Types and Sources of Long term funds Flashcards
Define Share
A fixed identifiable unit of capital in an entity which normally has fixed nominal value which may be different from its market value
What are charateristics of ordinary shares
- Each share has face/par/nominal value
- Sharesholders can attend meetings and vote on important matters
- Entitled to recieve a share of any dividend
- Recieve a share of any assets remaining after liquidation
- Participate in any new issue of shares
What kind of decisions can shareholders impact in general meetings
- Election of directors
- Appointments of external auditors
- APproving company’s remuneration policy
How are ordinary shares presented
- Presented as equity in the statement of financial position
What are advantages of ordinary shares
- No obligation to repay the funds raised through an ordinary share issue
- The amount and tiing of the dividend payment is flexible
What are the disadvantages of ordinary shares
- Issuing new shares might dilute the control of orginal shareholders
- Cost of equity finance is typically higher than the cost of debt finance:
- The adminstrative costs of issueing shares are expensive
- To investors-sharers are riskier than debt so shareholders expect hgiher return
- Dividends paid are not tax deductible
What are charecteristics of preference shares
- Have face/par/nominal value
- No voting rights
- Also recieve dividends normally at fixed rate
- Paid before ordinary dividends
- If liquidation: preference shareholders recieve their share of remaining assets after all debt holders and creditors but before ordinary shareholders
- May have conditions attached to them
What are conditions atatched to preference shares
- Redeemable: entity has to repay the principle or Irredeemable
- Cumulative: Insufficient distributable reserves to pay the dividend in the current year - the entity must pay it in future years
-Non-Cumulative: If there are insufficient distributable reserrves to pay the dividend in the curren tyear, the entity does not have to pay
What are other types of conditions
- Participating preference shares - fixed dividends plus extra earnings based on certain conditions
- Convertible preference shares - can be exchanged for a specific number of ordinary shares in future
How are preference shares presented
- If they meet definition of liability
- Cumulative irredeemable preference shares contain obligation to pay dividends so are liability
- Redeemable preference shares contain obligation to repay the principa so are liability
- Non cumulative irredeemable preference shares are treated as equity as they do not contain obligation
What are advantages of preference shares
- Preference share issues do not dilute control of ordinary shareholders
- The cost of the company of preference shares is cheaper than ordinary as lower risk and lower return
- When company is not allowed to obtain additional debt- preference shares are good alternative
What are disadvantages of preference shares
- Payment of preference dividends is mandatory when sufficient funds are available
- The cost of preference shares is more expensive than debt
- Ppreference dividends paid are not tax deductible
What are characteristics of long term debt
- Providers are not owners of business
- Entity normally has obligation to pay interest and repay principal
- On liquidation debt holders have priority access to assets
- Cost of debt is cheaper as interest is tax deductible
- Easier to raise debt finance comared to equity
What are long term debt sources
- Bank loan
- Conventional Bonds
- Convertible Bonds
What are characteristics of bank loans
- Bank lends fixed amount for period of time
- Interest may be fixed, variable or capped
- A repayment structure will be put in place
- Bank may require security
What is loan covenant
Condition set by bank that borrower must comply with and if they do not, the loan is considered to be in default and bank can demand repayment
What are examples of bank covenants
- Positive covenants: Involve maintaining certain levels of particular financial rations
- Negative covenants: limit the borrower’s behaviour eg/ not allowed to borrow from another lender
What are conventional Bonds
Debt instrument, offering a fixed rate of interest/coupon over a fixed period of time and normally with a fixed redemption value
What is coupon rate
- Interest rate of bond return of nominal value
- Gross rate before tax
What are features of bonds
- Issued at Par: coupon rate is fixed at the time of issue and will sell according to market conditions given credit rating of comapny
- Marketable: Ability to sell the debt
- Reddeemable:
What are perpetual or undated bonds
Bonds which do not have redemption date and are ireedemable
- Normally issued by banks
Convertible Bonds
The bond holders have the right to convert heir bonds into a new equity shares at a future date at a specified conversion rate
What type of coupon rate will convertible bonds have compared to conventional or fixed bonds
Lower: because holders have potential of additional benefit of value of shares being higher than redemption value on bond
Deep discounted bonds
- Issued at a large discount to nominal value and are reedemable at par or above when they mature
- Carry much lower rate of interest
- Issuer will have to pay much larger amount at maturity than it borrowed
Zero Coupon bonds
- Issued at discount to their redemption value but no interest is paid on them
- Extreme form of deep discount bond
What are two types of security for debts
Fixed Charge
Floating Charge
What is the meant by Fixed charge security
Security relates to specific asset and company can’t dispose of asset without providing substitute
What is the meant by Floating charge security
Security relates to certain group fo assets which will be changing eg. recievables or inventory
company can dispose of assets until default takes place
If default happens, the lender appoints a recieverrather than laying claim to assets
What are capital markets
For traading in medium and loong term finance
- In the form of equities and corporate bonds
What is the capital markets of UK
Principle market =stock market: companies with full stock exchange listing for publicallly listed companies
Secodn tier : alternative Investment market (aim)
What are the primary functions of the capital markets
Purpose: enable comanies to raise new finance by issues new shares or bonds
What is the secondary function of capital markets
Purpose: enable investors to sell their investments to other investers
What are advantages of stock market listing
- Access to wider pool of finance
- Improved marketabiity of shares
-Enhancced public image - Easier to seej growth by aquisition
- Original owners can sell holding for funds
What are disadvantages of stock market listing
- Significant public regulation, accountability and scrutiny
- Rules and legal requirements are higher
- Wider circle of investors
- Additional costs to issue market shares
What are the three method to obtaain a stock market listing
- Initial public offering: IPO
- Placing
- Introduction
What is meant by IPO
Initial public offering
- Selling of shares of company to public
- Issuing house publishes invittation to public to apply for shares at fixed price or tender basis
- Issuing house will underwrite the issue- for a fee it will guarantee to buy any unsold shares
What is the method of placing method
- Arrangement whereby shares are offered to a sponsering market maker for small number of investors
eg. pension funds
What is the method of introduction
- No shares are made available to the market
- Private company are already widely held but are introduced to the market so they are seen to exist
What is market maker
Company or an individual that undertakes to buy and sell securities at specific prices
Why would companies choose placings over IPO
- Cheaper
- Quicker
- Less disclosures of information
What are disadvatnages of placing
- SHares are for relatively small number of shareholders
- Likely to have larger amount of control of company
- Shares are less likely to be traded
Define Rights Issue
- Raising of new capital by giving existing shareholders the right to subscribe to new shares in proportion to their current holdings
- Shares are usually issued at discount to market price
What are characteristics of rights issue
- Price must be low enough to get shareholders to purchase but nt too low so earning is not diluted
- Cheaper than publicks hare issues
What are the possible course of actions for shareholders in rights issues
- Buy new shares
- Sell their rights to buy the shares
- Sell enough rights to finance their share purchases
-Do nothing
What are the impact of rights issue on the share price
- Cum-Rights: all existing shareholders have right to subscribe for new shares and rights are attached to the shares
-Ex-rights: Rights no longer exist and old shares are traded without rights attached
- Theoretical ex-right price(TERP): Weighted average price
Describe features of bond market
- Commonly issues in primary market
- Corporatebonds are underwritten and traded publically
- For bond to be issued, a prospectus must be prepared, and approved by listing authority for trading
What is meant by OTC
- Bonds are sold over the counted
- Bought and sold directly through financial institutions
What are the three groups of bond market
- Issuers: Sell bonds in capital markets to raise finance eg. government, bank and corporations
- Underwriters: Help issuer sell bonds eg. investment banks
- Purchasers: buy bonds to hold as an investment
Define Sponser and functions
Typically investment bank or large accountancy firm - acts as the lead advisor in an IPO on the main market
-Project managing the IPO process
- Co-ordinate due diligence and prospectus
-Ensure compliance
- Develop investment case, valuation and offer structure
Define Bookrunner and functions
- Main underwritter of syndicate (group of underwritters) for new share and debt issues
- Raises finance from investors
- Helps determine pricing of shares or debt
- Guarantees to buy unsold shares or debt
What is reporting accountant
- Reviews and reports on the company’s readiness for listing
What are the responsibilities of reporting accountant
- Financial reporting procedures: whether company is meeting reporting oblicgations as public company
- Financial historical records: audit oppinion of company’s track record
- Working capital: whether director’s workign capital statement in prospect is sound
- Other information: eg. profit forecast
What are the functions of IPO Lawyer
- Performs legal due diligence
- Drafts the prospectus
- Provides legal opinion
