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Finance structures and debt financing — Transcript

by NPTEL-NOC IITM · 3,465 words · 522 segments · language en · Watch on YouTube

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0:21Welcome, welcome to banking and finance
0:24loss course. This is the third week.
0:28This week we are discussing different
0:30kinds of finance. This is the 14th
0:34session. In this session we will discuss
0:37about finance structures and debt
0:39financing.
0:41Now as part of different kinds of
0:43finance. We have discussed about debt
0:46financing. We have discussed about
0:48different kinds of debt financing. We
0:51have also discussed about leverage
0:54buyout. And in this class we will
0:57discuss about different finance
0:58structures that are used in debt
1:01financing.
1:02Now we have discussed that debt equity
1:05ratio plays a major role in terms of
1:09financial decisions to be made by the
1:11lenders or by the persons who are
1:14borrowers companies which are taking the
1:17debt. Now what exactly is this debt and
1:20equity ratio and how is it calculated?
1:23It is the simply put ratio of debt visa
1:26v equity in a company at a given time.
1:30For example, a company has a debt of 75
1:33crores and equity worth 25 crores. Then
1:38your debt equity ratio will be 3 to1.
1:42Now debt equity ratio influences the
1:45decision of financing by a financial
1:48institution and it may also influence
1:51the success of a company or a firm.
1:54Generally often it is considered that
1:56the volume of debt has significant
1:59impact besides the nature of finance. If
2:03the entire money is only debt money, the
2:05chances of that company failing is more
2:08when the debt is slightly lesser and
2:12equity is more. This is a general
2:14consideration of every financer. And
2:17this is also a consideration while
2:20taking debt finance. That is the reason
2:22why even in individual financing they
2:25will never give 100% debt. Financial
2:28institutions usually insist on equity
2:31upfront investment or what is the
2:33investment that suppose even in a home
2:35loan borrower they will want the
2:37borrower to have some amount as his
2:40money and they will only finance a
2:43particular percentage of home purchase
2:45value 80% or 75% like that each
2:49financial institution as a part of
2:51policy wants some level of upfront
2:54investment by the borrower in particular
2:57financing because that helps the
3:00interest that they are very serious
3:02about it and at the same time debt
3:04financing becomes easy for them and
3:07secondly the servicing of the loan also
3:10becomes very easy and important but this
3:13is not the sole decision for the success
3:16of any particular thing. Now when we
3:19talk about acquiring firms by debt
3:22financing or leverage buyout
3:26or other kind of debt financing to
3:29acquire a particular firm there are
3:31usually two models in which acquisition
3:34could happen. It could be combination
3:37model also is possible but two prominent
3:40models are management buyin and
3:42management buy out. In management buyin,
3:46an external team or an external company
3:49purchases the business of a particular
3:52existing company. And in management
3:55buyout, the existing team purchases the
3:58shares of the other shareholders and
4:01they become the owners. So in a way
4:03management buyout the existing team of
4:05the company the directors and managers
4:07of the company purchase the shares of
4:10the other shareholders and in management
4:12buyin the other company will buy all the
4:16shares of this company and purchases
4:18this company. This is management buyin
4:21and management buyout. What are the
4:23advantages and disadvantages of
4:26management buyout model? That is the
4:29existing team purchasing the whole
4:31shares of that company. The best
4:34advantage for them is they have the
4:36knowledge of that company and they made
4:39the profits for that company. So growth
4:41potential of the company and
4:43opportunities that company has they are
4:46not allowing it to grow to the outside
4:49people. So in a way they are capping the
4:52opportunities and growth potential to
4:54themselves. So it's a form of ring
4:56fencing. So the management want to
4:58benefit out of the hard work and their
5:01intellect or their potential growth they
5:04have put in into that company in a way
5:06and they have familiarity with the
5:08people who are working. They have
5:10familiarity with the business and they
5:12have familiarity with all the
5:14stakeholders involved in that business.
5:16That is they know the clients. They know
5:19the business opportunities. They know
5:21with whom they can transact and all of
5:23that. So usually management buyout is
5:26considered as a very lowrisk investment
5:28for the creditors. So any investors and
5:31every credit will feel more safe when
5:35the management of their own company are
5:37buying their own shareholders because
5:39the management will not buy if it is
5:41making loss. If the company is making
5:43loss, they don't want to invest further.
5:46So in a way it is an assurance or in a
5:48way they are looking at some growth
5:50potential for their own company. So
5:52usually the creditors feel more safe and
5:55investors feel more safe in a management
5:58buyout company as compared to the
6:01management buyin.
6:04Now what are the advantages and
6:06disadvantages of a management buyin that
6:09is new team purchasing. So it the
6:12advantage is new thoughts and new people
6:14will come in. If the company is not
6:16performing well, the management buyin
6:19could infuse new thoughts into that and
6:21that business they may know very well to
6:24revive that company or they are buying
6:26because it is a small company and the
6:29acquiring company already has major
6:31business. They know the opportunities.
6:33They know the places to reach out to.
6:35These could be some of the reasons why
6:38external team is buying this company. So
6:40they might know that and they so they
6:42bring in new thoughts, new people, new
6:45regime, new management structure which
6:47could altogether revive that company or
6:50put that company in a growth trajectory.
6:52So these are the possibilities with
6:54that. So they might improve the
6:56performance in an unforeseen by the
6:58earlier management. But the biggest
7:01challenge in the management buyin is
7:04when they buy a company they have to
7:06learn about the existing company, their
7:08people, their businesses, their clients
7:10and they have to adapt to the challenges
7:13and the businessfriendly strategies. So
7:16they need to make acceptable those
7:18company employees have to accept this
7:20new management and they have to
7:22cooperate with the new management and
7:24they have to develop certain
7:26businessfriendly strategies and all this
7:28has to be done very quickly. They have
7:31to learn about that company more quickly
7:33so that they get adopt and they revive
7:36that company very often. So because it
7:39is brings in with certain challenges
7:41from the investor's point of view and
7:44from the institutions providing finance
7:47management buyin is considered more
7:49riskier than management buyout and
7:52creditors also will require more finance
7:55for management buyout because the
7:57existing company when team when they are
7:59buying the existing team already has
8:02substantial share or they might they
8:05will generally own substantial share in
8:07that business. So the remaining
8:09shareholders purchase will not be that
8:11expensive for them. But in a management
8:14buy in they are completely buying a new
8:16company and they completely buy that
8:18company shares. So the investment
8:21requirement and the finance requirement
8:24is far higher usually. So it will become
8:27more risk also for that in that way.
8:32Now how does financial institutions
8:36uh finance these particular acquisitions
8:38or in a way when huge loans are asked or
8:42in a way when companies are asking for
8:44thousands of crores or lacks of crores
8:47as financing one banker one financial
8:50institution lending is very very risky
8:52for them also. So usually there are
8:55other ways in which they try to lend. So
8:58they lend it in a form of a group of
9:01bankers or group of bankers and
9:03financial institution or group of
9:06financial institutions. So a combination
9:08of any of them could finance a
9:11particular uh particular loan. So this
9:14form of lending by group of financial
9:17institutions could be in two forms. One
9:20is called consortium lending pattern and
9:23the other is called syndicate lending
9:25pattern. These both have different forms
9:28of lending and they operate in a very
9:32distinct way. Now what is meant by
9:34consortium lending? In consortium
9:37lending, the borrower approaches
9:39multiple bankers and financial
9:41institutions or multiple bankers to or
9:44multiple financial institutions are a
9:46combination of bankers and financial
9:48institution for his loan and each one of
9:52them may enter into agreement to finance
9:54this borrower in a very diff what you
9:57call different proportions. Say for
9:59example there are four lenders an Indian
10:02bank, a state bank of India, a HSBC and
10:06Access Bank. Let us imagine these four
10:08financial institutions has decided to
10:11lend a particular borrower say X and
10:15company. So there need not be equal
10:18percentage of loans that they are
10:20giving. So each one of them have
10:22particular percentage of loan. So SBI is
10:25a major lender here 50%. Then the Axis
10:28Bank and HSBC are having 25% stake in
10:32the loan and Indian bank is having 10%
10:35stake. But all these lenders will enter
10:38into an agreement that each one will not
10:41do to the detriment of others and each
10:44one will proportionately take the
10:46secured assets in that proportion when
10:49the recovery comes. So if the borrower
10:51when he is repaying the cash flow also
10:54will be adjusted in this particular way
10:57only they will make the recovery or they
10:59might agree
11:01that particular borrower will pay to the
11:04first first particular citor will be
11:06paid first and then they will go to
11:08other creditors like that also they can
11:11enter into agreement. So in a way the
11:13creditors will enter into agreement to
11:16finance the particular borrower and the
11:18method of repayment also may be agreed.
11:21They may agree that all creditors will
11:24be paid in the same proportion and all
11:27creditors will recover also in the same
11:29proportion. All they may agree to pay a
11:33particular lender first or a particular
11:36portion of loan will be paid of a
11:38particular lender in the initial days
11:41like that. So the terms of repayment
11:43also could be determined on the basis of
11:46the agreement and the terms. So the
11:48terms among the lenders and the borrower
11:51will determine the debt agreement and
11:54the collateral that will be provided to
11:56whom and in what proportion they will
11:58recover also will be based on the
12:02agreement between the lenders. So in a
12:04way the lenders forming into a group and
12:08entering into an agreement to lend to
12:10the particular borrower. This agreement
12:13will determine the terms of loan for the
12:15borrower and the terms of repayment also
12:19for the borrower and the distribution of
12:22risks also happens to the lender. So if
12:26the borrower fails to repay, not one
12:29lender will be totally affected but
12:31multiple lenders can act as a kind of
12:33shock absorber to the lenders also. So a
12:37particular portion of loan remaining
12:39unpaid may not affect any particular
12:42lender adversely because their effect is
12:45not so high. So it depends on the
12:48absorbing nature of that particular
12:50lender to what extent they can take the
12:52shot they may enter into the agreement.
12:54So in a way borrower one particular
12:56lender may refuse to the borrower to
12:58give that loan because it is huge
13:01amount. So when multiple people comes
13:03together the risk to the lenders is also
13:06minimized and the borrower also will get
13:08the finance he requires to execute the
13:11project. So these are the advantages
13:14that the consortium lending brings to
13:16the lenders and to the borrower.
13:21And the other kind of lending that is
13:25available is called the syndicate
13:28lending pattern. Now what is the
13:30syndicate lending pattern? Here also
13:32there are multiple lenders who form into
13:35a syndicate that is the group take the
13:38same example Access Bank, HSBC, Indian
13:42bank and the uh SBI they formed into a
13:46syndicate a group which will finance a
13:49particular borrower but they will have
13:52one lead bank. Let us take State Bank of
13:55India is the lead bank. Now, State Bank
13:59of India will negotiate the deal. Now,
14:01with whom will it negotiate the deal? It
14:04will negotiate the deal with borrower
14:06also and with the syndicate members
14:08also. So, it will talk to the borrower.
14:11It will understand the borrower's needs.
14:14It will understand when financing what
14:16amount has to flow to the borrower at
14:19which stage of the business and how much
14:21money has to be financed. and SBI
14:24understanding all that needs will
14:26discuss with the syndicate people and
14:29will negotiate the deal with the
14:30syndicate people. So in a way if the
14:33entire deal loan will be only determined
14:36and discussed and terms will be
14:39determined by the lead band. In a way
14:41the other bankers and the other lenders
14:44will only be dealing with the SBI but
14:47not with the borrower directly and the
14:49borrower also is not dealing with the
14:52other lenders but is only dealing with
14:55the lead bank primarily. So in a way for
14:59the borrower it is like the loan is only
15:01given by SBI and for the SBI will in
15:05turn enter into an agreement with the
15:08other lenders. So in a way the other
15:11lenders will give the finance to the
15:13lead bank and lead bank will finance the
15:16borrower and borrower will repay to the
15:19lead bank and the lead bank will repay
15:22to the other lenders. So this is how it
15:25operates. So in a way there is no
15:29multiple borrowers transacting with the
15:32borrower in the syndicate lending.
15:35Whereas in consortium lending multiple
15:38borrowers will enter into discussion
15:40with the borrower and will understand
15:42the borrower's business and will try to
15:45understand the risks in the borrower's
15:47business and will make a decision
15:49individually to finance but collectively
15:52to lend. So that is how in the
15:55consortium lending model happens.
15:58Whereas when we come to the syndicate
16:00lending in syndicate lending it is the
16:03lead bank which will determine the need
16:07to finance the particular business and
16:09will determine the business will
16:11understand the business of the borrower
16:14and will start giving loans to the
16:16borrower. So in a way in syndicate
16:19lending the lead bank takes the
16:21negotiating role to the borrowers and
16:24also to the lenders. So the they will
16:27finance majorly. At times they may be
16:30the minor financer also but lead bank
16:34role does not mean they are the lead
16:36financers but they do the negotiation
16:38with the borrower and with the lenders
16:42and lead bank operates as a intermediary
16:46for collecting the loan amount or
16:49collecting the interest and repaying it
16:51to all the borrowers and all the lenders
16:54from the borrowers's money. So the role
16:57of the lead bank is slightly very
17:00distinct from the uh in the syndicate
17:04lending as opposed in the consortium
17:06lending. In consortium lending everybody
17:09is collectively liable and collectively
17:12entitled. So their entitles entitlements
17:15are collective their liabilities also
17:17are collective. But in syndicate lending
17:21lead bank has sole responsibility to
17:25give loan and to recover the loan while
17:28his agreement with other lenders is
17:30independent to the borrower. So the in
17:34syndicate lending the lead bank has a
17:36responsibility towards other lenders.
17:39For the other lenders, it is like
17:41financing the banker but they are
17:44financing a borrower through the banker
17:47but not dealing with the borrower are
17:49not interested to understand the
17:52borrower's business as greatly as is
17:54required in a consortium lending.
17:58So in a way it operates very very
18:00distinctly from the uh consortium
18:03lending and syndicate lending has very
18:05distinct consequences for the lenders.
18:08So it this is important for the
18:10financial institution also and for the
18:13borrower also to understand how this is
18:16going to operate their businesses and
18:18how the recovery will affect their
18:21particular business. Now debt needs and
18:24the volume of debt required has very
18:27distinct. For example, a company might
18:30require 100 cr debt. Now then requiring
18:33debt and the volume of debt for example
18:36what is the company's total assets a
18:3810,000 cr asset worth company requiring
18:41100 cr loan is very minimal for that
18:44particular company and even for the
18:47financial institution giving that amount
18:49of 100 cr debt is very easy for it to
18:52finance and to recover also because that
18:5410,000 cr company will have assets much
18:58much higher than them and can take the
19:00security also very high but for example
19:03a 20 cr turnover company asking for a
19:06100 cr debt will require a very distinct
19:09appreciation for the bankers to provide
19:12that loan so the amount of risks
19:14involved will be very far higher but a
19:1710,000 cr company if it is establishing
19:20an SPV and is taking 100 cr loan then it
19:23is very distinct because your 10,000 cr
19:27company is not going to repay the 100 cr
19:30loan if The SPV has 10 cr investment.
19:33Your 100 crore loan has to be recovered
19:35only from the 10 cr investment that is
19:38made by that company. So in a way it is
19:41equal to a 10 crore company only. So
19:44what is the volume of debt that you are
19:46providing to which company is not just
19:49determined on the company to which you
19:52are providing. So if you are providing
19:54to a wholly owned subsidiary of that
19:56company that subsidiary company's net
19:59worth is what the company's assets are
20:02on that particular day. So your
20:04collateral you should look for which
20:07company when so when you are taking a
20:0910,000 cr company's SPV to finance 100
20:13cr loan where the equity investment is
20:15only 10 cr you may ask that 10,000 cr
20:19company assets to be given as collateral
20:23in that case your debt is can be called
20:26as secured debt so in a way the volume
20:29of debt and debt needs of that
20:31particular company and what collateral
20:33you are getting is what you have to look
20:36at in that individual
20:38collateral and individual company that
20:41you are financing. If you are directly
20:43financing 100 cr to a 10,000 cr company
20:46then it is very distinct from 100 cr
20:50loan being given to a 10,000 cr
20:52company's SPV where their equity
20:55investment is only 10 cr. So these are
20:58very important debt consideration from
21:01the point of view of the company also
21:03and from the financial institution also.
21:06From the point of view of company for
21:08the SPV they may limit their liability
21:10only to the SPV investment and they may
21:13not provide a collateral if it is in the
21:15project finance model. So in that case
21:18the financial institution's risk is
21:21equal to financing a 10 cr company even
21:24if it is a 10,000 cr company's
21:26subsidiary because there is no
21:28collateral and the liability of the
21:30company is limited to that 10 cr
21:32investment. So these are very very
21:35important considerations in terms of
21:38financing. Similarly, debt equity ratio.
21:42Company may be doing profits, but if the
21:44entire profit is only used to service
21:46the debt and if there is no money
21:48available to pay the principal amount,
21:51the financial institution might become
21:53very difficult for it to recover because
21:55the debt ratio is far higher to its
21:58equity ratio and the profits are the
22:00cash flow is not sufficient to surpass
22:02that debt equity ratio and make the
22:05profit. So if it is unless the cash flow
22:07is very very abnormally huge you may the
22:11company may not be able to service the
22:13debt as opposed to the total equity
22:17investment is far less and the cash flow
22:20cannot be expected. So all this becomes
22:22very important decision and how do how
22:25is the debt structured that is whether
22:27it is through SPV whether it is through
22:29consortium whether it is to syndicate
22:31lending what is the amount all these are
22:34and whether it is a convertible
22:36instrument all these are extremely
22:39important financial decisions whether it
22:42is in general whether it is operating a
22:44business in particular whether it is in
22:46a growth stage whether it is in
22:48acquiring stage whether it is in
22:50expansion stage. All these are extremely
22:53important financial decisions and these
22:57decisions in many cases will have a
23:00major impact on the success or on the
23:04failure of a particular business because
23:06of huge debt being burdened on a
23:10company's cash flow which it may not be
23:12able to redeem. So these are very very
23:15important decisions. These decisions can
23:17only be made by the company managers if
23:21they understand how each of these
23:23operate and what are the implications of
23:27each of these decisions. So this is this
23:30is very important to understand finance
23:32and its implications before providing
23:35finance or seeking finance.
23:38We will discuss about project finance in
23:42the next class. With this we will
23:44conclude our discussion on finance
23:47structures and their implications.
23:50Thank you.

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