % Other financial institutions Pension funds Individuals Unit trusts Investment trusts Public sector Banks Charities 5 50 15 Rest of the world 53 6 11 2 1 Figure 11.9 Ownership of UK listed shares at the end of 2012

Distribution of AIM listed companies by equity market value 50 100 250 200 150 No. of companies 82 126 144 232 174 141 108 39 13 6 Market value range (£m) 0–2 Over 1,000 500–1,000 250–500 100–250 50–100 25–50 10–25 5–10 2–5 Figure 11.10 Distribution of AIM listed companies by equity market value Source: AIM Market Statistics, London Stock Exchange, November 2013.

Providing long-term finance for the small business Business angels Government assistance Venture capital

Financing small businesses Banks 57% 11% 21% 7% 4% Partners and shareholders Asset-based finance (for example HP, factoring and trade finance) Venture capital Other Figure 11.11 Financing small businesses Source: Cosh, A. and Hughes, A., British Enterprise: Thriving or surviving, Centre for Business Research, University of Cambridge, 2007.