1. LONG TERM FINANCE: SHARES, DEBENTURES AND TERM LOANS CHAPTER 20

2. LEARNING OBJECTIVES  Explain the features of ordinary shares  Focus on the benefits and valuation of rights shares  Discuss the pros and cons of debentures and preference shares  Highlight the features of term loans 2

3. INTRODUCTION  Ordinary shares provide ownership rights to investors.  Debentures or bonds provide loan capital to the company, and investors get the status of lenders.  Loan capital is also directly available from the financial institutions to the companies. 3

4. Ordinary Shares–Features  Claim on Income  Claim on Assets  Right to Control  Voting Rights  Pre-Emptive Rights  Limited Liability 4

5. Reporting of Ordinary Shares 5 Tata Motors' Share Capital as on 31 March 2008

6. Ordinary Shares–Pros and Cons  Advantages Permanent Capital Borrowing Base Dividend Payment Discretion  Disadvantages  Cost  Risk  Earnings Dilution  Ownership Dilution 6

7. Public Issue of Equity  Public issue of equity means raising of share capital directly from the public.  As per the existing norms, a company with a track record is free to determine the issue price for its shares. 7

8. Underwriting of Issues  It is legally obligatory to underwrite a public and a rights issue.  In an underwriting, the underwriters—generally banks, financial institution, brokers, etc.—guarantee to buy the shares if the issue is not fully subscribed by the public.  The agreement may provide for a firm buying by the underwriters.  The company has to pay an underwriting commission to the underwriter for their services. 8

9. Private Placement  Private placement involves sale of shares (or other securities) by the company to few selected investors, particularly the institutional investors.  Private placement has the following advantages:  Size  Cost  Speed 9

10. Right Issue of Equity Shares  Selling of Ordinary Shares to the existing shareholders of the company.  Value of Right 10

11. Effect on Shareholders’ Wealth  The shareholder has three options:  (i) he exercises his rights,  (ii) he sells his rights, or  (iii) he does not exercise or sell his rights.  He will lose under the third option. 11

12. Is the Subscription Price of any Significance?  It is irrelevant in terms of the impact on the shareholders’ wealth.  It can be fixed at any level below the current market price.  The primary objective in setting the subscription price low is that after the rights offering, the market price should not fall below it. 12

13. Right Shares – Pros and Cons  Advantages 1. Control is maintained 2. Less flotation cost 3. Issue more likely to be successful  Disadvantages 1. Shareholders lose if fail to exercise their right 2. If shareholding concentrated in hands of FI 13

14. Preference Shares  Similarity to Ordinary Shares: 1. Non payment of dividends does not force company to insolvency. 2. Dividends are not deductible for tax purposes. 3. In some cases, it has no fixed maturity dates.  Similarity to Debentures: 1. Dividend rate is fixed. 2. Do not share in residual earnings. 3. Preference shareholders have claims on income and assets prior to ordinary shareholders. 4. Usually do not have voting rights. 14

15. Preference Shares–Features 1. Claims on Income and Assets 2. Fixed Dividend 3. Cumulative Dividend 4. Redemption 5. Sinking Fund 6. Call Feature 7. Participation Feature 8. Voting Rights 9. Convertibility 15

16. Preference Shares–Pros and Cons  Advantages: Risk less leverage advantage Dividend postponability Fixed dividend Limited Voting Rights  Disadvantages:  Non-deductibility of Dividends  Commitment to pay dividends 16

17. DEBENTURES  A debenture is a long-term promissory note for raising loan capital.  The firm promises to pay interest and principal as stipulated.  The purchasers of debentures are called debenture holders.  An alternative form of debenture in India is a bond.  Mostly public sector companies in India issue bonds. 17

18. Debentures–Features  Interest Rate  Maturity  Redemption  Sinking Fund  Buy-back (call) provisions  Indenture  Security  Yield  Claims on Assets and Income 18

19. Types of Debentures 1. Non – Convertible Debentures 2. Fully – Convertible Debentures 3. Partly – Convertible Debentures 19

20. Debentures–Pros and Cons  Advantages: Less Costly No ownership Dilution Fixed payment of interest Reduced real obligation  Disadvantages:  Obligatory Payment  Financial Risk  Cash outflows  Restricted Covenants 20

21. Term Loans–Features  Maturity  Direct Negotiations  Security  Restrictive Covenants 1. Asset related covenants 2. Liability related covenants 3. Cash flow related covenants 4. Control related covenants  Convertibility  Repayment Schedule 21