LONG TERM FINANCING

TOPIC
OUTCOME

• At the end of this topic students should be able to:

 Identify and discuss long term sources of finance available to businesses
 TOPIC OUTLINE
DEBT
FINANCE
VENTURE
Loan stock,
Bond, Sukuk, CAPITAL
Introduction
Warrant

Equity
Finance LEASE
Common stock FINANCE
Preference
shares Operating Lease,
Finance Lease, Sales
& Leaseback
Agreement

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 INTRODUCTION

Big, successful and established company can raise funds in the public
equity market

Start up companies or companies experiencing financial trouble will

raise funds in a private equity market.

Two types of direct equity investment: ordinary shares and preference

shares

Debt financing includes long-term notes, loan stocks and sukuk.

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EQUITY
FINANCE
• COMMON STOCK
• PREFERENCE SHARES
 •
DEFINITION
A fixed unit of capital
COMMON STOCK Share premium
• Price above par
contributed by a
value
shareholder of a
• The premium forms
company
part of the
• A stock is a security
company’s equity
representing a share in a
capital
company

Par value Retained Earnings

• A value stated on Amount retained after the
each stock distribution of dividends
certificate.
• A company cannot
issue shares at a
price less than the
par value Book value
• Sum of the par value,
capital surplus and
Authorized share capital accumulated retained
earnings.
• it represents the amount
• Amount of shares that Market value contributed directly and
the company can issue • Quoted or traded price of indirectly to the company
• There is no limit to the a stock, determine by by shareholders
number of shares that supply and demand.
can be authorised.
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 FEATURES OF COMMON STOCK

VOTING
Voting rights- DIVIDENDS
RIGHTS

Characteristics

• Degree of control over its • A return on the • It is not a liability of the • Dividends • Single-tier
management through capital directly or company unless the payment is not system –
their right to elect indirectly BOD declares it. a business dividends
members of BOD. contributed to the • The decision on the expense received by
• Voting is conducted on a company by S/Hs amount of dividends • It is not the individual
one-share-one vote basis. • Payments od (paid or not) are based deductible for S/Hs are
• S/Hs may appoint proxies dividends occurs on the business corporate tax exempted
to exercise voting rights at discretion of the judgment of the BOD purposes from tax
on their behalf BOD
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 FEATURES OF COMMON STOCK

TRANSFERABILITY NO SPECIAL PREEMPTIVE

RESIDUAL CLAIM
RIGHTS RIGHT

• S/Hs may sell @ • If company is liquidated, • In the event of • If the company wants to
legally transfer their any assets left over after liquidation:- ord. shares raise additional share
shares to third party all other claims have been rank after all other capital by issuing more
of their choosing met belong to S/Hs liabilities of the company shares, it must first offer
• Residual assets are • Ord. S/Hs will expect this shares to the existing
liquidated and the higher return through S/Hs
proceeds are distributed dividends @ capital gain • S/Hs have privilege of
to shareholders as a fixed than interest payments buying the new shares
payment per outstanding on debts . before nonS/Hs or
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 EXTERNAL EQUITY FINANCING

PUBLIC
Initial OFFERING
Public Bonus
 Rights Offering
Offering  Private Issue
Placement
 EXTERNAL EQUITY FINANCING
INITIAL PUBLIC OFFERING (IPO)

IPO Issue Price

 First time sale of shares by a private company
to the public through the stock exchange. On establishing no. of securities to be
offered, the co. sets the issue price & obtain
approval from the Sec. Commission

Before issuance of shares Prospectus

 Firm will appoints investment banker - acts as An invitation or offer to the public to
advisors to manage flotation exercises & as its subscribe for or buy the securities of a
underwriters company.

Responsibilities of underwriters
Over/undersubscribed
• To purchase the shares from the issuer at an  Oversubscribed – the application will be
agreed-upon price balloted at the premises of the issuing house
• Bears the risk of loss in value & benefit of gains  Undersubscribed – balloting is uncessary
from market price changes
• Promoting the stock & facilitating the sale of the
company’s IPO shares
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 EXTERNAL EQUITY FINANCING:
PUBLIC OFFERING
 After a company has been listed, additional external funds will be
required at some future date to finance expansion.
Options:
 Issuing more shares
 Borrowings

RIGHTS OFFERING PRIVATE

(RIGHT ISSUE) PLACEMENT
 EXTERNAL EQUITY FINANCING
RIGHTS OFFERING (RIGHT ISSUE)
Terms
The term of issue specify the number of
rights required to subscribe the for an
Method additional share, subscription price per
Raise new share capital by offering to share, & the expiry date for the offer
existing SHs to take up more shares in the
company Ex-price rights
• After the issuance, of the new
shares, the ‘cum-rights’ will no
longer exist, the shares will become
Price
Usually at an issue price lower than Right ex-rights.
• Effect – Market price of the shares
the prevailing market price & at a Issue will drop to absorb the effect of the
ratio equivalent to their existing
discount on the new price
shareholding

Subscription price
Option • Price that the existing SHs are allowed
Gives option to existing SHs to buy to pay for a share of the new stock
additional new shares at the exercise • Rational SHs – subscribe the rights
price (subscription price) within a offering if the subscription price is
specified period of time [2@3 weeks] lower than the share market price on
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the offer’s expiration date
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 EXTERNAL EQUITY FINANCING
RIGHTS OFFERING (RIGHT ISSUE)

NUMBER OF “NEW SHARES”

NUMBER OF RIGHTS
NEEDED TO PURCHASE A Funds to be raised
SHARE Subscription fee

1. Need to determine the

number of new shares NUMBER OF RIGHTS
2. Determine number of NEEDED TO BUY ONE
rights needed to buy SHARE
one share Outstanding shares
“New” shares

VALUE OF A RIGHT
VALUE OF A RIGHT
Current market price – Exercise price of stock “cum-rights” The value of a right
n+1 attached to each existing
n = number of rights needed to buy one share stock is the theoretical
1 = is the new shares that will be created or every n number of the gain a SH will get by
firm’s current shares exercising the right

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 EXTERNAL EQUITY FINANCING
PRIVATE PLACEMENT
 Is the sale of new securities directly to institutional investors, i.e life insurance companies & pension
funds through merchant bank.
 Most private placement involve debt security, but equity security can also be issued through private
placement

ADVANTAGES

QUICKLY DISADVANTAGE
The placement can be made more quickly
than through a right issue
They dilute the proportionate
claims of the existing shareholders
PRICE to the company’s future profit
The price the company receives for new
shares is generally higher than through a
rights issue

RISK
The shares can be placed with ‘friendly’
institutions to reduce the risk of a takeover
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 EXTERNAL EQUITY FINANCING
BONUS ISSUE

 The issue of new common stock out of

the company’s reserve at no cost to
existing SHs & in direct proportion to
1 their existing shareholding in the firm

 A co. may decide to have bonuses issue

when there are sizeable accumulations
2 in retained earnings @ when a
revaluation of assets creates a sizeable
increase in the co.’s reserves funds.

 By issuing bonus shares, the

3 company capitalizes the retained
earnings into the shareholder’s
capital
 Used to enlarge the capital based of
4 the company
 Used as a means of rewarding its
existing shares

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 COMMON STOCK
COST OF ISSUING NEW COMMON STOCK
Underpricing
Spread or underwriting
 The stock price typically rises
discount substantially after its initial
public offering.
 The spread is the difference  This is a cost to the firm as
between the price the issuer the stock is sold less than its
receives & the price offered efficient price in the
to the public. secondary market.

Indirect expenses
Other direct expenses  Costs that are not reported
 Costs incurred by the issuer that in the prospectus & include
are not part of the compensation management time spent on
to underwriters. the new issues
 Include filing fees, legal fees, taxes
– reported in prospectus

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 COMMON EQUITY FINANCING
ADVANTAGES & DISADVANTAGES
Advantages Disadvantages
1. The company is not 1. Dividends are not tax-
committed to a fixed deductible
payout & repayment
2. The use of common stock
increases collateral for 2. External equity financing will
bondholders – increase the cause the company’s total
debt value number of shares
outstanding to increase,
3. The use of common stock resulting in stock dilution
may allow for a reserve of
borrowing power

3. Flotation costs of new equity

4. If the company believes that are higher compared to cost
its current share price is of new debt.
overvalued, then it can issue
fewer shares to raise the
needed capital.

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 PREFERENCE SHARES (PS)
TYPES

CUMULATIVE PS CONVERTIBLE PS
• Have priorities when it comes to div. payouts • Gives the holder the privilege to convert
• Cumulative – unpaid div. can be carried the shares into ordinary shares at a
forward and paid in future years. specified price
• Ord. SHs cannot be paid until the arrears of • Gives an advantage to the SHs when the
dividend have been paid to cumulative pref. market price of the ordinary shares
SHs increases

REDEEMABLE @ CALLABLE PARTICIPATING PS

• When redeemable PSPS are issued, the co. • Gives the holders the to share both fixed
would specify the payments & also the dividends and earnings of the company after
redemption dates all senior securities have been paid
• Co. can redeem the outstanding PS at its • This class of PS may be also cumulative,
discretion noncumulative @ convertible
• When this options is exercised, the • Will be paid a higher dividend rate than the
investors will receive a predetermined specified rate when the company increases its
sum of money (includes any unpaid div) dividend rate on its ordinary shares because
of high profits
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 PREFERENCE SHARES
CHARACTERISTICS
LIMITED OWNERSHIP RIGHTS
• Owners have no voting rights
• Do participate in earnings above the preset
amount
• Preemptive right to buy new securities is
also limited

FIXED DIVIDEND
• Annual dividend payments are fixed at a
certain %
• Dividends payable are either cumulative
(unpaid div. can be c/f) or non-cumulative
• Dividends must be paid before the ord. SHs
can receive anything

PRIORITY IN ASSET CLAIMS

• Refers to as senior securities
• In the event of company liquidation, pref.
SHs have a prior claim on the company’s
assets over the ordinary SHs.

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 PREFERENCE SHARES & BONDS
DIFFERENCES

1 2 3
• Unlike debt securities, • Dividends do not
• The securities are
the company is not accrue between
ranked from most
legally obligated to dividend payments
senior to junior
make dividend dates
class.
payments to the pref. • Bonds typically trade
• This ranking orders
SHs with accrued interest
will determine who
• Missing interest • Companies issue
receives payment
payments on a bond preference shares to
first; interest
will cause a default strengthen their FS
payments are made
because it is a debt. position – improve
to most senior debt
• Missing a dividend the issuing
holder, then to the
payment is not a breach company’s debt-to-
next, until the cash is
of contract , thus will equity ratio.
exhausted.
not cause a default.

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DEBT
FINANCE
• LOAN STOCK
• BONDS
• SUKUK
• WARRANT
 Loan Stock
A non-current debt capital raised by a company for which interest is paid,
usually half yearly & at a fixed rate

Basic features of loan stock ;

Redeemable / Secured or
Nominal value irredeemable unsecured

Loan stock has a Loan stocks are usually Secured loan stocks –
nominal value – redeemable. debt papers backed by
debt owed by Issued for 5 years or more. pledge of assets or
company , & They will mature at end of collateral.
interest is paid at a the period & become Unsecured loan stocks are
stated “coupon redeemable at par or par likely to expect a higher
yield” on this value plus interest. yield due to higher risk.
amount.
Some loan stocks do not
have a redemption date,
thus “irredeemable /
22 undated”.
 What is a bond & how does it work??

 A loan (negotiable / transferable)

whose repayment obligation is
represented by a debt instrument
issued by the company in the form of
a certificate.
 A bond certificate is evidence that the
company (issuer) has borrowed a
fixed amount of money from the
lenders (investors) with a promise to
repay the principal amount @
maturity & make periodic payments
 When an investor purchases a bond,
they are "loaning" that money (called
the principal) to the bond issuer,
which is usually raising money for
some project. When the bond
matures, the issuer repays the
principal to the investor. In most
cases, the investor will receive
regular interest payments from the
issuer until the bond matures.
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 Features of Bonds
Sinking fund
A sinking fund prov specifies
payment the issuer must make
to redeem a given % of the
Principal value / Par value outstanding issue prior to
maturity. It is required for the
This is the face value of the orderly retirement of the bond
bond. The issuing company issue during the life of the
promises to repay the principal bond.
amount by a certain date called
the maturity date. Collateral
Secured bonds – In the
event of a default, property
Indenture (legal claim) can be sold to
It is a legal agreement that satisfy debt for which
lists the obligations of the maturity is given.
issuer to the bondholders, Unsecured bonds
including the payment (debentures) – Bonds are
schedule & features ie call backed by promise of the
prov & sinking funds issuer to pay interest and
Call provision principal on a timely basis.
This gives the issuer the right
to call in the bonds before
Seniority
Indicates preference in position
maturity. Example, issuer may
over other lenders. In the event of
take up this option when the
a default, holders of subordinated
market rates drop below the
debt must give preference to
coupon rate on the
other specified creditors.
outstanding bonds.
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 Types of Bonds
Debentures
Unsecured bond, Not
Variable interest rate backed by company’s
bonds assets, ONLY by the credit
It is a long-term bond with a coupon or goodwill of bond issuer.
rate that varies with changes in the
short-term rates.
Subordinated bonds
Bonds with warrant Similar to debentures. However, in
event of a default, subordinated
The issuer offers the entire issues of bondholders have a claim on the
bonds with warrants at face value to assets of the company only after it
a primary subscriber who then has satisfies the claims of all
subsequently detaches the warrants senior secured bonds & debenture
& sells them to shareholders of the holders.
issuer in the secondary market.
Income bonds
It stipulates payment schedules, but the
interest is due & payable only if the issuer
earns an income to make the payments by
the given dates.
Income bonds usually offer higher returns
25 due to the risk of uncertainty in interest
payments of the issuer.
 SUKUK
.
Trust certificates or participation securities that grant investors a share of the asset along with the
cash flow & risks that commensurates from such ownerships

Considered as Shariah compliant bonds – Islamic bonds

Asset-based investment
Investor owns an undivided interest in an underlying tangible asset which is proportionate to
his investment

Money raised by the issuance of Sukuk notes are used to invest in an underlying asset, a trust is
declared over the particular asset in proportion to his investment.

The investor is entitled to the benefit that entail, including a proportion of the return
generated by the asset

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 SUKUK
FEATURES

Liquid instrument, Regular periodic

tradeable in income stream during
1 secondary market 2 the investment period

Easy & efficient settlement Provides medium to

& a possibility of capital long term fixed or
appreciation
3 4 valuable rates of return

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 SUKUK & CONVENTIONAL BONDS
SIMILARITIES & DIFFERENCES

DIFFERENCE: 1
SIMILARITIES
 Sukuk is a trust certificate, bond is a contractual debt obligation.
1.Has fixed term  Sukuk represent beneficial ownership interest in the underlying asset.
 Returns on Sukuk are tied up to the return earned through the underlying
securities assets
2.It bears a  Bonds – Issuer is contractually to pay the bondholder

coupon
DIFFERENCE: 2
3.Tradable on the
In the case of default:
normal yield  Conventional bond, the investor will loose their wealth
Sukuk assures the investors of their ability to retrieve a major part of
price
their investment even if things go terribly wrong as they will be having
an individual share in the ownership of the Sukuk assets

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 SUKUK
Sukuk Istisna’
Sukuk Ijarah • Use to fund real estate development, major
• Leasing structure coupled with a right industrial projects @ large equipment items
available to the lessee purchase the asset i.e. turbines, power plants, ships or aircraft
at the end of the lessee period. (construction / manufacturing financing)
• The certificates are issued on stand alone • Islamic financial institute finds the
assets identified on the statement of manufacturer or the contractor during the
financial position. asset construction, acquires asset & up to
• Rental rates – fixed@floating – depends the completion either immediately passes
on the agreement title to the developer on agreed deffered
• The CF from the lease- passed through payment terms, or leases the asset to the
investors in the form of coupon & developer.
principal payments
Sukuk Musharakah

TYPES
Sukuk Mudharabah • Represent ownership of Musharakah
• An agreement made between a entity
party , who provides a capital & • Require both party to provide
entrepreneur to enable the financing to the project
entrepreneur to carry out • Share of losses – based on the size of
business projects – based on investment
profit sharing basis • Use to mobilize funds to establish new
• Loses – borne by fund provider project @ to develop existing project
• To enhance public participation @ to finance a business activity based
29 investment project
in big
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on partnership contracts
 WARRANTS
Known as transferable subscription of rights

Permits the holder to buy new ordinary shares during a stated period and at a given price known as
the exercise price
It is a quoted right to buy into the equity of a company

It entitles the holder to subscribe for a given number of ordinary shares in the company at a
predetermined price before a specified expiry date
Usually issued by companies in conjunction with other forms of financing (bonds/loan stocks) –
allowing the company to obtain a lower interest rate
Issuers of warrants are required by Bursa Malaysia to protect investors from suffering losses through
right issues & bonus issues by adjusting the exercise price
Warrants usually include covenants that restrict the company’s ability to issue new shares & dilute the
value of warrants.
Market value of warrants will depend on the expectation of actual share price in the future

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 WARRANTS & CALL OPTIONS
SIMILARITIES DIFFERENCES

Are options on the Warrants are issued by

1 equity of the company companies, call options

are created by investors
1
2
Are protected against Warrants are LT in

2 stock dividends and

stock splits
nature, call options
expire within several
months
2
Both values are
affected in the same
3 way by changes in the
stock price, exercise
Warrants terms are not
standardized 3
price , etc

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 TYPES OF WARRANTS
COMPANY WARRANTS STRUCTURED WARRANTS
Issued by Listed company Third party financial
institution
Underlying shares Shares of the company Any company shares that are
not related to the financial
institution (must meet the
requirement under the
Securities Commission’
Guideline for the Issue of
Structured Warrants)
On exercise Company will issue additional shares to Does not result in dilution of
meet obligations. This will result in the underlying shares
dilution
Maturity period Up to 10 years 6 Months to 5 years
Settlement The issuer freely defines the terms and conditions of warrants
LEASING
OPERATING LEASE
FINANCE LEASE
SALE AND LEASEBACK ARRANGEMENT
 TYPES OF LEASING
Lessor does not recoup the total • It is cancelable by the
price of equipment during the lessee, at little or no cost if
primary lease period: the lessee gives the agreed
• Lessor will not be able to cover notice of cancellation to
the full cost of the asset lessor
\\
• May be due to shorter lease • Condition – if the
period than the useful economic equipment is obsolete or
life of the asset OPERATING LEASE no longer needed
Agreement to use asset
 Part of lessor’s investment & without ownership Example:
income: • Computers
• Subsequent renewal payments • Photostat machine
• Sales proceeds from disposal of
leased equipment
 Lessor is responsible for insuring &
maintaining the equipment
 TYPES OF LEASING: FINANCE LEASE
• Lessor provide finance rather than rent
out assets & prefer lessee to purchase
• Lessor transfers ownership of the the asset at the end of the lease term
asset to the lessee at the end o the
lease term
• Lessor is the legal owner of the
equipment
• Lessor will recover the capital cost of
equipment plus an amount equivalent LESSEE
to the financing charge • Specifies the equipment required,
the price & the manufacture @
• Lease agreement is either cancellable distributor
@ non cancelable only if the lessee • Is allowed exclusive and
pays a substantial penalty to the unrestricted use of the equipment
lessor & make periodic payment to
lessor for a specified period
• Is responsible for repairs,
maintenance & insuring the asset
 TYPES OF LEASING: SALES AND
LEASEBACK ARRANGEMENT
The owner of an asset sells the asset to a
financial institutions for an amount usually It is an alternative to raising cash by
equal to its current market value & borrowing by using the asset as
immediately leases it back from the security
institutions.

TITLE / OWNERSHIP TERMS

Lessee relinquishes the title to Depends on the type of property
the property in return for cash & leased
is required to make periodic Generally not exceed 10 years
payments to the lessor.

EXAMPLE
Real estates :
RESPONSIBILITIES OF LESSEE
• Maintenance costs • Hotels
• Insurance • Office buildings
• Local authority charges • Warehouses
• Any other occupation cost • Factories
VENTURE CAPITAL
 VENTURE CAPITAL
Venture capitalist:  A form of illiquid investment in high risk high return environment

A person who does venture

 Provided to new, high-growth, high potential companies with the
investing
intention to generate return through IPO or sales of the firm.
Brings managerial & technical  Provided by venture capital companies or rich individuals.
experience to the firm
 Takes the form of cash exchange for shares in the company receiving the
investment.
 Venture capital suitable for new companies which:
• Have limited history – not large enough to raise money in the public market
• Too newly formed to secure a credit via bank loan @ debt instrument.
 Venture capitalist get wide-ranging control over the company decision
 Venture capital investments are typically equity based – venture capitalists take a %
of the equity in the company that receives venture capital funding
 Venture capital funding does not require collateral
 Venture capitalist receives its payment in the form of capital gains when the
investee company undergoes a liquidity event i.e IPO @ trade sale
 MAIN REFERENCE:
Ross, A., Westerfield, R., Jaffe, J. & Jordan, B. (2016),
“ Corporate Finance”, 11th Edition, Mc Graw Hill Education
CREDIT TO:
Puan Nur Asyikin
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