6 Main Sources of Finance

This article throws light upon the six main sources of finance. The sources are: 1. Venture Capital 2. Seed Capital 3. Bridge Finance 4. Lease Financing 5. Hire Purchase Finance 6. Euro Issues.

Finance: Source # 1. Venture Capital:

The term ‘venture capital’ represents financial investment in a highly risky project with the objective of earning a high rate of return. While the concept of venture capital is very old, the recent liberalisation policy of the government appears to have given a fillip to the venture capital movement in India. In the real sense, venture capital financing is one of the most recent entrants in the Indian capital market.

There is a significant scope for venture capital companies in our country because of increasing emergence of technocrat entrepreneurs who lack capital to be risked. These venture capital companies provide the necessary risk capital to the entrepreneurs so as to meet the promoters’ contribution as required by the financial institutions.

In addition to providing capital, these VCFs (venture capital firms) take an active interest in guiding the assisted firms.

Venture capital financing involves a high degree of risk. Moreover the guidelines issued by the government for the setting up of venture capital companies are too restrictive and unrealistic and have come in the way of their growth.

In addition to the venture capital companies, the Government of India has been instrumental in setting up a number of new financial agencies to serve the increasing needs of the entrepreneurs in the area of venture capital.

These include:

(i) Venture Capital Scheme of IDBI.

(ii) Venture Capital Scheme of ICICI.

(iii) Risk Capital and Technology Corporation Ltd. (RCTC).

(iv) Infrastructure Leasing and Financial Services Ltd. (IL and FS).

(v) Stock Holding Corporation of India Ltd. (SHCIL) to provide help in the transfer of shares and debentures.

(vi) The Credit Rating Information Services of India Ltd. (CRSIL) to undertake the rating of fixed deposit scheme, debentures/bonds, and provide credit assessment of companies.

Finance: Source # 2. Seed Capital:

At the time of financing a project, financial institutions always insist that the promoter should contribute a minimum amount, called promoter’s contribution, towards the project. But there are number of technically qualified entrepreneurs who lack financial capability to provide the required amount of contribution.

The Industrial Development Bank of India (IDBI) has opened schemes to provide such funds to the ‘elligible’ entrepreneurs.

There are at present two schemes in operation:

(i) Special Seed Capital Assistance Scheme, and

(ii) Seed Capital Assistance Scheme.

Special Seed Capital Assistance Scheme is meant for smaller projects where assistance is restricted to 20% of the project cost or Rs. 2 lakhs whichever is less. This scheme is managed by State Level Financial Institutions (SFC’s) out of funds provided by the IDBI.

The state Governments also provide funds for seed capital in some states. The maximum amount of assistance provided under the Seed Capital Assistance Scheme is restricted to 50% of promoter’s contribution or Rs. 15 lakhs whichever is less subject to the condition that the project cost should not exceed Rs. 2 crores.

Under this scheme, IDBI may provide assistance either directly or through the state level financial institutions, i.e., SFC’s or SIDC’s. A nominal fee/service charge of 1% p.a. for the first five years, 2% p.a. for the next five years and 3% p.a. for the remaining period is charged on outstanding loan amount.

A moratorium period of maximum 5 years is allowed and the repayment has to be made within a maximum period of 12 years from the date of issue of such assistance/loan.

Finance: Source # 3. Bridge Finance:

There is usually a time gap between the date of sanctioning of a term loan and its disbursement by the financial institution to the concerned borrowing firm. The reasons for such delay include procedural formalities for creation of mortgage, etc. Such a delay may cause time as well as cost over-run to the project.

In the same manner, there may be a time gap between the sanctioning of a grant or subsidy and its actual release by the Government or the institution. The same delay may occur in case of public issue of shares with regard to receipt of public subscription. Therefore, to avoid delay in implementation of the project, the firms approach commercial banks for short-term loans for the period for which delay may otherwise occur. Such a loan is called ‘Bridge Finance.’

The rates of interest on such loans are usually higher by one to two percent than the usual term loans. These loans are repaid by the borrowing firms as and when term loan disbursements are received from the financial institutions or out of funds received as grant, subsidy or public subscription as the case may be.

Finance: Source # 4. Lease Financing:

In addition to debt and equity financing, leasing has emerged as another important source of intermediate and long-term financing of corporate enterprises during the recent few decades. In India, leasing is a recent development and equipment leasing was introduced by First Leasing Company of India Limited in 1973 only.

Since then, a number of medium to large-scale companies have entered the field of leasing. Leasing is an arrangement that provides a firm with the use and control over assets without buying and owning the same. It is a form of renting assets.

Once a firm has evaluated the economic viability of an asset as an investment and accepted/selected the proposal, it has to consider alternate methods of financing the investment. However, in making an investment, the firm need not own the asset. It is basically interested in acquiring the use of the asset.

Thus, the firm may consider leasing of the asset rather than buying it. In comparing leasing with buying, the cost of leasing the asset should be compared with the cost of financing the asset through normal sources of financing, i.e., debt and equity.

Since payment of lease rentals is similar to payment of interest on borrowings and lease financing is equivalent to debt financing, financial analysts argue that the only appropriate comparison is to compare the cost of leasing with that of cost of borrowing. Hence, lease financing decisions relating to leasing or buying options primarily involve comparison between the cost of debt-financing and lease financing.

Finance: Source # 5. Hire Purchase Finance:

Hire purchase means a transaction where goods are purchased and sold on the terms that:

(i) Payment will be made in installments,

(ii) The possession of the goods is given to the buyer immediately,

(iii) The property (ownership) in the goods remains with the vendor till the last installment is paid,

(iv) The seller can repossess the goods in case of default in payment of any installment, and

(v) Each installment is treated as hire charges till the last installment is paid.

The main characteristics of a hire purchase agreement are as below:

1. The payment is to be made by the hirer (buyer) to the hiree, usually the vendor, in installments over a specified period of time.

2. The possession of the goods is transferred to the buyer immediately.

3. The property in the goods remains with the vendor (hiree) till the last installment is paid. The ownership passes to the buyer (hirer) when he pays all installments.

4. The hiree or the vendor can repossess the goods in case of default and treat the amount received by way of installments as hire charged for that period.

5. The installments in hire purchase include interest as well as repayments of principal.

6. Usually, the hiree charges interest on flat rate.

Leasing Versus Hire Purchase:

Both Leasing and hire purchase provide a source of financing fixed assets. However the two are not similar on many accounts. The following points of distinction are worth consideration from points of view of the lessee and the hirer:

Finance: Source # 6. Euro Issues:

Euro issue is a method of raising funds required by a company in foreign exchange. It provides greater flexibility to the issuers for raising finance and allows room for controlling their cost of capital.

The term ‘Euro issue’ means an issue made abroad through instruments denominated in foreign currency and listed on an European stock exchange, the subscriptions for which may come from any part of the world. The idea behind Euro issues is that any one capital market can absorb only a limited amount of company’s stock at any given time and cost.

The following are the primary instruments through which finance is raised by Indian companies in international markets:

(i) Foreign Currency Convertible Bonds (FCCBs)

(ii) Global Depository Receipts (GDRs)

(iii) American Depository Receipts (ADRs)

(i) Foreign Currency Convertible Bonds:

FCCBs are bonds issued to and subscribed by a non-resident in foreign currency which are convertible into certain number of ordinary shares at a pre-fixed price. They are like convertible debentures, have a fixed interest rate and a definite maturity period. These bonds are listed on one or more overseas stock exchanges. Euro convertible bonds are listed on an European Stock Exchange.

The issuer company has to pay interest on FCCBs in foreign currency till the conversion takes place and if the conversion option is not exercised by the investor; the redemption of bond is also to be made in foreign currency. Essar Gujarat, Reliance Industries, ICICI, TISCO and Jindal Strips are some of the Indian companies which have successfully issued such bonds.

(ii) Global Depository Receipts:

GDR is an instrument, denominated in dollar or some other freely convertible foreign currency, which is traded in Stock Exchanges in Europe or the US or both. When a company issues equity outside its domestic market, and the equity is subsequently traded in the foreign market, it is usually in the form of a Global Depository Receipt. Through the system of GDRs, the shares of a foreign company are indirectly traded.

The issuing company works with a bank to offer to its shares in a foreign country via the sale of GDRs. What happens under this system is that a bank holds the shares of a foreign firm and it further issues claims against the shares it holds.

The bank issues GDRs as an evidence of ownership. Thus foreign company/corporation instead of directly making the issue to the public in the foreign market deals through the bank called Overseas Depository Bank.

The equity shares or bonds representing the GDRs are registered in the name of the overseas depository bank and the share/bond certificates are delivered to another intermediary called the ‘Domestic Custodian Bank’. A holder of a GDR is given an option to convert it into equity shares or bonds. However, till conversion, the GDR does not carry any voting rights.

The biggest advantage of issuing GDR is that the issuing companies are relieved from the burden of complying with various legal formalities imposed by the regulatory authorities of that country in which they are making issues through GDRs. It also gives them the benefit of reducing license fees and exempt them from reporting various information regarding issue of securities required by the regulatory authorities.

Further, the GDR issue does not involve any foreign exchange risk to the issuing Indian companies as the shares represented by GDR are expressed in rupees. The listing of GDRs on Overseas Stock Exchange provides liquidity and makes the company’s securities more attractive.

(iii) American Depository Receipts (ADRs):

American Depository Receipts (ADRs) are the US version of GDRs. American Depository Receipts have almost the same features as of GDRs with a special feature that ADRs are necessarily denominated in US dollars and pay dividend in US dollars.