Other international alternatives

Another possibility for a company is to issue shares or bonds on a local market. In this case the foreign bond or share issues and trading are conducted under the supervision of local market authorities.

6.5.1 Foreign bonds

Foreign bonds are issued on a local market by a foreign borrower and are usually denominated in the local currency. In the US, non-US companies are able to issue bonds in a 'private placement' market. This is a stock market in which investors are restricted to investment institutions, and the wider general public cannot invest. Australian companies might, therefore, choose to issue bonds or shares in this market, to gain exposure to US investors and a more international investor base.

6.5.2 Foreign equity

Alternatively a company may apply for its shares to be traded on a foreign stock market.

For example, equity of large non-US companies might be traded on US stock markets in a special form known as American Depositary Receipts, or ADRs. An ADR is a security denominated in US dollars, that is backed by a number of shares in the non-US company. An Australian company wanting to raise capital in the US might therefore place a number of new shares in the custody of a bank, and a US bank will issue ADRs backed by these shares. The ADRs are registered in the US, and accepted to trading on a US stock market, such as the New York Stock Exchange or Nasdaq. When the Australian company pays dividends on the shares, it makes the dividend payment in Australian dollars, but ADR holders receive their dividends in US dollars from the US bank.

6.5.3 Regulation and compliance

When the bonds or shares (ADRs) of an Australian company are traded in the US, the company must comply with US market regulations. In the US, shares cannot be offered for sale to the general public unless they have been registered with the Securities and Exchange Commission (SEC). Australian companies not wanting to go through the costly and time-consuming procedures for obtaining registration can opt instead for the private placement market (for which registration is not required) but they must comply with the

Key chapter points

• Capital structure refers to how a company is financed and involves choosing a suitable balance between debt capital and equity capital (gearing level), and deciding to what extent current assets can safely be financed by current liabilities.

• Gearing is a term that is used to refer to the balance between debt capital and equity capital.

• Factors influencing the choice of financing method, other than gearing, include the company's profitability, the relative cost of different sources of finance, ease of access to different sources of finance, dilution of ownership with some forms of equity issue, maximum borrowing limits and other loan covenants, the security required for borrowing, conditions in the capital markets and the purpose for which the finance is required.

• As a general rule businesses should aim to match the length of finance with the maturity of the asset being financed, therefore non-current assets would be financed by long term capital and the majority of current assets by short-term capital.

• A range of short-term sources of finance are available to businesses including overdrafts, short-term loans, trade credit and lease finance. Long-term sources of finance are available to businesses including debt finance, leasing, venture capital and equity finance.

• The choice of debt finance that a company can make depends upon the availability of funds due to the size of the business, the duration of the loan, preference for a fixed or floating interest rate, the security that can be offered.

• The term bonds describes various forms of long-term debt a company may issue, such as loan notes or debentures, which may be redeemable or irredeemable.

• Convertible bonds are bonds that gives the holder the right to convert to other securities, normally ordinary shares, at a pre-determined price/rate and time.

• Equity finance refers to the ordinary share capital of the company and can come from three sources:

retained earnings, rights issue, or new share issue.

• A company can obtain a stock market listing for its shares through a public offer or a placing.

• A rights issue is an offer to existing shareholders enabling them to buy more shares, usually at a price lower than the current market price.

• Venture capital is risk capital, normally provided in return for an equity stake to companies with high growth potential.

• International money and capital markets are available for larger companies wishing to raise larger amounts of finance.

• The eurocurrency market is the money market for borrowing and lending by banks in

currencies other than that of the country in which the bank is based. Typically, only available in major currencies for which active markets exist.

• Eurobonds are long-term loans raised by international companies or other institutions and sold to investors in several countries at the same time.

Quick revision questions

1 Debentures are more similar to equity than preference shares.

true false

2 Which of the following sources of equity finance is a company most likely to use in practice?

A rights issue B retained earnings C venture capital D new share issue

3 Which of the following is least likely to be a reason for seeking a stock market flotation?

A improving the existing owners' control over the business B access to a wider pool of finance

C enhancement of the company's image D transfer of capital to other uses

4 Which of the following is not true of a rights issue by a listed company?

A rights issues do not require a prospectus

B the rights issue price can be at a discount to market price C if shareholders do not take up the rights, the rights lapse

D relative voting rights are unaffected if shareholders exercise their rights 5 Consider the following statements concerning share issues.

I An offer for sale involves a listed company making a direct invitation to the public to purchase shares in the company.

II A bonus issue involves the issue of new shares for cash to existing shareholders in proportion to their existing shareholdings.

Are the statements above true or false?

Statement

I II

A true true

B true false

C false true

D false false

6 Three important sources of long-term finance are loan capital, ordinary shares and preference shares.

Which one of the following correctly ranks these sources of finance according to their relative cost to the business? (Where 1 represents the source of finance that is normally the most expensive and

7 The following comments, relating to methods of issuing shares by a public company, were recently made:

I An offer for sale is an invitation to the public to buy shares that are not yet in issue.

II A placing is an invitation to selected investors to buy either new shares or shares already in issue.

Which one of the following combinations (true/false) concerning the above statements is correct?

Statement

I II

A true true

B true false

C false true

D false false

8 What is the term for an arrangement whereby a listed company issues new shares which are bought by a small number of institutional investors, such as pension funds and insurance companies?

A placing B offer for sale

C offer for subscription D IPO

Answers to quick revision questions

1 False

Debentures pay a fixed return each year to investors, as do preference shares, while ordinary shares (equity) pay a variable return each year depending on the fortunes of the company. Also debentures and preference shares are both repaid on a liquidation before ordinary shares.

Therefore debentures are more similar to preference shares than to equity.

2 B For most companies, retained earnings are the most important source of equity finance and would be used before considering a new/rights issue. Venture capital is high risk equity finance and is only provided to companies with significant growth potential.

3 A Flotation is likely to involve a significant loss of control to a wider circle of investors.

4 C Shareholders have the option of renouncing the rights and selling them on the market.

5 D An offer for sale involves a sponsoring intermediary such as an investment bank making a public invitation to purchase shares in the company. An offer for subscription is where the listed company makes a direct invitation itself.

A rights issue involves the issue of new shares for cash to existing shareholders in proportion to their existing shareholdings. A bonus issue is a free issue of shares to existing shareholders in proportion to their existing shareholdings.

6 C Loan finance is normally the cheapest external source since its cost (interest) attracts tax relief and has the lowest risks. Neither preference share nor ordinary share returns (dividends) attract tax relief. Preference shares are lower risk than ordinary shares due to their preferred right to dividends and capital and therefore have a lower cost.

7 C An offer for sale involves the sale of shares already in issue.

8 A An offer for sale and offer for subscription are issues of shares to the general public, and are larger issues than a placing. An IPO (initial public offering) is a term for an issue of shares to the general public when a company comes to the stock market for the first time.