Chapter 8: Sources of Business Financing
Businesses need funds for starting operations, expansion, and day-to-day activities. Understanding different sources of financing — their characteristics, costs, advantages, and limitations — helps managers make optimal financing decisions. This chapter covers equity, debt, and hybrid sources available to Nepali businesses.
8.1 Classification of Sources
| Basis | Types |
|---|---|
| By Duration | Long-term (>5 yrs): shares, debentures, term loans | Medium-term (1-5 yrs): bank loans | Short-term (<1 yr): trade credit, overdraft |
| By Ownership | Owned funds (equity, retained earnings) | Borrowed funds (debt, debentures, loans) |
| By Source | Internal (retained earnings, depreciation) | External (shares, debentures, loans, venture capital) |
8.2 Equity Financing
| Source | Features | Advantages | Disadvantages |
|---|---|---|---|
| Ordinary/Equity Shares | Ownership stake, voting rights, variable dividend | No fixed obligation, permanent capital, no collateral | Dilution of control, expensive (higher Ke), dividend not tax-deductible |
| Preference Shares | Fixed dividend, priority over equity, limited voting | No dilution of equity control, flexible (redeemable option) | Higher cost than debt, not tax-deductible |
| Retained Earnings | Plowing back profits | No issue costs, no dilution, readily available | Limited amount, opportunity cost to shareholders |
8.3 Debt Financing
| Source | Features | Advantages | Disadvantages |
|---|---|---|---|
| Debentures/Bonds | Long-term debt securities with fixed interest | Tax-deductible interest, no ownership dilution, lower cost | Fixed obligation, increases financial risk, collateral required |
| Term Loans | Bank loans for 3-10 years | Flexible terms, quick arrangement | Collateral, covenants, regular repayment burden |
| Bank Overdraft | Short-term borrowing facility | Flexible, interest on used amount only | High interest, can be recalled anytime |
| Trade Credit | Credit from suppliers (30-90 days) | Easy, no formal process, automatic | Expensive if discount forfeited, limited amount |
8.4 Other/Hybrid Sources
| Source | Description | Nepal Context |
|---|---|---|
| Lease Financing | Using assets without owning; periodic lease payments | Growing for vehicles, equipment, office space |
| Venture Capital | Equity investment in high-growth startups | Emerging; few VC firms (True North, Dolma Impact) |
| Convertible Debentures | Debt convertible to equity at holder's option | Used by some NEPSE-listed companies |
| Microfinance | Small loans to low-income entrepreneurs | Active sector — Chhimek, Nirdhan, Swabalamban |
| IPO (Initial Public Offering) | First sale of shares to public via stock exchange | Regulated by SEBON; popular among Nepali investors |
8.5 Equity vs Debt Financing
| Basis | Equity | Debt |
|---|---|---|
| Obligation | No fixed payment required | Interest must be paid regardless of profit |
| Tax Benefit | Dividend not tax-deductible | Interest is tax-deductible |
| Control | Dilutes ownership and control | No dilution of control |
| Risk | Lower financial risk | Higher financial risk (fixed obligation) |
| Cost | Higher (Ke > Kd) | Lower (tax benefit + priority in claims) |
| Maturity | Permanent (no repayment) | Must be repaid at maturity |
8.6 IPO Process in Nepal — Step by Step
| Step | Activity | Key Players | Duration |
|---|---|---|---|
| 1 | Company decides to go public; passes board resolution | Board of Directors | — |
| 2 | Appoint Issue Manager (merchant banker) and underwriter | NIBL Capital, NMB Capital, Prabhu Capital etc. | 1 month |
| 3 | Prepare and file prospectus with SEBON | Issue Manager, Legal advisor, Auditor | 2-3 months |
| 4 | SEBON reviews and approves prospectus | SEBON | 1-3 months |
| 5 | Issue opens — public applies through ASBA (bank-based) | Banks (collection centers), CDS | 5-30 days |
| 6 | Allotment — shares allocated (lottery if oversubscribed) | Issue Manager, CDS | 15-30 days |
| 7 | Listing on NEPSE — trading begins | NEPSE | Within 30 days of allotment |
Nepal IPO Facts: IPOs in Nepal are almost always oversubscribed (10x-50x common for banks/hydropower). Share price at par value NPR 100. IPO shares often trade at 2x-5x par on listing day. This makes IPOs extremely popular among retail investors.
8.7 Lease vs Buy Decision
Example: Equipment costs NPR 10,00,000. Life 5 years. Salvage NPR 1,00,000.
Option A (Buy): Loan at 12%. Depreciation: SLM. Tax rate 25%.
Annual depreciation = (10,00,000-1,00,000)/5 = NPR 1,80,000
Tax saving on depreciation = 1,80,000 × 25% = NPR 45,000/year
Option B (Lease): Annual lease payment NPR 2,80,000 for 5 years.
Tax saving on lease = 2,80,000 × 25% = NPR 70,000/year
Net lease cost = 2,80,000 - 70,000 = NPR 2,10,000/year
PV of lease payments @12% = 2,10,000 × PVIFA(12%,5) = 2,10,000 × 3.6048 = NPR 7,57,008
Comparison: Buy cost (PV) = 10,00,000 - PV of tax savings - PV of salvage
= 10,00,000 - 45,000(3.6048) - 1,00,000(0.5674) = 10,00,000 - 1,62,216 - 56,743 = NPR 7,81,041
Lease cost (PV) = NPR 7,57,008
Lease is cheaper by NPR 24,033 → Lease the equipment
8.8 Choosing the Right Source — Decision Framework
| Situation | Best Source | Reason |
|---|---|---|
| Startup with no collateral | Equity (angel/VC), personal savings | No repayment obligation; share risk with investors |
| Established firm, stable cash flows | Debt (bank loan, debentures) | Tax benefit, no dilution, cheaper than equity |
| Expansion needing large capital | Mix: equity + debt (IPO + term loan) | Balance leverage with growth funding |
| Equipment purchase | Lease or hire purchase | Preserve cash; match asset life with financing |
| Short-term seasonal needs | Bank overdraft, trade credit | Flexible, short-term, no long commitment |
| Rural micro-enterprise | Microfinance | Accessible, no traditional collateral needed |
| Government/development project | External loan (ADB/World Bank) | Concessional terms, long tenure, technical assistance |
8.9 Nepal Capital Market Development
| Milestone | Year | Significance |
|---|---|---|
| Securities Exchange Centre established | 1976 | First organized securities trading in Nepal |
| NEPSE established | 1993 | Formal stock exchange with automated trading |
| SEBON created | 1993 | Securities regulator to protect investors |
| CDS and Clearing Ltd | 2010 | Dematerialized shares — no physical certificates |
| Online trading (TMS) | 2018 | Investors can trade from anywhere via broker platforms |
| MeroShare system | 2016+ | Centralized IPO application and share management |
Practice Questions
Short Answer:
1. Classify sources of financing by duration, ownership, and source.
2. Compare equity shares and preference shares.
3. What are debentures? How do they differ from shares?
4. Explain lease financing and its types.
5. Compare equity and debt financing.
Long Answer:
6. Discuss the various long-term sources of financing available to a Nepali company planning to expand. Which sources would you recommend? (15 marks)
7. Compare equity and debt financing. Under what circumstances should a firm prefer each? (15 marks)
8. Explain the IPO process in Nepal including SEBON's role. What are the advantages and risks for companies going public? (15 marks)
9. Discuss the role of venture capital and microfinance in Nepal's entrepreneurship ecosystem. (15 marks)
10. A startup needs NPR 1 crore. Evaluate the pros/cons of: bank loan, angel investment, IPO, and microfinance. (15 marks)
Exam Tips: ✓ Equity vs Debt comparison is very frequently asked ✓ Know features of all major sources ✓ IPO process in Nepal is a relevant topic ✓ Understand tax benefit of debt ✓ Match source to type of business need