ALTERNATE SOURCES OF FINANCE- Part 1

Alternate sources of Finance is one of the topic that is confusing as there is a limited clarity about it. We are releasing a material on this based on a best guess method. This is part of RBI Grade B -Phase 2- Finance Syllabus.


Alternate sources of Finance – Part 1

Lease

A lease agreement is drawn up between the owner of the asset (lessor) and the user of the asset (lessee) and is a legal contract with rights and obligations on both sides. The agreement promises the lessee use of the property for an agreed length of time while the owner is assured consistent payment over the agreed period. Both parties are bound by the terms of the contract, and there is a consequence if either fails to meet the contractual obligations.

Types of Lease

  1. Financial Lease

Financial leasing is a contract involving payment over a longer period. It is a long-term lease. It is irrevocable. In this type of leasing the lessee has to bear all costs and the lessor does not render any service.

2. Operating Lease

In an operating lease, the lessee uses the asset for a specific period. The lessor bears the risk of obsolescence and incidental risks. There is an option to either party to terminate the lease after giving notice. In this type of leasing

  • lessor bears all expenses
  • lessor will not be able to realize the full cost of the asset
  • specialized services are provided by the lessor.

This kind of lease is preferred where the equipment is likely to suffer obsolescence.

3. Leveraged and non-leveraged leases

Leveraged lease refers to a lease agreement wherein the lessor acquires an asset partially financed by the financial institutions and lease out the same to the lessee for the agreed lease payments.

4. Conveyance type lease

In Conveyance type lease, the lease will be for a long-period with a clear intention of conveying the ownership of title on the lessee.

5. Sale and leaseback

In a sale and leaseback, a company owning the asset sells it to the lessor. The lessor pays immediately for the asset but leases the asset to the seller. Thus, the seller of the asset becomes the lessee. The asset remains with the seller who is a lessee but the ownership is with the lessor who is the buyer. This arrangement is done so that the selling company obtains finance for running the business along with the asset.

6. Full and non pay-out lease

A full pay-out lease is one in which the lessor recovers the full value of the leased asset by way of leasing. In case of a non pay-out lease, the lessor leases out the same asset over and over again.

7. Specialized service lease

The lessor or the owner of the asset is a specialist of the asset which he is leasing out. He not only leases out but also gives specialized personal service to the lessee. Examples are electronic goods, automobiles, air-conditioners, etc.

8. Net and non-net lease

In non-net lease, the lessor is in charge of maintenance, insurance and other incidental expenses. In a net lease, the lessor is not concerned with the above maintenance expenditure. The lessor confines only to financial service.

9. Sales aid lease

In case, the lessor enters into any tie up arrangement with manufacturer for the marketing, it is called sales aid lease.

10. Cross border lease

Lease across national frontiers are called cross border lease, Shipping, air service, etc., come under this category.

11. Import Lease

In an Import lease, the company providing equipment for lease may be located in a foreign country but the lessor and the lessee may belong to the same country. The equipment is more or less imported.

12. International lease

Alternate sources of Finance

Here, the parties to the lease transactions may belong to different countries which is almost similar to cross border lease.


New Age Alternate sources of Finance

Peer to Peer Lending (P2P)

P2P lending is a method of debt financing enabling individuals and companies to lend and borrow money through an online platform instead of making use of a traditional bank as an intermediary. Because the loans are split up in minor parts, many different agents can finance the loan. P2P lending is also known as crowdlending or marketplace lending. For this the platforms charges a fee from both the lender and borrower.

RBI Now Regulates Peer to Peer Platforms and they are categorized as NBFCs . The Reserve Bank of India has increased the limits imposed on peer-to-peer lenders to ₹50 lakh. The limit is the total amount of money any investor can invest across all P2P platforms.



Franchising

A franchise is a type of license that a party (franchisee) acquires to allow them to have access to a business’s (franchisor) proprietary knowledge, processes, and trademarks in order to allow the party to sell a product or provide a service under the business’s name. In exchange for gaining the franchise, the franchisee usually pays the franchisor an initial start-up and annual licensing fees.

Alternate sources of Finance

Factoring

Factoring is a financial transaction and a type of debtor finance in which a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount. Factoring, receivables factoring or debtor financing, is when a company buys a debt or invoice from another company. Factoring is also seen as a form of invoice discounting in many markets and is very similar but just within a different context. In this purchase, accounts receivable are discounted in order to allow the buyer to make a profit upon the settlement of the debt. Essentially factoring transfers the ownership of accounts to another party that then chases up the debt.

Factoring therefore relieves the first party of a debt for less than the total amount providing them with working capital to continue trading, while the buyer, or factor, chases up the debt for the full amount and profits when it is paid.

Types of factoring

  • Recourse Factoring

Here, if your customer does not pay your factored invoices for any reason, you are responsible to make the factor whole. That is, you must repay the factor for the advance you received plus the factoring discount owed on date of the “chargeback.” There is no debt protection under this type of service.

  • Non-Recourse Factoring

If your customer does not pay due to insolvency or bankruptcy – in other words, your customer can’t pay your invoices – the factor does not need to be made whole by you, since you are factoring “without recourse.” The factor simply absorbs the loss.

  • Non-Notification Factoring

With this method, the customer is not notified of the arrangement between seller and the factor.

  • Invoice Discounting

With invoice discounting, creditors do not sell their invoices but rather use them as collateral for a loan, usually in bulk. Typically, an agreed percent of invoices’ face value is provided, and as the invoices are repaid by the customers, the factor providing the invoice discounting is repaid.

  • Maturity Factoring

Here, the factor takes over all credit and collection functions and ordinarily provides receivables insurance to the business owner.

Forfaiting

 Forfaiting is a factoring arrangement used in international trade finance by exporters who wish to sell their receivables to a forfaiter. Forfaiting is the purchase of an exporter’s receivables – the amount that the importer owes the exporter – at a discount by paying cash. The purchaser of the receivables, or forfaiter, must now be paid by the importer to settle the debt. This is a common process used for speeding up the cash flow cycle and providing risk mitigation for the exporter on 100% of the debts value.

New Age- Alternate sources of Finance – “Crowdfunding

Crowdfunding is a way of raising money to finance projects and businesses. It enables fundraisers to collect money from a large number of people via online platforms.

Alternate sources of Finance

Crowdfunding is most often used by startup companies or growing businesses as a way of accessing alternative funds.

Types of crowdfunding

1.     Peer-to-peer lending

The crowd lends money to a company with the understanding that the money will be repaid with interest. It is very similar to traditional borrowing from a bank, except that we borrow from lots of investors.

2.     Equity crowdfunding

Sale of a stake in a business to a number of investors in return for investment. The idea is similar to how common stock is bought or sold on a stock exchange, or to a venture capital.

3.     Rewards-based crowdfunding

Individuals donate to a project or business with expectations of receiving in return a non-financial reward, such as goods or services, at a later stage in exchange of their contribution.

4.     Donation-based crowdfunding

Individuals donate small amounts to meet the larger funding aim of a specific charitable project while receiving no financial or material return.

5.     Profit-sharing / revenue-sharing

Businesses can share future profits or revenues with the crowd in return for funding now.

6.     Debt-securities crowdfunding

Individuals invest in a debt security issued by the company, such as a bond.

7.     Hybrid models

Offer businesses the opportunity to combine elements of more than one crowdfunding type

Angel investor – New Age Alternate sources of Finance

An angel investor (also known as a private investor, seed investor or angel funder) is a high net worth individual who provides financial backing for small startups or entrepreneurs, typically in exchange for ownership equity in the company. The funds that angel investors provide may be a one-time investment to help the business get off the ground or an ongoing injection to support and carry the company through its difficult early stages.

The big advantage is that financing from angel investments is much less risky than debt financing. Unlike a loan, invested capital does not have to be paid back in the event of business failure. The primary disadvantage of using angel investors is the loss of complete control.

Venture Capital

A venture capitalist (VC) is a private equity investor that provides capital to companies exhibiting high growth potential in exchange for an equity stake. This could be funding startup ventures or supporting small companies that wish to expand but do not have access to equities markets. Venture capitalists are willing to risk investing in such companies because they can earn a massive return on their investments if these companies are a success.

Alternate sources of Finance– Part 2