Alternative Sources of Finance

8/8/2019 Alternative Sources of Finance

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Alternative sources of finance

n bonds,

n leasing,

n franchising,n factoring and forfeiting,

n venture capital

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Bonds

n Bond debt instrument issued by a business whichobligates it to make periodic interest payments to theholder of the bond, as well as to repay the principal ofthe bond at the maturity day;

n The issuer obtains funds by placement of bonds in thecapital market, i.e. they are sold to the economicsubjects that invest their funds to purchase thesesecurities.

n The process of the issue is similar to that one of the

shares.



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Characteristics of bonds

n Nominal value (face value ang., par value am.) due sum lendedby the creditor to its issuer, it is given on the bond

n Quotation the present market price, given as a percentage of itsnominal value

n Interest payment a coupon rate

n Bond duration measure of sensitivity of the price of a fixed-income investment to a change in interest rates

n Yield upon investment rate of return of really invested funds

n Yield to maturity (YTM) an internal rate of return of the bond



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Bond as a security has to contain:

n name and seat of issuer,n name of bond and ISIN,n nominal value,n determination of return,

n declaration of the issuer that he owes the principal to thebondholder,n obligation of the issuer to repay the principal and pay return,

determination of these payments and place of payment,n registered bonds name of their first holder,

n date of issue, signature of authorized person,n information about official approval of issue.



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Factors important for investors

n Price of bond in secondary market may besignificantly different than the nominal value(bond return, average rate of return of

comparable investment opportunities, life ofbond, relation market supply-demand)

n Risk of bond depends on how is the issuesecured and on creditworthiness of the issuer

(not secured and secured bonds)



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Factors important for investors

(continued)n Return of bond depending on determination of the coupon rate

different types of bondsn Date and form of payment maturity 5 30 years; can be repaid

by one balloon payment, by periodical payments;- some bonds may have a call feature allows the firm to call orretire the bond earlier than on maturity date

n Bond liquidity ability to trade bonds efficiently without causingany major changes in their price with minimum cost



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Classification of bonds (continued)

Classification according to the form of interest payments:n fixed coupon rates when issued, bond has stated coupon rate,

which, multiplied by the bonds nominal value, yields the annualinterest payment

n floating rate bond interest rate can be adjusted up or downdepending on the pre-stated indicator

n hybrid rate bond combines fixed and floating returnsn extraordinary return extraordinary motivation type used in

addition to the above forms

n zero-coupon bond pays no interest for the life of the contract;investor earns a return by purchasing the bond at one price andeither selling it in a secondary market at a different price, or simplyholding it to maturity and receiving nominal value



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Bonds - pros

n large loans depending on the capital marketsituation,

n obtaining funds from many anonymousinvestors,

n the principal is paid once at the bonds maturitydate,

n possibility to repay the loan earlier without aspecial agreement



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Bonds - cons

n official approval of the issue, complicated legalregulations, publicity necessary,

n initial issue costs higher than obtaining anothertype of loan,

n additional costs for issue administration,

n appropriate for larger companies, smallerbusinesses are not able to place the bonds inthe market



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Leasing

n Lease a rental agreement that extends for a year or more andinvolves a series of fixed payments

n Leasing similar to borrowing funds in order to purchase an assetn It is an agreement between 2 parties the user (the lessee), the

owner (the lessor). The lessor of an asset grants the lessee the right

to its exclusive possession and use for a specific period and underspecified conditions, in return for specified periodic rental or leasepayments. The lessee acquires the use but not ownership, he bindshimself to make periodic lease payments at stipulated intervals for astated period. So, the lessor actually owns and is contracting out theservices of the asset, retains title to and consequently ownership of,that asset.



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Lease rate factor

[1st payment + other payments + residual value] : purchase price > 1 !!!



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Types of leases

According to the length of the lease period:n operating lease short-term, the contract period much shorter than

the economic life of an asset, is cancellable, after a set period anasset is returned to the lessor, rewards and risks of ownership staywith the owner

n financial lease long-term relation between the lessor and thelessee; although legal ownership remains with the lessor, it virtuallytransfers all the rewards and risks to the lessee; covers a significantpart of the economic life of the asset; generally cannot be cancelled;transfers ownership to the lessee by the end of the lease period;allows the lessee to purchase the asset at a price lower than the fairmarket value of the asset when the lease expires



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Types of leases (continued)

Other types:n direct leasing the lessor purchases the property directly from the

manufacturer and leases that property to the lesseen sale and leaseback agreement a business sells an asset to a

lessor and simultaneously enters into a lease contract to lease it

back in order to raise finance and continues to use the assetn leveraged lease has 3 parties involved: lessee, lessor, lender

(supplies funds to the lessor to acquire an asset)n employee leasing leasing company (professional employer

organization) is the official employer, assumes responsibility forwork, overseeing all HR-related functions



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Leasing - pros

n no need to have the entire amount of purchase price available at thebeginning,

n the lease payments periodically become the part of the costs andreduce profit as well the tax base and tax payable as they are tax-deductible,

n the lessee repays the lease payments from the revenues of thefinanced assets after their launching (in case of manufacturingassets),

n contract is flexible, less restrictive and not so time consuming asmost loans,

n maintenance of leased assets is often performed by the lessor



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Leasing - cons

n higher costs due to high profits of leasingcompanies and all costs associated with leasing,

n the sum of lease payments is higher than the

purchase price of the leased asset,n usually it is required to pay the increased first

payment or initial fees that can negatively affectbusiness liquidity,

n the lessee is usually not allowed to sell, rent or

return the leased asset, contract is notcancellable



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Venture capital

n VC long-term capital provided to SMEswishing to grow without ready access to

stock markets with higher level of potentialreturns as well as higher level of risk;normally long-term finance

n Equity finance!!!



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Venture capital types

n Start-up capital for businesses at a concept stage

n Growth capital for young, expanding businesses

n Buy-out or buy-in capital to fund the acquisitions

n

Share purchase capital to fund the purchase ofshares in a business in order to buy-out part of theownership of an existing business

n Recovery capital rescue finance used to turn arounda business after a period of poor performance



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Venture capital process

n Step 1: Obtaining the funds

n Step 2: Evaluating investment opportunities andmaking a selection

n Step 3: Structuring the terms of the investment

n Step 4: Implementing the deal and monitoringprogress

n Step 5: Achieving returns and exiting from theinvestment



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Business Angels

n BA often wealthy individuals who have beensuccessful in business, they are usually willing toinvest 10,000 - 100,000 in a start-up business

or a business that is at an early stage ofdevelopment through a shareholding. In additionto providing finance, a BA can offer a wealth ofbusiness experience.

n SBAN the Slovak Business Angels Network

n EBAN the European Business Angels Network



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Franchising

n Franchising a method of expanding businesson less capital than would otherwise be needed.

n A franchisee pays a franchisor for the right to

operate a local business, under the franchisorstrade name. The franchisor will charge thefranchisee an initial franchise fee and regularpayments (usually a percentage of the

franchisees turnover).



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Franchising pros

Advantages to the franchisor:

n the capital outlay needed to expand the business isreduced substantially,

n the image of the business is improved

Advantages to the franchisee:

n he obtains ownership of a business for an agreed period,

n he is able to avoid some mistakes because thefranchisor has already learned from its own pastmistakes and developed a scheme that works



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Factoring

n Factoring a method of raising short-termfinance; a factor will manage the sales ledger ofthe business and will be prepared to advancesums to the business based on the amount of

trade debtors outstanding;n means the selling of receivables to a financial

institution so funds can be received earlier thanthe normal credit period;

n the business can receive between 80-90%

funding f the invoice amount



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Factoring (continued)

Factoring fee:n the discount (the interest for the period from selling the account

receivable to its maturity),n the price of services provided to the client (debt management),

n the risk margin (the price for the assumption of the credit risk)

The factor may purchase:n one account receivable,n all clients accounts receivable,

n accounts receivable within the pre-determined limit (in the absoluteamount or as a percentage of the accounts receivable)



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Types of factoring

n notified/non-notified factoring

- notified - the debtor is informed that the debt has beenpurchased and requested to pay the factor directly

- non-notified - the debtor is not informed

n export/import factoring

- export domestic companies (exporters) use thefactors services in their country for internationalbusiness

- import the use by foreign companies of factorsservices in domestic country



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Factoring - pros

n improved CF through reduction of outstandingdebts,

n savings through discounts when purchasing,

n up to 100% protection against credit losses,n savings through debt management,

n ongoing credit rating of debtors,

n savings on credit insurance,

n improved balance sheet structure.



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Forfeiting

n Forfeiting similar to factoring, a method of tradefinance allowing exporters to obtain cash by selling theirmedium term foreign accounts receivable at a discount

n Forfeiter a specialized finance firm or a bank

department performing non-recourse export financing,virtually eliminates the risk of non-payment

n Unlike factors, forfeiters typically work with the exporterwho sells capital goods commodities, or large projectsand needs to offer periods of credit from 180 days to up

to 7 years



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Forfeiting pros and cons

n Advantages:

- eliminates the risk of non-payment by foreign buyers,

- strong capabilities in emerging and developing markets

n

Disadvantages:- cost can be higher than commercial bank financing,

- limited to medium-term and high amount transactions



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Commercial papers

n a short-term unsecured promissory notebacked by the promise of the issuer toredeem the note at maturity,

n sold on a discount basis like treasury bills;slightly higher return

n limited secondary market of commercial

papersn not issued by Slovak companies


Alternative Sources of Finance

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