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ICAS - AFin > Module 7 > Flashcards

Module 7 Flashcards

1
Q

Principles of raising finance (2)

A
  • Matching

- Relationship between risk and return

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2
Q

Matching

A

Should attempt to match the life of the funding with the life of the asset being funded

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3
Q

If borrowing company can pledge security to the lender

A

The return the lender will expect to receive will fall

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4
Q

Financial priorities to consider when deciding appropriate source of finance for firm (borrower) (4)

A
  • Liquidity
  • Diversification of source
  • Flexibility
  • Cost
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5
Q

Business plan details

A

The structure of the business in both financial and operational terms

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6
Q

Lender concerns to be considered in business plan (5)

A
  • Market rather than product focus
  • Some track record (of product/ management)
  • Recognition of lender’s needs
  • Management control
  • Credible projections
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7
Q

Factors to consider when advising on the most appropriate finance package (4)

A
  • Type of business/ industry
  • Stage of development
  • Size of operation
  • Intended use of funds (long/ short term)
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8
Q

Key aim of financial package

A

To minimise the cost and risk to the business

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9
Q

Four main categories of long-term finance

A
  • Equity
  • Debt
  • Preference Shares
  • Quasi-Equity
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10
Q

Equity (or ordinary shares) =

A

Shares or ownership rights in a business.
Primary risk capital of a company
Expensive source of finance due to the high return required by shareholders to compensate their risk

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11
Q

Equity (ordinary shares) > Providers of finance

A

Institutional investors (aim is to achieve real growth and returns above the risk free rate)

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12
Q

Equity (ordinary shares) > Cost

A

Dividends - must be sustainable

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13
Q

Capital growth/ dividend income are of different levels of importance to investors at

A

Different stages of company’s development

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14
Q

Equity (ordinary shares) > Investors’ rights

A
  • Last in line to be paid in case of liquidation

- Voting rights

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15
Q

Equity (ordinary shares) > Impact on gearing

A

Reduces gearing ratio > enables company to increase debt capacity in the future

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16
Q

Debt vs equity

A

Debt is cheaper than equity because of relationship between risk and return, and tax-deductibility of interest

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17
Q

Debt > Cost

A

Cheaper than equity. After-tax cost of debt capital is important measure.
Cost depends on:
- Company’s perceived credit risk (incl level of leverage)
- Supply and demand for credit
- Market level of interest rates and margins
- Prevailing tax rates

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18
Q

Debt > Investors’ rights (3)

A
  • No right to vote
  • Seniority - repaid ahead of ordinary shareholders in case of winding up (if funds available)
  • Can determine pre-requisites in covenants of loan
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19
Q

Debt > Impact on gearing

A

Increase the gearing ratio and financial risk of the company

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20
Q

Leasing =

A

Type of debt finance

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21
Q

Leasing > legal ownership

A

Does not pass to the lessee but remains with the lessor

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22
Q

Advantages of leasing (2)

A
  • Tax benefits (passing on capital allowances)

- Flexibility/ cash flow

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23
Q

Hire Purchase (debt)

A

Finance company buys equipment that hiree requires then allows them to use the equipment in return for a series of regular payments

24
Q

Hire Purchase > Features (3)

A
  • HP company remains legal owner until all payments repaid
  • Legal ownership passes to hiree at end of agreement
  • Payments cover interest charges and contribute to paying off principle
25
Q

Hire Purchase > Advantages (3)

A
  • Small initial outlay
  • Easy to arrange
  • Certainty
26
Q

Hire Purchase > tax relief (2)

A
  • Asset can be subject to WDA on capital expenditure

- Interest payments are tax deductible

27
Q

Preference shares =

A

Part of shareholder’s funds but not equity share capital. Do not usually benefit from good performance of the firm in the form of higher dividends.

28
Q

Preference shares > Providers of finance

A

Investors - offer regular income at higher rate than available on debt (dividend is not guaranteed)

29
Q

Preference shares > Cost (2)

A
  • Not tax deductible

- Higher than debt providers, but lower than equity shareholders

30
Q

Preference shares > Investors’ rights (3)

A
  • Fixed dividend paid annually (can increase if ‘participating’
  • Reimbursement of principle value of share in liquidation prior to ordinary shareholders
  • Usually no voting rights
31
Q

Types of preference share (4)

A
  • Participating
  • Cumulative
  • Redeemable
  • Convertible
32
Q

Participating preference share

A

Possibility of receiving dividend linked to company’s profits

33
Q

Cumulative preference share

A

If dividend is not paid due to insufficient profits, amount due will accumulate and paid when there are sufficient profits

34
Q

Convertible preference share

A

Converts preference shares to ordinary shares at specific dates and on pre-set terms (yield may be lower)

35
Q

Redeemable preference share

A

Business needs to arrange finance for redemption - can be viewed as debt

36
Q

Quasi-equity

A

Hybrid between debt and equity eg convertible bond issues and bonds with equity warrants

37
Q

Convertibles

A

Debt instrument issued first but embedded with right or option to exchange for shares in the company (usually at price which is a premium to current share price)

38
Q

Convertibles > Providers of finance

A

Investors - attractive as they can participate in growth in value in underlying shares but at reduced risk.
Way of attracting venture capital.

39
Q

Convertibles > Cost

A

Opportunity to raise funds at lower interest than straight non-convertible debentures

40
Q

Convertibles > Investors rights (3)

A
  • Usually unsecured obligation
  • In liquidation holder ranks ahead of ordinary and preference shareholders but behind senior debt providers
  • Conversion depends on performance of underlying share price
41
Q

Convertibles > Impact on gearing

A

Initially increases gearing ratio, however upon conversion the ratio will subsequently reduce

42
Q

Advantages of convertibles to the business (4)

A
  • Cost
  • Cash flow benefit
  • Fewer restrictions
  • Build capital base
43
Q

Bonds with equity warrants

A

Company issues bond with fixed rate of interest with fixed maturity. Accompanying bond is one or more warrants which entitle holder to purchase a fixed number of ordinary shares at fixed price for fixed period. Warrant is ‘detachable’ and can be removed from bond and traded separately.

44
Q

Financing needs > Stage 1 - Introduction

A

Significant amount of cash needed for R&D and start up capital (owners’ personal money/ VC/ debt/ leasing/ HP)

45
Q

Financing needs > Stage 2 - Take off

A

Cash to market the business and its’ products

46
Q

Financing needs > Stage 3 - Slow down

A

Similar to stage 1 + 2 but also retained earnings

47
Q

Financing needs > Stage 4 - Maturity

A

Period of consolidation. Now has history of funding so better position to obtain further funding from banks or others/ sell shares to the public

48
Q

Financing needs > Stage 5 - Decline

A

If not used funding from stage 4 effectively, may suffer decline. Increased capital costs will diminish profits.

49
Q

Different sources of equity funding available for start ups (6)

A
  • Personal funds
  • Venture capital
  • Corporate venturing
  • Business angel
  • Investment crowdfunding
  • Internally generated funds/ retained profits and reserves
50
Q

Different sources of debt funding available for start ups (7)

A
  • Bank borrowing (loan/ overdraft)
  • Enterprise Finance Guarantee (EFG) (guarantees on bank loans)
  • Government grants
  • Soft loans (eg pubs)
  • Hire purchase/ leasing
  • Factoring
  • Local enterprise companies
51
Q

Crowdfunding

A

When unlisted business brings together large group of investors to raise finance for new investment opportunity - equity based or reward based

52
Q

Equity based crowdfunding

A

Investors buy shares in company, gain ownership rights based on number of shares acquired and receive dividend if the company performs well

53
Q

Reward-based crowdfunding

A

If owners do not wish to have their ownership share diluted due to issuing further equity, reward based crowdfunding could be considered.
Investors offered reward eg unique perk/ acknowledgments/ tickets/ option to buy new product first

54
Q

Peer to peer lending

A

Similar to crowdfunding, money is raised from a large number of people who pool together. Money is raised using dedicated peer-to-peer lending site eg Funding Circle.

55
Q

Peer to peer lending - key points (3)

A
  • Not suitable for start ups, borrowers must demonstrate creditworthiness and capability to repay.
  • No bank involvement - lender gets better interest than bank savings account, borrower pays less than bank interest loan.
  • No guarantee money will be repaid.
56
Q

Islamic finance key principles (4)

A
  • Asset based
  • Taking or receiving interest at exorbitant rates (riba) is not allowed
  • Risk in any transaction must be shared
  • Speculative behaviour eg gambling/ derivatives is prohibited
57
Q

Main Islamic finance instruments (2)

A
  • Shariah-compliant current and savings accounts

- Murabaha (cost-plus sale)

ICAS - AFin (21 decks)

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