Download Limited Liability Partnership

Long Term Sources of Finance
FORMS OF BUSINESS OWNERSHIP
Sole proprietorship
Decision-making is
simple
Can be set up easily &
inexpensively
The owner receives all
income from business.
Income is taxed at only
one level (that of the
owner).
Subject to few
regulations
Unlimited liability.
Limited life of the
proprietorship
The business has limited
access to additional
funds.
Partnership
The general partners are
decision-makers.
The owners (the partners)
divide income according to
partnership agreement.
Income is taxed once.
Set up with ease
Few government regulations
Unlimited liability for each
partner.
A limited life of partnership.
Limited access to additional
funds.
Corporation
The separation of ownership
and decision-making.
Distinct legal entity
Limited liability
The business enterprise has a
life in perpetuity
Access to additional funds
through the sale of new share
of stock.
Income is distributed
according to proportionate
ownership.
Double taxation on income
Regulated by Companies Act
Corporation
Private Company
Minimum 2 persons
Maximum Shareholders 50
Public subscription not allowed
Restricted rights to transfer shares
Promoters enjoy unchallenged
control over the firm
Firms ability to raise capital is
limited
Public Company
Minimum 7 persons
Unlimited Shareholders
Public subscription allowed
Free transfer of shares
Firm can raise substantial funds
Cumbersome procedure for
Formation
• Public Company is the most appropriate
form of organisation as
– Limited liability
– Enormous growth potential
– Free and easy transferability of shares
Limited Liability Partnership
• Limited Liability Partnership form of business has
been introduced in India in Dec 2008
• Limited liability of partners.
• This form is suitable for small and medium
enterprises, service providers, doctors, CAs,
lawyers etc. to limit liability and yet have the
flexibility of a partnership structure.
Limited Liability Partnership
Features• Liability of the partners would be limited to the agreed contribution of
partners.
• Partners would not be liable for independent and unauthorized actions
of other partners.
• Name of an LLP must end with the words ‘LLP’
• LLPs can have individual, body corporates, including other LLPs,
foreign LLPs and Indian as well as foreign companies as partners
• No upper limit on maximum number of partners.
• The mutual rights and duties of partners shall be governed by an
agreement between the partners.
Limited Liability Partnership
• LLP will have perpetual succession.
• The rights of a partner to share the profits
and losses are transferable.
• LLP will maintain annual accounts
• LLP will not be subject to Company Law
• Other entities such as firms, companies etc.
can convert to LLP.
Sources of long term finance
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•
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Retained Earnings
Equity Capital
Debenture Capital
Preference Capital
Term Loans
Retained Earnings
• Retained earnings are profit after tax and
dividend.
• Internal Source of Finance
From Company’s point of view
Advantages
• Readily available
• No additional expenses to raise
• No dilution of control
Disadvantages
• Limited Fund
• Opportunity cost is high. Because, it represents the
dividends foregone by the shareholders.
Shareholder’s Point of view
Advantages
• Convenient as no hassle of reinvesting.
Disadvantages
• Lower dividend
Debenture Capital
• Debentures are instruments for raising long term debt
capital
• Characteristics
 Trustee – Bank , Institution, Insurance Company
 Appointed through a Deed
 Security – Secured by a charge on assets present and future
assets
 Debenture Redemption Reserve
 Coupon Rate / Interest Rate - Fixed or floating
 Maturity Period – fixed maturity period
 Convertible and Non convertible
Evaluation
Company’s point of view
Upside
•
•
Post tax cost of debentures is lower than shares
No dilution of control
Downsides
• Obligatory payment
Investor’s point of view
Upside
• Stable earnings
• Secured Investment
Downside
• Interest is Fully taxable in the hands of investors
• No right to vote
Equity Capital
• Represents ownership capital
• Enjoys the rewards and bear the risks
Some Terms
• Authorized capital is the amount of capital that a
company can potentially issue, as per its memorandum.
• The amount offered by the company to the investors is
called the Issued Capital.
• The part of issued capital which has been subscribed to
by the investors represents the Subscribed Capital.
• The actual amount paid up by the investors is called the
Paid-up Capital.
Equity Capital
Authorised Capital
Say: 10,00,000 Equity
Shares of Rs.10 each
Issued capital
Say :5,00,000 Equity
Shares of Rs.10 each
Subscribed Capital
Say :4,00,000 Equity
Shares of Rs.10 each
Paid up Capital
Say :4,00,000 Equity
Shares of Rs.5 each
Par Value
Face value of the share
The stated value on a stock certificate is called the par value.
The par of equity shares is generally Rs. 10, or Rs. 100.
Issue Price
The issue price is the price at which the equity share is
issued.
–Generally par and issue price are same for new companies
When issue price exceeds the par value, the difference is
referred as share premium
Market Price is the price at which the share is traded in the
stock market
• Contributed Surplus Usually refers to
amounts of directly contributed equity capital in
excess of the par value
– For example, suppose 1,000 shares of common stock
having a par value of Rs.1 each are sold to investors for
Rs. 8 per share. The contributed surplus would be
(8 – 1) × 1,000 = Rs. 7,000
Rights and position of equity
Shareholders
• Right to Control
– Elect the board
– Lack effective control
• Right to Income = Profit After Tax
– Income of the shareholder is called Dividend
– as recommended by the Board
– unchallengeable
• Pre-emptive right on pro rata basis
• Right in liquidation
– Residual claim over assets of the firm
• Pradhan enterprises has 1,000,000 outstanding equity
shares with a par value of Rs.10 and a market value of
Rs.20 .The firm plans to issue 500,000 additional equity
shares at a price of Rs.12 per share .The market value per
share after this issue is expected to drop to Rs.17.33. Now
if a shareholder has 100 shares, his financial situation with
respect to Pradhan’s equity when he exercises the
preemptive rights and when he does not exercise the
preemptive rights would be as shown below:
Takes Pre-emptive Rights
No Pre-emptive Rights
Value of initial
holding( 20 * 100)
Value of initial
holding( 20 * 100
= 2000
= 2000
Additional Subscription
(12 * 50)
= 600
Additional Subscription = 0
Value of equity holding
after the additional
Issue (17.33 * 150) = 2600
Value of equity holding
after the additional
Issue (17.33 * 100) =1733
Expected Price = 100*20 + 50*12 = 17.33
150
Evaluation Company’s point of view
• Positives
• Permanent Capital- no liability for repayment
• Dividend Non obligatory
• Enhances Creditworthiness
Negatives
• Investors expect High rate of return/ high cost of capital
• Issue cost quite high
–
Underwriting commission, brokerage costs, publicity cost etc
• Dilution of control
Shareholder’s point of view
Positives
• Limited liability
• High rewards
• Equity dividend exempted from tax
Negatives
• No say in Dividend matters
• Residual claim to income & assets
• Risky investment- wide fluctuations in price
Preference Capital
• A hybrid form of financing-
It has some features of Equity
and some features of Debentures
• Dividend rate is fixed -Not
an obligatory payment but
dividends get accumulated
• Preference dividend is paid out of profit after tax
– Not a Tax-deductible payment
•
•
•
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Preference over equity shareholders
No voting power
Convertible into equity
Redeemability
Evaluation
Company’s point of view
Upside
•
•
•
•
No legal obligation to pay dividend
No dilution of control
Enhances creditworthiness
No collateral security
Downside
• Pay dividend Tax
• No tax advantage
• Skipping of dividend adversely affects corporate image
Shareholder’s point of view
Upside
• Stable dividend
• Dividend exempted from income tax
Downside
• Can not enforce payment of dividend
• Modest returns
Term Loans
• A source of Debt Finance –
– for a period more than a year
– For financing Fixed Assets and Working Capital
FeaturesSecurity- The borrowing is secured. The assets financed
with the loan are termed as Prime Security and other
assets of the firm may serve as Collateral securities.
Interest- Interest is a fixed obligation. Rate is fixed or
floating.
Evaluation
Company’s point of view
Upside
• Interest is tax deductible
• No dilution of control
Down sides
• Obligatory payments
Lender’s point of view
• Fixed Income
• Secured loans
• No right to vote