Sources of finance Debt

1
Sources of finance - Debt

• Reasons for borrowing
• Sources of debt
• Factors to consider
• Loan stock
• Deep discount bonds
• Zero coupon bonds
• Redemption of loan stock
• Convertibles and warrants

2
Reasons for borrowing

• Maintain shareholder balance
• Avoid dilution
• Funds will be repaid
• Shareholders do not have resources
• Shareholders unwilling to commit resources
• Access to funds
• Cost

3
Sources of debt

• Loan
• Lease
• Loan stock
• redemption
• conversion
• warrants

4
Loan stock

• Most common form is debentures
• Long term
• Interest usually fixed
• Nominal (par / coupon) value
• Usually in blocks of 100
• Interest stated as on nominal
• May be issued at par / discount
• May be redeemed at premium
• Deed will specify covenants (conditions)

5
Advantages

• Compared to Preference Shares
• cheaper
• interest is tax deductible
• lower issues costs
• secured on assets more attractive to investors
• rank before preference shares in liquidation

6
Deep discount bonds

• Issued at large discount
• Redeemed at or above par
• Investors get large capital gain
• Interest rates are lower
• Investors may prefer due to tax

7
Zero Coupon Bonds

• No interest paid
• Investor obtains capital gain
• difference between issue and redemption prices

8
Redemption

• Redemption will be stated at issue
• May be on a date, or in a period
• Need to assess ability to raise funds for
  redemption
• But redemption may be by issue of shares or
  convertible debentures

9
Convertibles

• Securities which may be converted into equity
  shares
• Date and terms specified at issue
• Conversion may be at several dates, with
  different terms
• Conversion value is market value of shares which
  can be obtained
• Conversion premium is difference between issue
  value and conversion value

10
Warrants

• The right to buy shares at a future date at a
  fixed (exercise) price
• Usually offered with unsecured loan stock
• Exercise period is between issue and exercise
  date
• Warrants may be separately traded
• Value will depend on expected share price
• But lower limit will be theoretical value
• (current price exercise price) x number of
  shares

11
Advantages of warrants

• To investors
• low outlay
• ceiling on loss
• potential for high returns
• profits are capital gains
• To company
• no interest or dividend payments
• will reduce interest rate on loan stock
• make loan stock more attractive
• generate future equity funds