Chapter 18 RAISING LONG – TERM FINANCE

1. Chapter 18 RAISING LONG – TERM FINANCE  Centre for Financial Management , Bangalore

2. OUTLINE • Venture Capital • Initial Public Offer • Secondary Public Offer • Rights Issue • Private Placement • Preferential Allotment • Dilution • Obtaining a Term Loan  Centre for Financial Management , Bangalore

3. VENTURE CAPITAL VENTURE CAPITAL REPRESENTS FINANCIAL INVESTMENT IN A HIGHLY RISKY PROPOSITION MADE IN THE HOPE OF EARNING A HIGH RATE OF RETURN  Centre for Financial Management , Bangalore

4. FEATURES OF VENTURE CAPITAL • The venture capitalist (VC) subscribes to equity or • quasi-equity instruments. • The VC takes an active interest in guiding the assisted • firm. • The VC normally plans to liquidate its investment in the • assisted firm after 3 to 7 years.  Centre for Financial Management , Bangalore

5. GUIDELINES FOR PREPARING A BUSINESS PLAN • Use simple and clear language • Focus on four basic elements, viz., people, product, • market, and competition. • Give projections for about two years with emphasis on • cash flows. • Identify risks and develop a strategy to cope with the • same. • Convince that the management team is talented, • committed, and determined.  Centre for Financial Management , Bangalore

6. BENEFITS OF GOING PUBLIC • Access to Capital • Respectability • Investor Recognition • Window of Opportunity • Liquidity • Diversification  Centre for Financial Management , Bangalore

7. COSTS OF GOING PUBLIC • Adverse Selection • Dilution • Loss of Flexibility • Disclosures • Accountability • Public Pressure • Costs  Centre for Financial Management , Bangalore

8. BOOK BUILDING Book building is a method of offering shares to investors in which the issue price is not fixed in advance (as is done in a fixed price offer) but is determined through a bidding process.  Centre for Financial Management , Bangalore

9. ROLE OF THE LEAD MANAGER OF THE ISSUE • The lead manager of a public issue may be likened to the ‘conductor’ of an opera. • His principal tasks are to : • Structure the issue • Coordinate the appointment of various intermediaries • Prepare the draft prospectus and finalise the same • Market the issue • Monitor the issue during the subscription period • Finalise the allotment • Secure stock exchange listing.  Centre for Financial Management , Bangalore

10. RIGHTS ISSUE A rights issue is an issue of capital to the existing shareholders of a company on a pro rata basis through a Letter of Offer. Rights are negotiable and can be exercised only during a fixed period which is usually about 30 days.  Centre for Financial Management , Bangalore

11. VALUE OF A SHARE The value of a share, after the rights issue, is expected to be: NP0 + S N + 1 where : N = number of existing shares required for a rights share P0 = cum-rights market price per share S = subscription price at which the rights share are issued  Centre for Financial Management , Bangalore

12. VALUE OF A RIGHT The theoretical value of a right is : P0 – S N + 1  Centre for Financial Management , Bangalore

13. KEY POINTS ABOUT A RIGHTS ISSUE • The wealth of existing shareholders, per share, is not • affected by the rights offering, provided, of course, the • existing shareholders exercise their rights in full or sell • their rights. • Theoretically, the subscription price is irrelevant • because the wealth of a shareholder who subscribes to • the rights shares or sells the rights remains unchanged, • irrespective of what the subscription price is.  Centre for Financial Management , Bangalore

14. PRIVATE PLACEMENT AND PREFERENTIAL ALLOTMENT • Private placement and preferential allotment involve • sale of securities to a limited number of sophisticated • investors such as financial institutions, mutual funds, • venture capital funds, banks, and so on. • In a preferential allotment, the identity of investors is • known when the issuing company seeks the approval of • the shareholders, whereas in a private placement, the • identity of investors is not known when the offer • document (popularly known as the information • memorandum) is prepared.  Centre for Financial Management , Bangalore

15. PRIVATE PLACEMENT AND PREFERENTIAL ALLOTMENT In the Indian context we find broadly (i) private placement refers to sale of equity or equity related instruments of an unlisted company or sale of debentures of a listed or unlisted company and (ii) preferential allotment refers to sale of equity or equity related instruments of a listed company.  Centre for Financial Management , Bangalore

16. DILUTION When a firm plans to sell securities, dilution is an issue that often comes up for discussion. We can think of dilution in terms of proportionate ownership or market value or book value or earnings per share.  Centre for Financial Management , Bangalore

17. TERM LOAN PROCEDURE • Submission of loan application • Initial processing of loan application • Appraisal of the proposed project • Issue of the letter of sanction • Acceptance of the terms and conditions by the • borrowing unit • Execution of loan agreement • Disbursement of loans • Creation of security • Monitoring and recovery of dues  Centre for Financial Management , Bangalore

18. PROJECT APPRAISAL BY FINANCIAL INSTITUTIONS • Market Appraisal • Technical Appraisal • Financial Appraisal • Economic Appraisal • Managerial Appraisal  Centre for Financial Management , Bangalore

19. SUMMING UP • Venture capital funds seek to support promising firms during their initial • stages before they are ready to make a public offering of securities • The decision to go public is a complex one which calls for carefully weighing • the benefits against costs. • An Indian company can make an IPO if it satisfies certain conditions. • A series of steps is involved in a public issue, whether it is an IPO or a • secondary offer. • The manager of a public issue may be likened to the ‘conductor’ of an • opera. • A rights issue involves selling securities in the primary market to the existing • shareholders. • Private placement and preferential allotment involve sale of securities to a • small number of sophisticated investors. • The procedure associated with a term loan involves several steps. • Financial institutions appraise a project from the marketing, technical, • financial, economic, and managerial angles.