Revision: Unit-2 : Financing >> Sources of Finance for a Joint Stock Company Commerce ISC (Commerce) Class 12 CISCE

As per Section 2(84) of the Companies Act 2013, “Share is the share in the capital of a company and includes stock as well.”

Employee Stock Option is a plan where the company's whole-time directors, officers, and employees get an opportunity of purchasing their own company's shares at a predetermined price in the future. The price at which these shares are offered is usually lower than the market price.

• According to section 2(30) of the Companies Act, 2013, " Debenture includes debenture stock, bonds and any other securities of a Company, whether constituting a charge on the assets of the Company or not." 
• “A Debenture is a document given by a company as evidence of a debt to the holder, usually arising out of a loan and most commonly secured by a charge." -Topham
• According to Evelyn Thomas, "a debenture is a document under the company's seal which provides for the payment of a principal sum and interest thereon at regular intervals, which is usually secured by a fixed or floating change on the company's property or undertaking and which acknowledges a loan to the company".

• According to Evelyn Thomas, "a debenture is a document under the company's seal, which provides for the payment of a principal sum and interest thereon at regular intervals, which is usually secured by a fixed or floating change on the company's property or undertaking and which acknowledges a loan to the company".

• According to the Companies Act, "a share is a share in the share capital of a company, and includes stock except where a distinction between stock and shares is expressed or implied".
• According to Justice Farewell, "A share is the interest of the shareholders in the company measured by a sum of money for the purpose of liability and of interest (dividend). It also consists of other rights given by the Articles of Association".

• Debenture: A written promise by a company to repay a loan with interest.
• Legal View: Includes all debt instruments, as per the Companies Act, 2013.
• Key Features: Fixed interest, secured by assets, issued under seal, max 10-year term (30 for infrastructure).
• Debentureholders: They are lenders, not owners of the company.
• Bond vs Debenture: Bonds may have no fixed interest; debentures always do.

• Meaning: Commercial banks are a major source of short-term finance for businesses, mainly to meet working capital needs.
• Forms of bank credit: Banks provide finance through loans and advances, cash credit, overdrafts, and discounting of bills.
• Interest & security: Interest is charged at a fixed rate; loans are usually secured, and interest is paid only on the amount actually used in cash credit and overdrafts.
• Advantages: Bank credit is flexible, offers various financing options, ensures secrecy, and does not interfere in business management.
• Limitations: It involves legal formalities, security requirements, high interest, and loans are short-term with uncertain renewal.

• Meaning: Sweat equity shares are issued to employees or directors at a discount, for non-cash consideration, or for providing know-how / intellectual property.
• Legal provision: They are issued under Section 79A of the Companies Act and must follow SEBI guidelines.
• Approval required: Issue must be authorised by a special resolution in the general meeting specifying number, value and eligible employees/directors.
• Eligibility conditions: Company must have completed at least one year of business and shares must be of a class already issued.
• Purpose & restriction: Issued to retain talent; these shares cannot be sold for 3 years, and employees may choose cash instead of shares.

• Meaning: Commercial banks provide short-term loans and sometimes medium/long-term loans to SSMEs as term loans.
• Lump-sum & security: A fixed amount is given for a fixed period, usually against security or personal guarantee.
• Advantages: Funds are available for a fixed time, allow trading on equity, and interest is tax-deductible.
• Repayment: Loan is repaid in instalments out of future earnings of the business.
• Disadvantages: Requires mortgage of assets, involves formalities, and interest must be paid even in losses.

• A joint stock company needs two types of finance: long-term and short-term.
• Long-term finance is used to buy fixed assets like land, buildings, machinery, etc.
• Sources of long-term finance include shares, debentures, retained earnings, and long-term loans.
• Short-term finance is needed for day-to-day requirements like stock, cash and debtors.
• Funds are classified as owned funds (shares, retained earnings) and borrowed funds (debentures, deposits, loans).

• Equity shares are ownership securities and form the ownership capital of a company.
• They carry no preferential rights in payment of dividend or repayment of capital.
• Dividend on equity shares is paid only out of profits and after preference shareholders.
• Equity shareholders are repaid last at winding up, so they bear the maximum risk.
• They enjoy voting rights and control and are entitled to the residual profits of the company.

• No fixed dividend obligation – dividend is paid only when profits are available, so there is no burden on the company.
• Permanent source of capital – equity capital is repaid only at winding up, but this may cause over-capitalisation.
• Full voting rights to shareholders – gives control to owners, but may lead to manipulation of control by a few.
• High return and capital gains possible – shareholders can earn high dividends and capital appreciation, but face high risk.
• Costly and risky source – issuing equity shares is expensive for companies and prices fluctuate for investors.

• Priority in dividend and capital – Preference shareholders get a fixed dividend before equity shareholders and their capital is repaid first at winding up.
• Limited voting rights – Generally, preference shareholders do not have voting rights, except when dividend remains unpaid for a specified period.
• Hybrid security – Preference shares have features of equity (dividend paid only out of profits) and debentures (fixed rate of dividend).
• Types based on dividend and benefits – They may be cumulative or non-cumulative and participating or non-participating.
• Types based on conversion and redemption – Preference shares can be convertible or non-convertible and redeemable (maximum period 20 years).

• Fixed priority return – Preference shareholders get a fixed dividend before equity shareholders and priority in repayment of capital, so risk is lower than equity.
• No control in management – Generally, preference shares do not carry voting rights, so promoters retain control, but investors have no say.
• No charge on assets – Issue of preference shares does not create a mortgage on company assets, improving borrowing capacity.
• Fixed burden for company – Dividend on preference shares is payable before equity dividend and is not tax-deductible, making it costlier than debentures.
• Limited growth benefit – Preference shareholders usually do not enjoy capital appreciation or high profits, except in participating preference shares.

• Meaning: Bonus shares are fully paid shares issued free of cost to existing shareholders in proportion to their holdings, instead of cash dividend.
• Purpose: Bonus issue is used to capitalise undistributed profits of the company.
• Authorisation: Issue of bonus shares must be authorised by Articles of Association and approved by shareholders in a general meeting.
• Conditions: Bonus shares can be issued only if the company has no default in payment of interest, debts, statutory dues, and all partly paid shares are made fully paid.
• Source & Rules: Bonus shares are issued only from free reserves or share premium, not from revaluation reserves, and cannot replace dividend.

• Meaning: Right shares are new shares offered to existing shareholders in proportion to their holdings, usually at a price lower than the market price.
• Legal provision: Under Section 62 of the Companies Act, 2013, a company must first offer new shares to existing shareholders (Right of Pre-emption).
• Offer procedure: A notice is issued specifying the number of shares, and shareholders are given at least 30 days to accept the offer.
• Shareholder options: Shareholders may accept, reject, or renounce (transfer) their right shares to someone else.
• Exceptions: Right shares need not be offered in special cases such as early-stage issues, special resolution approval, Central Government approval, or when all shareholders decline.

• Meaning: ESOP gives employees the right to buy company shares at a fixed price (usually below market price) after meeting eligibility conditions.
• Motivation: It links employee reward with performance and encourages better work.
• Retention: Helps in retaining efficient employees and reduces employee turnover.
• Ownership feeling: Creates a sense of ownership, responsibility and team spirit among employees.
• Limitations: Useful mainly for profit-making companies; falling share prices and lack of transparency can cause losses and dissatisfaction.

• Meaning: Retained earnings mean keeping a part of net profit in the business for reinvestment instead of distributing it as dividend; it is also called self-financing.
• Source & use: It is an internal source of finance, mainly used for expansion, modernisation, debt repayment and replacement of old assets.
• Advantages to company: It is cheap and convenient, creates no charge on assets, improves financial strength and creditworthiness, and does not dilute control.
• Benefits to shareholders & society: Shareholders get safety, regular dividends and higher profitability, while society benefits through capital formation, stability and better quality goods.
• Limitations: Excessive retention may cause low dividends, shareholder dissatisfaction, over-capitalisation, misuse of funds and unbalanced growth.

• Debentures = Loan capital of a company; holders are creditors.
• Fixed interest is paid even if there is no profit; no voting rights.
• Secured or Unsecured: May be issued with or without charge on assets.
• Redeemable or Irredeemable: Repaid after a fixed time or at winding up.
• Bearer or Registered: Transferable by delivery or through records.
• Convertible or Non-convertible: May or may not convert into shares.
• Priority: Repaid before shareholders and legal action is possible on default.

• Safe & fixed return: Debentures provide regular fixed interest and are usually secured on assets, so they suit cautious investors.
• Economical for company: Cost of issuing debentures is lower than shares and interest is tax-deductible.
• No loss of control: Debentureholders have no voting rights, so management control is not diluted.
• Fixed burden: Interest must be paid even during losses, which can strain company finances.
• Limited investor appeal: Debentures offer no voting rights or capital appreciation, so they are unattractive to risk-taking investors.

• Meaning: Special financial institutions provide medium- and long-term finance for new, expanding and modernising businesses.
• Types of finance: They provide both equity and loan capital and also offer technical and managerial support.
• Major institutions: IFCI, IDBI, ICICI, SIDBI, LIC, GIC and State Financial Corporations are important sources.
• Advantages: Finance is available on easy terms, with expert guidance, foreign currency loans and repayment in instalments.
• Disadvantages: Involves strict investigation, security requirements, and sometimes restrictions on management freedom.

• Meaning: Public deposits are loans taken by companies from the public, including shareholders and employees, for a short or medium period.
• Economical & simple: They are cheaper than bank loans, involve low formalities, and interest paid is tax-deductible.
• No control or charge: Public deposits do not dilute ownership, give no voting rights to depositors, and usually do not create a charge on assets.
• Flexible source: Deposits can be repaid when not needed, help in trading on equity, and are available for a longer period than bank loans.
• Limitations: They are uncertain and risky, not available to new firms, may encourage speculation, and can restrict capital market growth.

• Meaning: Trade credit is credit given by sellers to buyers for goods and services, allowing the buyer to purchase now and pay later.
• Nature: It is a short-term, unsecured credit, usually for 15 days to 3 months, and does not provide cash.
• Forms: Trade credit is given through open account or bills payable.
• Advantages: It is simple, interest-free, flexible, and more economical than bank loans.
• Limitations: Credit prices are higher, cash discounts are lost, and sellers bear the risk of bad debts.

• Meaning: Instalment credit allows a business to buy machinery and durable goods on credit by paying in instalments.
• Payment system: A part of the price is paid at delivery and the balance in fixed instalments.
• Interest: Interest is charged on the outstanding balance and is included in each instalment.
• Ownership: In hire purchase, ownership remains with the seller until all instalments are paid.
• Merit & Limitation: It helps firms use assets immediately and pay from earnings, but involves high interest cost.

• Meaning: It is a method of raising finance by selling or pledging book debts (debtors).
• Source: Finance companies or factors provide funds against accounts receivable.
• Amount financed: Usually up to about 60% of receivables is advanced.
• Factoring: Outright sale of receivables is called factoring; the factor collects debts.
• Merit & Limitation: It reduces collection work, but is costly due to heavy discount.

• Meaning: Advance payment taken from customers at the time of booking goods.
• Nature: It forms part of the sale price of goods to be delivered later.
• Usage: Common for durable goods with waiting period (e.g., cars, phone connections).
• Benefit: Provides working capital to the business before delivery.
• Limitation: Available only to firms with high demand or short supply products.

• Meaning: Short-term loan (up to about 6 months) taken by one company from another company.
• Nature: ICDs are generally unsecured and arranged through a financier.
• Procedure: No legal formalities are involved and borrower’s identity is not disclosed publicly.
• Cost: Interest rate is usually lower than bank and financial institution loans.
• Availability: Given only to reputed companies and based on mutual trust and personal relations.