Kumar Fernando

EQUITY FINANCE

Capital MarketsNew share issuesRights issues Issue of marketable debt

Bank Borrowings

Venture Capital Funds

Government and similar sources

EXTERNAL SOURCES OF FINANCE

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Third levelFourth level

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Cost of different sources of finance How long the requirement of funds Lending restrictions Gearing level Ability to service debt Currency of cash flow of the project Impact on FS of different options Tax implications Availability

CRITERIA FOR SELECTING SOURCE OF FINANCE

Equity is another name for shares or ownership rights in a business

Shareholders receive returns from their investments in shares in the form of dividends and also capital growth in share price

EQUITY FINANCE

Share- A fixed identifiable

unit of capital in an entity

which normally has a

nominal value which may be

different from its market

value

Ordinary shares pay dividends at the discretion of the entity directors

They are the owners of the company They receive their money last- subordinate to all

other finance providers They receive the entire residual after settling all Preference shares are a from of equity that pays a

fixed dividend It is paid in preference to ordinary shareholders In a winding up they get paid just before ordinary

shareholders

ORDINARY SHARES VS PREFERENCE SHARES

Preference shares pay a fixed dividend proportion of the share’s nominal value

Thus it is considered there is an obligation to pay preference dividend and treated as non current liability in SOFP

Preference dividend is paid out of profits where as interest is paid before arriving at profits.

Thus preference dividends are not tax deductible where as debt interest is tax deductible

Debt interest is obligatory and cannot be skipped but preference dividend may be skipped in certain circumstances

Because of the non tax deductibility preference shares are relatively unattractive to companies as a source of finance

PREFERENCE SHARES VS DEBT

Cumulative preference shares- Here dividends must be paid including skipped dividends

Non cumulative preference shares- No need to pay skipped dividends

Participating preference shares- This gives the holder fixed dividend rights plus extra earnings based on certain conditions just like ordinary dividends

Convertible preference shares- They can be exchanged for a specific number of ordinary shares at some given future date

Redeemable preference shares- Here holders will be repaid their capital usually at par on some future date

TYPES OF PREFERENCE SHARES

Capital markets (stock markets) must fulfil two functions: Primary function- This function enables companies to

raise new finance (equity or debt) Through the stock market a company can communicate

with large pool of potential investors thus facilitating company to raise finance this way than contacting investors individually

In UK a company must be a plc before it can raise finance in the stock market

Secondary function-This function enables investors to sell their investments to other investors

Therefore a listed company shares are more marketable and thus more attractive to investors.

CAPITAL MARKETS

A private company limited by shares is usually called a private limited company

Shareholders have a limited liability and shares may not be offered to the public

Limited liability means the liability of the shareholders to the creditors is limited to the capital originally invested.

Disclosure requirements for a private limited company are lighter and for this reason shares may not be offered to the public

LISTED VS PRIVATE COMPANIES

Public limited company may sell share to public It can be an either unlisted company or a listed company on the

stock exchange When an entity obtains a listing (quotation) for its shares on a

stock exchange it is referred as a flotation or an IPO Shareholders will normally benefit from a listing because their

shares are becoming more marketable Listing can have a positive impact on the reputation of the

company thus share price may rise It will also raise the profile of managers and employees The better reputation will enhance its credit ratings and thus cost

of capital may be lower. More favorably viewed by suppliers

PUBLIC LIMITED COMPANY (UK-PLC)

AdvantagesOnce listed market will provide a more accurate valuation

of the entityRealization of paper profitsMechanism to buying and selling shares in the futureRaise of profile entityFacility to raise capital for the futureMakes ESOP more accessible

ADVANTAGES VS DISADVANTAGES OF LISTING

Costly for a smaller entity such as floating costs/underwriting costs etc;

Loss of control as you need to make enough shares available to the market

Reporting requirements are very onerous Rules to obtain a quotation may be very stringent

DISADVANTAGES OF LISTING

Full stock exchange- This is the market for larger companies Entry costs are high Scrutiny is very high for companies listed on the full exchange Profile of a company listed here is very high and shares are

extremely marketable Alternative Investment Market (AIM)- This is a market for a

smaller company with lower associated costs and less stringent entry

Prices of shares in nay stock market is determined by the forces of supply and demand

A company that is performing well there will be a demand and thus upward movement in share prices

UK CAPITAL MARKET

There are three common methods: 1. IPO-Shares are offered for sale to investors through an

issuing house Offer could be made at a fixed price set by the company or in a

tender where investors are invited to offer their price. Here all shares are subsequently sold at the best single price at which they would be taken up.

2. Placing- Here shares are placed directly with certain investors (normally institutional investors) on a prearranged price

3. Rights issue- Here shares are offered to existing shareholders in proportion to their size of their holding.

METHODS OF ISSUING SHARES

These offers could be completely new shares or a transfer of shares already held by existing shareholders privately

An issuing house normally a merchant bank acquires the shares and offers them to public at a fixed price

Offers are usually made in the form of a prospectus detailed in newspapers etc;

Government privatizations are done through IPO Stagging- Some investors apply for new shares with the hope of selling

immediately and reaping a quick profit IPO lock up period- This is a contractual restriction that prevents

insiders such as founders, managers who are holding company shares before it goes public from selling shares for a period which could range 90– 180 days after the company goes public

The purpose of lock up period is to prevent market from being flooded with a large no of shares which could depress the share price

INITIAL PUBLIC OFFERINGS (IPO)

This is an alternative to a fixed offer price Under this method subscribers tender for shares at above a

minimum fixed price Once all offers are received the company sets a strike price

and allocates shares to bidders who have offered the strike price or more

Strike price is set to make sure that the company raises the required amount of finance from the share issue

Once the strike price is set all bidders who offered the strike price or more are allocated shares and they all pay the strike price irrespective of what their original bid was

TENDER OFFER

Placing is the sale of securities to a relatively small number of select investors as a way of raising capital

Investors are generally large banks, mutual funds, insurance companies and pension funds

Since placement offers shares to a few the placement does not have to be registered or publicly announced

Generally a need for a prospectus is waived Generally since placement is private average investor is made aware of it

only after it has been occurred This method is very popular because it is cheaper and quicker to arrange

than most other methods However it does not normally lead to a very active market for shares

after a flotation

PLACINGS

Private equity is equity capital that is not quoted on a public exchange It consists of investors and funds that make investments directly into

private companies They invest in public companies that result in a delisting of public equity Capital for private equity is raised from retail and institutional investors

and others who can commit large sums of money for a long period of time Private equity investments often demand long holdings giving time for a

distressed company to turn around, or to prepare a company for IPO etc; They try to improve the financial results and prospects of the company in

the hope of reselling the company to another firm or cashing out via an IPO. Sometimes private equity firms conduct large leveraged buyouts (LBO)

where large amounts of debt are issued to fund a large purchase

PRIVATE EQUITY

Investment banks- They take the lead role in IPO and will advise on: The appointment of other specialists such as lawyers Stock exchange requirements Forms of any new capital to be made available The number of shares to be issued and the issue price Arrangements for underwriting Publishing the offer Stockbrokers- Provide advice on the various methods of obtaining a listing.

They will work with investment banks on identifying institutional investors but generally they are involved with smaller issues and placing

Institutional investors-They may be asked about the likely take up price for shares. They will also have a major influence on evaluation and the market for shares

ADVISORS TO IPO

This is where new shares are offered for sale to existing shareholders in proportion to the size of their shareholding

The right to buy new shares ahead of outside investors is known as the pre-emption rights of shareholders

The purpose of pre-emption rights is to ensure that shareholders have an opportunity to prevent their stake being diluted by the new issues

Pre-emption rights are protected by law, and can only be waived with the consent of the shareholders

Rights issues are far cheaper to organize than a public share issue but expensive than a placing

RIGHTS ISSUE

The price should be set below the existing market price to secure acceptance of shareholders

Should not be too low to avoid excessive dilution of EPS Generally issued around 20% discount to the market price Inn theory there is no upper limit to an issue price but in

practice it would be never set above the prevailing market price

In theory there is no lower limit but in practice should never be lower than the nominal value

However if the issue price is reduced you need to issue a higher quantity of shares to raise the required sum

RIGHTS ISSUE PRICE

This avoids the risk of that the entity will not sell all of the shares it is issuing and so receiving less than what it expects.

Underwriters are normally financial institutions such as merchant banks and in return for a fee they agree to buy any shares that are not subscribed in the issue

They receive their fee whether or not they are required to take up any unsubscribed shares.

Underwriting costs could be avoided through a deep discounted rights issue thus reducing the possibility of shareholders not taking their rights.

UNDERWRITING

Decide 1st on the rights issue price Then depending on the amount required to raise decide the

quantity The effect on EPS /DPS and dividend cover should be

considered Then the selected additional quantity wlil be issued in

proportion to the existing no of shares to decide on terms of issue.

SELECTION OF RIGHTS ISSUE QUANTITY

After the announcement of a rights issue generally the share price drops

This fall is due to uncertainty about the consequences of the issue, future profits and future dividends

After the actual issue the market price will normally fall again because there are more:Shares in issue (adverse effect on EPS)And also shares were issued at market price discount

MARKET PRICE AFTER RIGHTS ISSUE

When rights is announced all existing shareholders have the right to buy new shares and thus there are rights (cum rights)attached to the shares and thus are traded at cum rights.

On the 1st day of dealings in the newly issued shares the rights are no longer exist and old shares and new shares all are traded at ex rights without rights attached

Theoretical ex rights price is calculated

CUM RIGHTS AND EX RIGHTS PRICE

TERP= (N * cum rights price)+ issue price/N+1

N= no of rights required to buy 1 share

Value of rights= (TERP-issue price)/N

Do nothing- Here the market value of the investment could be expected to fall of the shareholder. The company would normally reserve the right to sell any unaccepted shares for the best price in the market

Sell the rights-in this case shareholder sell the rights to buy the shares to another investor. No ne will offer over the value of rights. The existing shareholders % holding will get reduced

Fully subscribe for the new shares- The shareholder % will be maintained

Sell some rights to buy some new rights- He can use funds sold from rights to buy some rights. This also will reduce shareholder %

ACTIONS OPEN TO A SHAREHOLDER ON RIGHTS

From shareholder point of viewThey have the option to buy shares at a preferential priceThey have the option of withdrawing cash by selling their

rightsThey are able to maintain their existing relative voting

position

From view point of the companyIt is simple and cheap to implementit is usually successful (fully subscribed)it often provides favourable publicity

IMPLICATIONS OF A RIGHTS ISSUE

THANK YOU

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