APT TECHNICAL CPD - MAF FINANCING DECISION
Sources of finance and the financing decision Nicholas Riemer Nicholas.Riemer@firstrand.co.za
Agenda • Workflow to understanding sources of finance and the financing decision. • What are the sources of finance available? Generic Problem (theory) • How to address the financing decision relating to the industry at hand? • What is the specific problem? • How to incorporate into your file
Workflow Approach
Sources of finance
Generic problem • Where does this fit in for APT/APC? • Need to consider: – Broad categories of finance – Mix of debt and equity – Specific sources of finance and types of financial instruments – Cost, risk, control and other implications 6
The JSE • Are we working with a listed entity? If so • Types of securities? • JSE Debt Market • JSE Derivatives Market • Main board vs ALTx • Listing requirements • Advantages and disadvantages of listing – De-listing / taking a company private • Methods of obtaining a listing • All of the above Key if sources of finance triggered, and the entity is listed. 7
Financial institutions • Financial services offered: – Commercial banking – Investment banking (merchant banking): • Corporate finance • Project finance • Lending • Money-market 8
BASIS FOR INVESTMENT BANK COMMERCIAL BANK COMPARISON Meaning Investment bank refers to a Commercial bank is a bank financial institution, that offers that provides services like services like underwriting of accepting deposits, lending securities, brokerage services money, payment on standing and so on. order and many more. Offers Customer specific service Standardized service Associated with Performance of financial Nation's economic growth and market. demand for credit Customer base Few hundreds only Millions Banker to Individuals, government and All citizens corporations. Income Fees, commissions or profit Fees and interest income on trading activities. 9
Financial institutions cont. – Private equity and venture capital: • Why? • Required returns? • What do private equity firms look for? • Advantages / disadvantages? • Difference? • Special institutions: – Industrial Development Corporation (“IDC”) – Public Investment Corporation (“PIC”) – National Empowerment Fund (“NEF”) and Khula Enterprise Finance – Business Partners – Small Enterprise Development Agency (“SEDA”) 10
Financial institutions cont. • Need to consider “life-stage” of entity • E.g. Small entities / start ups: – Majority of capital usually not from financial institutions / external investors – Usually owners invest personal savings, bank loans in their personal capacity, family and friends (loans or part ownership) 11
Types of finance • Equity – internal or external • Debt – financial institutions or investors • Hybrids – Combination of debt and equity – E.g. preference shares, convertible instruments (e.g. convertible bonds) • Foreign finance – E.g. international listing of shares, international bond issue, international loans 12
Equity-related instruments • Usually primary source of finance • Ordinary shares: – Investors? • Public vs private company • New vs existing shareholders • Retained earnings: – Cost? – Benefit? • Preference shares: – Why? – Hybrid – Cumulative vs non-cumulative – Participating vs non-participating – Redeemable vs non-redeemable – Convertible vs non-convertible 13
Debt-related instruments • Two main types – bank loans and corporate debt • General: – Medium vs long-term – Fixed vs variable rate – Secured vs unsecured – Covenants – Credit ratings • Debentures / corporate bonds / notes • Long-term loans: – Mortgage loans 14
Debt-related instruments cont. • Short-term debt: – Liquidity management (as opposed to financing investments) – Working capital cycle – bridging finance – Includes creditors (raised ‘spontaneously’); bank overdraft; banker’s acceptance; bills and notes; asset based financing (i.e. against debtors and inventory); revolving credit facility 15
Leases • Leases – Application: • General (why lease) • Asset specific finance decisions (discounted lease instalments) – Advantages of leasing NB – Things to look out for include: • Move to IFRS 16. Might be a finance trigger, in terms of using Leasing as finance option but then how would one account for the transaction? What are the tax implications? • Debt covenants. Have they changed ? 16
Debt and equity compared • Return: – Leverage (positive gearing, increase the value of the company) – Tax implications (deductions debt) – Cost (Ke more expensive than debt) • Risk: – Commitment to debt – Capital repayment – Capital structure optimal debt equity ratio • Control: – Dilution (issue of additional shares) – Levels of control NB 75%, 50%, 35% etc – Covenants NB keep a look out for this 17
Financing decision to the specific industry
Generic Considerations • Must consider consequences, relative costs and benefits (including tax implications) and implications for operational and future financing decisions • Factors to consider include: – Cost – Risk – Control – Availability – Market conditions – Impact on financial performance and financial position – Impact on credit rating (if applicable) – Cash flows (matching) – Structure of the entity • NB – suitability for that specific entity and situation! 19
Preparing a financing plan – considerations 1. Purpose of financing e.g.: – Redemptions – Projects – Working capital 2. Period and pattern of financing – Long/short-term – Pattern of cash flow – Try match period of finance with life-time of investment 3. Amount of financing 20
Preparing a financing plan – considerations cont. 4. Different sources – discuss & consider the pro’s and con’s of each – General (i.e. main categories) from the company’s perspective in terms of: • Risk – interest commitment, capital repayment, saturation (risk of financial distress), signaling effects • Return – ongoing returns/leverage, tax implications, cost • Control – dilution, restrictive covenants – Debt-related instruments e.g.: • Various terms and conditions - secured/ unsecured/ convertible/ redeemable/ fixed rate/ variable rate/balloon repayment/ residuals • Debentures • Mortgage bonds 21
Preparing a financing plan – considerations cont. • Loans • Leases – Hybrid instruments e.g.: • Preference shares – Fixed rate/ variable rate/ cumulative / non-cumulative/ redeemable/ non-redeemable/ convertible / participating – Equity related instruments e.g.: • Ordinary shares • Retained earnings – Consider availability, market conditions, availability of security etc. 5. Foreign finance? 22
Preparing a financing plan – considerations cont. 6. Appropriate mix of instruments – Dependent on the company’s current financial position • Perform an analysis – Target capital structure 7. Get specific i.e. where will the funds be raised? – Look at the industry triggered as well as the entity at hand in determining what the ideal solution will be. – This is where the problem at hand can be solved. – Need to have a key idea as to the problem at hand and then involve all the theory above to address the problem at hand. 23
Building a file for coverage • My File. • Theory in terms of the sources of finance summarized in front of the file. NB • Coverage, all questions asked of you labelled for the trigger in the pre release • A summarized sheet with the different finance decisions available with adv and disadantages for both. • Lastly all information used and researched behind this for inclusion where needed. • All the best!
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