Types of Equity and Debt instruments
Equity
instruments
Equity instruments refer to the business
documents that are utilized as legally binding, thus can comfortably be
enforced by the evidence that a business owner have the right to possession and
ownership of all the business pursuits being run by a firm. Ordinarily, equity
instruments are declared by the start-up company to the willing investors who
finance various projects initiated by the company. There are multiple documents
used today as equity instruments. These documents include share or stock
certificate, warrants, equity shares, preference shares and stock (Weiss 2009).
When a start-up company joins an agreement
with a financial institution so as to be funded via equity, they have to be
completely aware that part of the ownership of the start-up will be taken over
by the financial institution. Legally, these investors are permitted to have
some level of control on how the start -up business will be run so that they
can have a return on the amount they invest. Generally, start- up ventures can
declare stocks as shares to the speculating shareholders. Therefore, the more
the number of shares that a financial institution gains from the start-up
company, the greater the level of possession of the firm; hence, the financial
institution exercises greater decisive power and influence in the day to day
operations of the company (Parameswaran et al.2011).
Distinctly, there
is a greater imminent risk arising from becoming an equity holder. This is
mainly because in a likely event that a start-up company is unable to endure
the market competition and, therefore, declares bankruptcy, the equity lender
will be granted the utmost priority as compared to the equity holder. Besides,
higher rates of return can be realized by the holder in case of initial success
levels at the start- up company. In contrast with debt instruments, equity
instruments have the ability to variable rates of return that relates to the
level of success achieved by a start-up company. Ultimately, the better the
business performs, the higher the return to an investing financial institution.
Common
Stock
Common stock is an equity
instrument that is mostly preferred by start- up public companies to solicit
funds from the members of the general public. Once a financial institution
invests in these shares, their status is immediately elevated to the ownership
status of the company. Henceforth, they are unanimously granted the voting
rights during the meeting of shareholders to pass major decisions. Chandra (2008) argues that the voting rights are accorded
as per the number of shares owned by the investor. Voting rights come with many
privileges to the investor, which include playing a role in some of the vital
decisions being made by the company. The decisions include a capital raise for
supplement in dividend payments, managerial roles, and the need to consolidate
the company with other like-minded business organization so as to improve the
level of performance and raise the chances of success.
Preferred
Stock
Compared to common stock, preferred
stock owner earns more on the company’s assets and profits made. In fact,
corporate laws grant preferred stock owners to be considered for payment before
the common stock owners’ dividend payment is declared. For preferred share
owners, there are fixed dividend rates which are usually paid in every quarter
of a given financial year. This is not the case with the common stock
investors. However, the payment structure should be in accordance with their
dividends in the company.
During its infantry, a company is
likely to consider a financial institution as a preferred stock owner. This
ensures that the company has a security that can revive it in order to
withstand market shocks that are encountered during the early stages of a
business venture development. On the other hand, a financial institution
benefits from an investment in preferred stock of a start-up company in that
there is a higher chance of rate of return as compared to common stock. The
benefits can further be magnified especially if a business becomes successful,
thus raising the income levels of a financial institution (Fabozzi2002).
Convertible
Debenture
There is a remarkable correlation
between convertible debenture and ordinary bonds. However, the former can
easily be altered to the ordinary share stock, especially when stipulated
prices and rates as indicated in the disclosure document or the prospectus are
achieved. This is unlikely in the common bonds.
For a financial institution ready
to invest in a start-up business, it is advisable that they contemplate the
acquisition of the convertible debentures due to their flexibility. With decent
guidance, the convertible debenture can demonstrate itself to be highly
profitable more so when converted to common bonds at the right time.
Additionally, a profitable firm points to higher income to an investment
through convertible debentures (Coyle 2002).
Depository
Receipts
A depository receipt is another
equity instrument which bestows rights to the investor that are similar to
those of ordinary bonds, convertible and common debentures. Equipped with
depository receipt, a financial institution is subscribed to both the company's
voting rights as well as the financial rights. There are other specific
additional benefits to the holder of the depository receipt. Consequently, these
rights are outlined in the contract signed between the business owner and a
financial institution as an investor.
Transferable
Subscription Rights (TSR)
TSR refers to an equity instrument
issued to the respective investors and shareholders of a company in accordance
with the allotment of shares that they own in the venture. The role of the
transferable subscription right is that it is a suggestive evidence of the
number of shares owned by an individual investor. Additionally, TSR can be
negotiated amongst the shareholders to signify the transfer of rights and
privileges from one stockholder to the other.
In case a business venture becomes
successful, a financial institution can buy TSR from other investors in the
same venture so that absolute control of the business can be ensured. This will
subsequently lead to a long-term transfer of ownership of the business to the
institution hence increase in sources of revenue (Sangiuoloet al. 2008)
Debt
Instruments.
A debt instrument refers to a law
binding contract signed between a financial institution ready to invest in a
start-up company, the presumed owner of the start-up business venture and the
stakeholders of the company who act as a third party to the contract. Legally,
the instrument authorizes a lending institution to give out credit to the
company as a capital to run its business activities. If the venture registers
failure in its activities, the financial institution can justly be compensated
in accordance with the agreements that are laid down in the contract. There are
various types of debt statement. These include mortgages and mortgaged
properties, business loans, corporate bonds, business leases, and banknotes (Fitzpatrick
et. al 2013).
Loan
Loan refers to a debt instrument
whereby property, money, or material goods ownership are transferred from a
lending financial institution to a start-up company in accordance with the
terms and conditions agreed to and mutually signed by both lender and borrower.
The terms and conditions include the time frame with which the loan can be
repaid, the periodic installments of the repay, the rate of interest charged by
the financial institutions on the periodic repayment structure, among other
particularized terms. In case of larger loans demanded, the financial
institution has a choice of asking for security to the loan. The security can
comprise properties such as land, buildings and other non-liquid assets owned
by the borrower. Additionally, business securities can also be sourced from the
guarantors to the borrower (Brigham et. al 2013).
A bond is a debt instrument that
symbolizes the value of a loaned amount to a business entity or to a government
as an investment. At maturity period, the bond loan is repaid back to the
lending financial institution inclusive of the fixed interests that were
initially agreed upon by the financial institution and the borrower. The main
benefit of a bond is that they are widely accepted as securities in case
financial institutions require further funding from last resort lenders such as
central banks. This is a likely case when a government is offering a stimulus
package in order to boost a country’s slowing economic performance (Brigham et.
al 2013).
Mortgage
A mortgage refers to a debt
instrument that is in many ways similar to a loan, only that it is a secured
lien. Generally, a mortgage is loaned for residential building and property.
The borrowing party can fully own the mortgaged property, after all, the loan
has been paid back to the source, which, in this case, is the financial
institution. Failure to repay the loan signals the retake of the mortgaged
property by the financial institution so as to clear the outstanding debt of
the borrower.
Fabozzi (2002) observes that mortgages
are attractive to the start-up businesses in that the property can be rented to
a third party hence generating income. The income from the property being
mortgaged can, therefore, be utilized to scrap the outstanding balances of the
periodic investment to the lending institution. Eventually, the remainder of
the amount can further be used to accelerate the performance of the start-up.
To the lending financial institution, the risk of incurring
losses from written off debts is highly diminished as the mortgaged property
can be retaken back from the borrower if there is a failure to meet the stated
terms in the contract. Therefore, the property can be re-mortgaged back or
auctioned to recover the outstanding balances owed by the start-up.
Lease
A lease is a form of long-term
debt, whereby it is composed of a legally binding agreement between the
property owner (financial institution) and the property tenant (Start-up
Company). Because a start-up company usually lacks enough capital to acquire
property which requires large funding, the better alternative is to lease the
property from an established lease firm. Through leasing, they will be able to
run their operations using the property while paying periodic rent (usually on
a monthly basis) at a significantly lower compared to when they fully acquire
the property. Properties that can be leased include buildings, motor vehicles,
land area, and even machinery. Notably, all the maintenance costs of the leased
property are usually catered for by the property owner unless the contract
agreements stipulate otherwise.
On the other hand, a financial
institution is assured of a regular rent payment from the lessee. The payment
can by far outweighs the maintenance cost of the property. Additionally, the
ownership of the property can never be transferred to the lessee unless the
overall contract is fully terminated and a new one is sealed. Furthermore, the
lessor has an option of raising the amount of one-time periodic lease payment
to factor in the inflation, fluctuation in market prices and other rising
maintenance costs. Therefore, a financial institution in completely unaffected
by the burden of low returns due to entry into faulty contracts with an
inability to withstand the test of time (Boobyer 2004).
Conclusion.
Before investing in a start-up
business, a financial institution should be able to look at the long-term goals
and interest of the firm. Additionally, a firm should have a well laid down
strategies on how it will be able to meet its short term and long term goals,
which should include maximization of profit and taking care of the stakeholders’
welfare. Furthermore, the chosen instruments for investment in the start-up
should ensure an immediate return on investment to the financial institution by
ensuring efficiency in a conversion from one instrument to the other.
Ultimately, it is highly recommended that a financial institution make a choice
of an instrument that grants greater voting and financial rights so as to
guarantee wider influence on the company's activities to meet the long term
needs of the financial institution.
Reference
List
Boobyer,
C. (2004). Leasing and asset
finance: The comprehensive guide for practitioners. London
Brigham,
E. F. ,
& Ehrhardt, M.
C. Mason , Ohio
Coyle, B. (2002). Hybrid financial instruments. Canterbury
Fabozzi, F.J. (2002). The
Handbook of Financial Instruments. Hoboken ,
NJ John
Wiley & Sons. http://www.123library.org/book_details/?id=7915.
Fitzpatrick, J., Symes, C., Veljanovski, A.,&Parker, D(2013). Business and
Corporations Law, LexisNexis, Bluesworth. https://store.lexisnexis.com.au/product?product=business-and-corporations-law-2nd-edition&meta_F_and=9780409336887
Parameswaran,
S.K. (2011). Fundamentals of financial
instruments: an introduction to stocks, bonds, foreign exchange, and
derivatives. Singapore , John Wiley & Sons (Asia )
Pte. Ltd.
Sangiuolo,
R., &Seidman, L.F. (2008). Financial instruments: a
comprehensive guide to accounting and reporting. Chicago , IL CCH .
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