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Chapter 12. Sources of finance. Contents. 1. Sources of finance. 2. Debt finance. 3. Venture capital. 4. Equity finance. Overview – sources of finance. Maximisation of shareholder wealth. Investment decision. Financing decision. Dividend decision. Short-term finance.

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sources of finance

Chapter 12

Sources of finance

contents
Contents

1

Sources of finance

2

Debt finance

3

Venture capital

4

Equity finance

overview sources of finance
Overview – sources of finance

Maximisation of

shareholder wealth

Investment

decision

Financing

decision

Dividend

decision

Short-term finance

Long-term finance

sources of finance1
Sources of finance
  • Range of short-term sources

– overdrafts: quickly and flexibility

– short-term loans

– trade credit

– lease finance

– factoring

  • Range of long-term sources

– debt finance

– leasing

– venture capital

– equity finance

sources of finance2

Overdrafts

Sources of finance

Definition:

Where payments from a current account exceed income to the account for a temporary period, the bank finances the deficit by means of an overdraft.

sources of finance4
Sources of finance
  • Overdrafts an short-term loans compared:

(a) In most cases, when a customers wants finance to help with ‘day to day’ trading and cash flow needs, an overdraft would be the appropriate method of financing.

(b) When a customer wants to borrow from a bank for only a short period of time, even for the purchase for a major fixed asset, an overdraft facility might be more suitable than a loan, because the customer will stop paying interest as soon as his account goes into credit.

sources of finance5
Sources of finance
  • Advantages of an overdraft over a loan
  • The customer only pays interest when he is overdrawn.
  • The bank has the flexibility to review the customer’s overdraft facility periodically, and perhaps agree to additional facilities, or insist on a reduction in the facility.
  • An overdraft can do the same job as a loan; a facility can simply be renewed every time it comes up for review.
sources of finance6
Sources of finance
  • Advantages of a loan for longer term lending
  • Both the customer and the bank know exactly what the repayments of the loan will be and how much interest is payable, and when. This makes planning(budgeting) simpler.
  • The customer does not have to worry about the bank deciding to reduce or withdraw an overdraft facility before he is in a position to repay what is owed. There is an element of ‘security’ or ‘peace of mind’ in being able to arrange a loan for an agreed term.
  • Loans normally carry a facility letter setting out the precise terms of the agreement.
sources of finance7
Sources of finance
  • Trade credit:

-

sources of finance9
Sources of finance

A company would raise more cash from a sale and leaseback arrangements than from a mortgage.

Disadvantages:

debt finance
Debt finance

Factors to choose debt finance

debt finance2
Debt finance

Fixed rate debenture

Debentures with floating rate of interest

Deep discount bonds

– issued at a large discount and redeemable at par (or above par) in maturity

– no or very low interest

– taxed in lump sum rather than annual interest income

Zero coupon bonds

– raise cash immediately

– advantage for lenders is restricted

debt finance4
Debt finance
  • Zero coupon bonds:

-are bonds that are issued at a discount to their redemption value, but no interest is paid on them.

  • Advantages:
bonds
Bonds

Evaluation of long term debt finance from company

  • Disadvantage
  • interest paid regardless of profit
  • raise gearing and risk
  • with fixed maturity dates, provision must be made in advance
  • Advantage
  • cheap, as less risky
  • cost is limited to interest
  • no dilution of control
  • interest cost tax deductible
slide20

Advantages of long term debt finance

Bonds (debentures/loan notes)

Bank loans

  • Available to most companies
  • Supported by the loan guarantee scheme for small businesses
  • Quick to arrange
  • Often cheaper because avoid bank fees & liquid investment
  • Can be convertible
  • Can be zero coupon
  • Can be in foreign currency (Eurobond)
bonds1
Bonds

Evaluation of long term debt from investor

Disadvantage

no voting right

Vs.

Advantages

priority in interest payment and liquidation

fixed interest whatever profit is

convertibles
Convertibles
  • Convertibles

– are bonds that give the holders the right to convert to other securities, normally ordinary shares, at a pre-determined price/rate and time.

convertibles1
Convertibles
  • Convertibles

– fixed return security and may be converted into ordinary shares

– conversion value

value of share to be converted by 1 loan stock

– conversion premium

difference between the market value of the stock and conversion value at issue date

convertibles2
Convertibles
  • Characteristics of convertible debentures
  • convertibles can provide immediate finance at lower cost since the conversion option effectively reduces the interest rates payable.
  • convertibles represent attractive investments to investors since they are effectively debts risks for future equity benefits. Hence, finance is relatively easy raised.
  • convertibles allow for higher gearing levels than would
  • otherwise be the case with straight debt, because costs are
  • potentially lower with convertibles.
  • where company wish to raise equity finance, but share prices are currently depressed, convertibles offer a safeguard share issue method.
  • where convertibles are converted into shares, the problem of repayment disappears.
convertibles3
Convertibles
  • Delayed equity and dilute EPS
  • Market value of convertible

– issued at a low conversion value to maximize conversion premium

– low coupon rate of interest

– price depend on

  • price of straight debt
  • current conversion value
  • length of time before conversion
  • market’s expectation
bonds2
Bonds
  • Secured and unsecured
  • fixed charge: specific assets
  • floating charge: general charge on all assets
  • unsecured with higher rates
  • Redemption of loan notes
  • preference shares
  • debentures
  • Tax relief on loan interest
venture capital
Venture capital

Very high growth potential

V

Very significant amounts

Very high returns

venture capital1
Venture capital
  • Venture capital: is risk capital, normally provided in return for an equity stake.
  • Venture capital funds
  • Finding venture capital

– want an equity stake

– the company can be successful

– have a representative or have an independent director

venture capital2
Venture capital
  • Factors in investment decisions
slide32
创业板发行条件

第十条 发行人申请首次公开发行股票应当符合下列条件:

(一)发行人是依法设立且持续经营三年以上的股份有限公司。

有限责任公司按原账面净资产值折股整体变更为股份有限公司的,持续经营时间可以从有限责任公司成立之日起计算。

(二)最近两年连续盈利,最近两年净利润累计不少于一千万元,且持续增长;或者最近一年盈利,且净利润不少于五百万元,最近一年营业收入不少于五千万元,最近两年营业收入增长率均不低于百分之三十。净利润以扣除非经常性损益前后孰低者为计算依据。

(三)最近一期末净资产不少于两千万元,且不存在未弥补亏损。

(四)发行后股本总额不少于三千万元。

2009年3月31日中国证监会公布了《首次公开发行股票并在创业板上市管理暂行办法》,该办法就首次公开发行股票并在创业板上市的公司的股票发行条件作出了相应的规定。

slide33
创业板上市必要条件

根据深圳证券交易所于2009年6月5日正式发布的《深圳证券交易所创业板股票上市规则》,发行人申请股票在深圳证券交易所创业板上市,应当符合下列条件:

(一)股票已公开发行;

(二)公司股本总额不少于3000万元;

(三)公开发行的股份达到公司股份总数的25%以上;公司股本总额超过四亿元的,公开发行股份的比例为10%以上;

(四)公司股东人数不少于200人;

(五)公司最近三年无重大违法行为,财务会计报告无虚假记载;

(六)本所要求的其他条件。

slide34
创业板发行的询价和定价

根据最新修订的《证券发行与承销管理办法》(2010年6月24日通过审议,2010年10月11日施行),首次发行的股票在创业板上市的,其发行定价应遵守以下的规定:

第五条首次公开发行股票,应当通过向特定机构投资者(以下称询价对象)询价的方式确定股票发行价格。

第十四条首次发行的股票在中小企业板、创业板上市的,发行人及其主承销商可以根据初步询价结果确定发行价格,不再进行累计投标询价。

equity finance
Equity finance
  • Ordinary shares
  • classification of shares
  • market value and par value
  • purposes of new issue of shares

raise fund

float its shares

merge and acquisition

  • Equity fund
  • cash from retained earning
  • new share issues
  • rights issues
equity finance1
Equity finance
  • Why listing
  • access to a wider pool of finance
  • improved marketability of shares
  • transfer of capital to other uses
  • enhancement of the company image
  • facilitation of growth by acquisition
  • obtain funds for other projects
  • Disadvantage of listing
  • loss of control to wider investors
  • risk of being take over
equity finance2
Equity finance
  • Methods of obtaining a listing

– initial public offer (IPO)

– a placing

– an introduction

  • Typical costs of a share issue

– underwriting costs

– listing fee

– fees of the issuing house, solicitors, auditors and consultants

– charges for printing and distributing the prospectus

– advertising

slide38

Equity finance

Initial public offer

-is an invitation to apply for shares in a company based on information contained in a prospectus.

A placing:

-is an arrangement whereby the shares are not all offered to the public, but instead, the sponsoring market maker arranges for most of the issue to be bought by a small number of investors, usually institutional investors such as pension funds and insurance companies.

equity finance3
Equity finance
  • The choice between an IPO and a placing
equity finance4
Equity finance
  • A stock exchange introduction:

This will only happen where shares in a large company are already widely held, so that a market can be seen to exist.

A company might want an introduction to obtain greater marketability for the shares, a known share valuation for inheritance tax purposes and easier access in the future to additional capital.

By this method of obtaining a quotation, no shares are made available to the market, neither existing nor newly created shares; nevertheless, the stock market grants a quotation.

equity finance5
Equity finance
  • Pricing shares for a stock market launch
equity finance6
Equity finance
  • Pricing shares for a stock market launch

– price of similar quoted companies

– current market conditions

– desire for immediate premium

– future trading prospects

  • Underwriting
slide43

第八条 发行人应当是依法设立且合法存续的股份有限公司。第八条 发行人应当是依法设立且合法存续的股份有限公司。

经国务院批准,有限责任公司在依法变更为股份有限公司时,可以采取募集设立方式公开发行股票。

第九条 发行人自股份有限公司成立后,持续经营时间应当在3年以上,但经国务院批准的除外。

 有限责任公司按原账面净资产值折股整体变更为股份有限公司的,持续经营时间可以从有限责任公司成立之日起计算。

第三十三条 发行人应当符合下列条件:

 (一)最近3个会计年度净利润均为正数且累计超过人民币3000万元,净利润以扣除非经常性损益前后较低者为计算依据;

 (二)最近3个会计年度经营活动产生的现金流量净额累计超过人民币5000万元;或者最近3个会计年度营业收入累计超过人民币3亿元;

 (三)发行前股本总额不少于人民币3000万元;

 (四)最近一期末无形资产(扣除土地使用权、水面养殖权和采矿权等后)占净资产的比例不高于20%;

 (五)最近一期末不存在未弥补亏损。

我国《证券法》、《公司法》和证监会于2006年5月17日公布的《首次公开发行股票并上市管理办法》,就公司首次公开发行股票规定了相应的条件。这些条件适用于在上海证券交易所主板市场上市的公司和在深圳证券交易所中小板市场上市的公司。

首次公开发行股票(IPO)发行条件
slide44
首次公开发行股票(IPO)的询价和定价

询 价

首次发行的股票在中小企业板上市的,发行人及其主承销商可以根据初步询价结果确定法,不再进行累计投标询价。

slide45
上市公司增发股票发行条件

2006年5月7日《上市公司证券发行管理办法》

公开

发行

slide46
上市公司增发股票发行条件

上市公司增发股票的一般规定

  第六条 上市公司的组织机构健全、运行良好

  第七条 上市公司的盈利能力具有可持续性,

  第八条 上市公司的财务状况良好;

  第九条 上市公司最近三十六个月内财务会计文件无虚假记载

  第十条 上市公司募集资金的数额和使用应当符合规定

slide47
上市公司增发股票发行条件

配股

增发

第十三条 向不特定对象公开募集股份(简称“增发”),除符合本章第一节规定外,还应当符合下列规定:

  (一)最近三个会计年度加权平均净资产收益率平均不低于百分之六。扣除非经常性损益后的净利润与扣除前的净利润相比,以低者作为加权平均净资产收益率的计算依据;

  (二)除金融类企业外,最近一期末不存在持有金额较大的交易性金融资产和可供出售的金融资产、借予他人款项、委托理财等财务性投资的情形;

  (三)发行价格应不低于公告招股意向书前二十个交易日公司股票均价或前一个交易日的均价。

第十二条 向原股东配售股份(简称“配股”),除符合本章第一节规定外,还应当符合下列规定:

(一) 拟配售股份数量不超过本次配售股份前股本总额的百分之三十;

(二) 控股股东应当在股东大会召开前公开承诺认配股份的数量;

  (三)采用证券法规定的代销方式发行。

  控股股东不履行认配股份的承诺,或者代销期限届满,原股东认购股票的数量未达到拟配售数量百分之七十的,发行人应当按照发行价并加算银行同期存款利息返还已经认购的股东。

slide48

配股一般采取网上定价发行的方式。配股价格的确定是在一定个价格区间内由主承销商和发行人协商确定。价格区间通常以股权登记日前20个或30个交易日该股二级市场价格的平均值为上限,下限为上限的一定折扣。配股一般采取网上定价发行的方式。配股价格的确定是在一定个价格区间内由主承销商和发行人协商确定。价格区间通常以股权登记日前20个或30个交易日该股二级市场价格的平均值为上限,下限为上限的一定折扣。

配股

的发行方式

(一)上网定价发行与网下配售相结合

这种方式是往下通过向机构投资者询价确定发行价格配售,同时网上对公众投资者定价发行。

(二)网下网上同时定价发行

在此中发行方式下,对于网上发行部分,既可以按统一配售比例对所有公众投资者进行配售,也可以按一定的中签率以摇号抽签方式确定获赔对象。

增发

的发行方式

上市公司增发股票发行定价
right issue
Right issue
  • Key term:

– new share offers made to existing shareholders at a lower price

  • Advantages of a right issue

– cheaper than offer for sale

– more beneficial to existing shareholders

☆new shares at a discount price

– relative voting rights are not affected

– reduce gearing

right issue1
Right issue
  • Cum-right price and Ex-right price

n

cum-right price

issue price

ex-right price

n+1

  • Value of rights

n = number of shares required to buy 1 new share

  • difference between ex-right price and exercise price for each right
  • can be divided by n for each existing share
right issue2
Right issue
  • Theoretical gain or loss to shareholders

The possible courses of action open to shareholders are:

right issue3
Right issue
  • The actual market price after a right issue
dividend policy

Chapter 13

Dividend policy

contents1
Contents

1

Internal sources of finance

2

Dividend policy

overview dividend policy

Investment decision

Financing decision

Makes it

difficult to pay

a dividend?

Debt finance

may enable a

dividend to be

paid

A reflection

of investment

and financing

decision

Dividend decision

Overview – dividend policy

Maximisation of

shareholder wealth

Investment decision

internal sources of finance
Internal sources of finance

Internal sources of finance

– retained earnings

– increasing working capital management efficiency

Advantages of using retentions

– a flexible source

– does not involve a change and on dilution of control

– have no issue costs

Disadvantages of using retentions

– shareholders may be sensitive to the loss of dividends

– there is an opportunity cost

dividend policy1
Dividend policy
  • Factors influencing dividend policy
  • Dividends as a signal to investors
  • Theories of dividend policy
  • residual theory
  • traditional view
  • irrelevancy theory
slide63

Dividend policy

(a) The need to remain profitable.

(b) The law on distributable profits.

(c) The government which may impose direct restrictions on the amount of dividends companies can pay.

(d) Any dividend restraints that might be imposed by loan agreements.

(e) The effect of inflation, and the need to retain some profit within the business just to maintain its operating capability unchanged.

(f) The company’s gearing level.

(g) The company’s liquidity position.

(h) The need to repay debt in the near future.

  • The ease with which the company could raise extra finance from sources other than retained earnings.

(j) The signalling effect of dividends to shareholders and the financial markets in general-see below.

  • Factors influencing dividend policy
dividend policy2
Dividend policy

Scrip dividends

  • key term: dividend payment takes the form of new shares
  • converts profit and loss reserve into share capital

Advantages of scrip dividends

– preserve cash position

– tax advantages

– expand holding without incurring the transaction cost

– do not dilute the share price significantly

– decrease gearing, enhance the borrowing capacity

dividend policy3
Dividend policy
  • Stock splits

– split one share into several small shares

– cheaper and more marketable

  • Share repurchase
dividend policy4
Dividend policy

Advantages of share repurchase

  • a use for surplus cash
  • increase in earnings per share
  • increase in gearing
  • readjustment of the company’s equity base
  • preventing a takeover

Disadvantages of share repurchase

  • can be hard to arrive at a price
  • the company cannot make better use of the funds
  • taxed on a capital gain
slide68

Dividend policy - summary

Mature company

Young company

0 / low dividend

High dividend

gearing and capital structure

Chapter 14

Gearing and capital structure

contents2
Contents

1

Gearing

2

Effect on shareholder wealth

3

Finance for small and medium-sized entities

overview gearing and capital structure
Overview – gearing and capital structure

Maximisation of

shareholder wealth

Investment decision

Investment decision

Financing decision

Dividend decision

How much debt finance?

gearing
Gearing
  • financial risk: financial gearing
  • business risk: operating gearing

Financial gearing

Operating gearing

= contribution/PBIT

  • the relationship between shareholders’ capital plus reserves,
  • and either prior charge capital or borrowings or both
  • based on book value
  • based on market value

Total gearing

the sum of operating gearing and financial gearing

Interest cover

= profit before interest and tax/interest

Debt ratio

gearing1
Gearing

Operating gearing

Financial gearing

Firms with high levels of fixed costs are usually regarded

as high operating gearing and the operating earnings are more

volume-sensitive, because fixed costs must be made irrespective

of the level sales volume. Hence a company with higher

operating gearing will have greater variability in earnings before

interest and tax (EBIT) relative to a given level of variability in

sales.

High financial gearing is risky, for fixed interest payment

must be made regardless of the level of earnings. Therefore, a

company with higher financial gearing will have greater

variability in returns to shareholders relative to a given level of

variability in earnings before interest and tax (EBIT).

gearing2
Gearing

Relationship between financial and operating gearing

If the sales of a company vary, the ultimate variability of returns to shareholders will be determined by the level of operating gearing-which determines the EBIT variability- as ‘amplified’ by the level of financial gearing. So there is a trade off between operating and financial gearing, if a firm has a high degree of operating gearing, then unless sales were stable, it would prefer to avoid high financial gearing, and vice versa.

capital structure
Capital structure
  • Capital structure

– the way in which an organization is financed, by a

combination of long-term capital and short-term liabilities.

  • Matching assets with funds

– as a general rule, assets that yield profits over a long period of time should be financed by long-term funds, but instead finance short-term assets partly with short-term funding and partly with long-term funding.

  • Long-term capital requirements

– maintenance of current operations: internal sources

– growth: external sources

capital structure1
Capital structure

Restrictions on capital structure

– attitudes to risk and return

– loss of control

– costs

– commitments

– present sources of finance

– availability of capital

– future trends

– restrictions in loan agreements

– maturity dates

capital structure2
Capital structure

Choosing between equity and debt

– Growth and stability of sales. If growth rate is high or

stable, high gearing can maximize the gain for equity, debt is

a choice then.

– Control. Debt is irrelevant to control, while equity will

dilute control.

– Tax position. If the tax shield doesn’t work, the company

may still suffer agency and insolvent costs. In this situation

debt financing is not attractive.

– Asset quality. Company with a high proportion of

intangible assets will be required to pay a higher return by its

creditors, because creditors know it’s harder to get the money

back than company having land and buildings.

capital structure3
Capital structure

Comparing debt and equity finance

– commonly debt is cheaper than equity on an after-tax

basis. One reason is debt is less risky, the other reason is tax shield.

– debt is more flexible because it can be borrowed, repaid and re-borrowed in general terms.

– debt is normally evidenced by a straightforward contract, creating rights and obligations on both sides. Equity carries with the additional benefits of ownership of the business, including the right to elect directors and appoint auditors.

– however, debt still has some weakness.

practical influences on the level of debt
Practical influences on the level of debt

L

Lifecycle

O

Operational gearing

S

Stability of revenue

S

Security

stock market ratios
Stock market ratios
  • Dividend yield

= (gross dividend per share/market price per share)×100%

  • Interest yield

= (gross interest/market price of loan stock)×100%

EPS and fully diluted EPS

  • P/E

= market price of share in pence/EPS in pence

  • Dividend cover
  • Dividend payout ratio

reflects the market’s appraisal of the share’s future prospects

problems for sme finance
Problems for SME finance

Characteristics of SMEs

unquoted –

owned by a small numbers of individuals –

not micro-businesses –

Problems for SME finance

– uncertainty

– no long track record

– less public exposure

– low asset

sources of sme finance
Sources of SME finance

Owner financing

Overdraft financing

Bank loan

Factoring

Trade credit

Equity finance

Leasing

Business angel financing

Venture capital

sources of sme finance1
Sources of SME finance
  • Capital structure of SMEs

– lack of separation between ownership and management

– lack of equity finance

  • Government aids

– Loan guarantee scheme

– Enterprise initiative: grants

– Development agencies

– Enterprise investment scheme: tax benefit

– Venture capital trust: tax benefit

  • Student accountant

– Business finance and the SME sector(2001)

– Selecting sources of finance for business(2003)

slide85

Gearing - summary

High gearing

Low gearing

Young company (SME)

Mature company

  • High growth /investment needs
  • Wants to minimise debt
  • Lower growth
  • Able and willing to take on debt
slide86

Gearing - summary

Low gearing

High gearing

Young company (SME)

Mature company