Revise Lecture 15

Financial Services

Factoring

Features of Factoring

Financial services Features of Factoring: 3. A factor performs at least two of the following functions; Providing finance Maintaining accounts ledgers Collecting receivables Protecting risk of default in payments

Financial services Features of Factoring: 4. Factor acts as another financial intermediary between the buyer and the seller. 5. Unlike a bank, a factor specializes in handling and collecting receivables in an efficient manner. The factor receives the payments directly since the invoices are assigned in favour of it.

Mechanism of Factoring

Financial services Mechanism of Factoring: The mechanism of factoring is summed up as the following; 1.An agreement is entered into between the selling firm and the buying firm. 2.The sales documents should contain the instructions to make payments directly to the factor who is assigned the job of collection of receivables.

Financial services Mechanism of Factoring: 3. When the payment is received by the factor, the account of the firm is credited by the factor deducting its fee, charges, interest etc as agreed upon. 4. The factor may provide advance finance to the selling firm if the conditions of the agreement so require.

Types of Factoring

Financial services Types of Factoring: However, the following are some of the important types of factoring arrangements; 1.Recourse and non-recourse factoring 2.Advance and maturity factoring 3.Conventional or full factoring 4.Domestic and export factoring 5.Limited factoring

Financial services Types of Factoring: 6. Selected seller based factoring 7. Selected buyer based factoring 8. Disclosed and undisclosed factoring

Financial services Types of Factoring: Recourse & Non- recourse In a recourse factoring arrangement, the factor has recourse to the client (selling firm) if the receivables purchased turn out to be bad. Let the risk of bad debt is to be borne by the client and the factor does not assume credit risks associated with the receivables.

Financial services Types of Factoring: Recourse & Non- recourse In the case of non-recourse factoring, the risk or loss on account of non-payment by the customers of the client is to be borne by the factor and he cannot claim this amount from the selling firm. Since here he bears the risk of non-payment, commission or fee charged for the services is higher than that under the recourse factoring.

Financial services Types of Factoring: Advance and maturity factoring

Financial services Advance and maturity factoring Under advance and maturity factoring arrangement, the factor pays only a certain percentage (between 70% and 90%) of the receivables in advance to the client, the balance being paid on the guaranteed payment date. The rate of discount / interest is determined on the basis of the creditworthiness of the client and volume of sales.

Disclosed and undisclosed factoring

Financial services Disclosed and undisclosed factoring In disclosed factoring, the name of the factor is mentioned in the invoice by the supplier telling the buyer to make payment to the factor on the due date. However, the supplier may continue to bear the risk of bad debts without passing it to the factor. The factor assumes the risk only under non- recourse factoring agreements.

Financial services Disclosed and undisclosed factoring Under undisclosed factoring, the name of the factor is not disclosed in the invoice. But still the control lies with the factor. He maintains sales ledger of the seller of goods and provides short-term finance against the sales invoices, but the entire transactions take place in the name of the supplier company (seller).

Functions of a Factor

Financial services Functions of a Factor The purchase of a book debts or receivables is central to the functions of factoring permitting the factor to provide the basic services such as; 1.Administration of seller’s sales ledger 2.Collection of receivables purchased 3.Provision of finance 4.Protection against risk of bad debts / credit control and credit protection 5.Rendering advisory services by virtue of its experience in financial dealings with customers.

Lecture 16

Financial services Venture Capital

Financial services Venture capital has been emerged as a new financial method of financing during the 20 th century. It is the capital provided by firms of professionals who invest alongside management in young, rapidly growing or changing companies that have the potential for high growth.

Financial services It is a form of equity financing especially designed for funding high-risk and high- reward projects. There is a common perception that venture capital is a means of financing high technology projects. The term ‘venture capital’ represents financial investment in a highly risky project with the objective of earning a high rate of return.

Financial services A young, high tech company that is in the early stage of financing and is not yet ready to make a public offer of securities may seek venture capital. Such a high risk capital is provided by venture capital funds in the form of long-term equity finance with the hope of earning a high rate of return primarily in the form of capital gain. In fact, VC acts as a partner with the enterprenuer.

Features of venture capital

The main features of VC can be summarized as; High degree of risk: VC represents financial investment in a highly risky project with the objective of earnings a high rate of return.

Features of venture capital Equity participation: VC financing is, invariably, an actual or potential equity participation wherein the objective of the VC is to make capital gain by selling the shares once the firm becomes profitable.

Features of venture capital Long-term investment: VC financing is a long-term investment. It generally takes a long period to encash the investment in securities made by venture capitalists.

Features of venture capital Participation in management: In addition to providing capital, VC funds take an active interest in the management of the assisted firm. Thus, the approach of VC firms is different from that of a traditional lender or banker.

Features of venture capital It is also different from that of a ordinary stock market investor who merely trades in the shares of a company without participating in their management. It has been rightly said, ‘VC combines the qualities of banker, stock market investor and entrepreneur in one’

Features of venture capital Investment is liquid: A VC is not subject to repayment on demand as with an overdraft or following a loan repayment schedule. The investment is realized only when the company is sold or achieves a stock listing. It is lost when the company goes into liquidation.

Modes of VC finance

Venture capitalists provide funds for long-term in any of the following modes; Equity: Most of the venture capital funds provide financial support to entrepreneurs in the form of equity by financing 49% of the total equity. This is to ensure that the ownership and the overall control remain with the entrepreneur.

Modes of VC finance Conditional loan: From a venture capitalist’s point of view, equity is an unsecured instrument and hence a less preferable option than a secured debt instrument. A conditional loan usually involves either no interest at all or coupon payment at nominal rate.

Modes of VC finance Convertible loans: The convertible loan is subordinate to all other loans, which may be converted into equity if interest payments are not made within the agreed time limit.

Areas of Investment

Different venture groups prefer different types of investments. Some specialize in seed capital and early expansion while other focus on exit financing. Biotechnology, medical services, communications, electronic components and software companies seem to be attracting the most attention from venture firms and receiving the most financing.

Areas of Investment The venture capital firms finance both early and later stage investments to maintain a balance between risk and profitability. The venture capitalists usually take into account the following factors while making investments;

Areas of Investment 1.Strong management team 2.A viable idea 3.Business plan 4.Project cost and return 5.Future market prospects 6.Existing technology 7.Miscellaneous factors