SRI KRISHNA COLLEGE OF TECHNOLOGY

SCHOOL OF MANAGEMENT

22PMBE006 – STRATEGIC FINANCIAL

MANAGEMENT

Mr. SARAVANAN
ASSISTANT PROFESSOR
 Module 3
FINANCING STRATEGY & VALUATION
OF INTANGIBLE ASSETS

• Financing Strategy – Innovative sources of finance – Asset backed

securities – Securitisation –Hybrid securities – Convertible and
Non-convertible debentures, secured premium notes – Convertible
preference shares - Goodwill – meaning – various methods of
valuation of goodwill – capitalization method – Intellectual Property
Rights – Amortisation of Intangible assets.
 Financing Strategy
• A Financing strategy is basically a set of strategic sector development targets and the scenarios to achieve
them. These scenarios implicate the absence of a financing (cash flow) gap (no deficit).

• In other words there should be a balance between the expenditure and the funds available. The development of
the financing strategy includes selecting strategic goals for sector development and a scenario(s) to achieve
them that meet the country’s priorities, and are technically and financially feasible and affordable.

• The financing strategy does not provide final answers to all questions, but it assists in defining priority actions.
This strategy could be used as a basis for the creation of a realistic long-term (10-20 years) financing and
investment programme in the considered sector for the country (or for the region)
• The computerised decision support tool FEASIBLE, which abbreviates Financing for
Environmental, Affordable and Strategic Investments that Bring on Large-scale
Expenditure, was designed to facilitate the development of a financing strategy.
• The FEASIBLE model can assist in the preparation of the financing strategies through
providing an aggregate picture of the finance needs associated with certain targets.
• FEASIBLE can also facilitate the iterative process of balancing the financing needs
related to certain environmental and service targets with the available finance.
• Being a computerised model, FEASIBLE may be used to analyse the consequences of
changing a certain policy in a systematic and transparent manner.
Innovative sources of finance
• Funding sources available to businesses may include seeking equity
finance, applying for government or university funding, and considering
an initial public offering. It is imperative that startup businesses plan for
growth in order to be able to meet their commercial objectives.
• Financial success is the major goal of business. In order to achieve this
goal, businesses must:
have realistic financial plans
monitor and review costs
gain support of bankers, investors and venture capitalists.
Innovative sources of finance
Some important sources of funding for innovation activities include:
• Own funds
• Government grants
• Family and friends
• Debt
• Equity
• Business angels
• Venture capital
• Crowdfunding.
Asset-Backed Securities (ABS)

• Asset-backed securities (ABS) are securities derived from a pool of

underlying assets. To create asset-backed securities, financial institutions
pool multiple loans into a single security that is then sold to investors.
• The pools can include many types of loans, such as mortgages, credit
card debt, student loans, and auto loans. As many of the loans cannot be
sold separately, securitising them into asset-backed securities provides
investors with further investment opportunities, and allows financial
institutions to remove risky assets from their balance sheets.
Benefits of Asset-Backed Securities
1. Protects from potentially risky loans
2. Provides an alternative and more stable investment vehicle
3. Reduces default risk and other credit risks

• Downsides of Asset-Backed Securities

1. Lack of due diligence

2. Lower yield from prepayments
3. Potential widespread defaults during an economic downturn
 Hybrid Securities
• Hybrid securities are investment instruments
that combine the features of pure equities and
pure bonds.
• These securities tend to offer a higher return
than pure fixed-income securities such as
bonds but a lower return than pure variable-
income securities such as equities.
• They are considered less riskier than pure
variable income securities such as equities but
more risky than pure fixed income securities.
• Returns from Hybrid Securities
The return generated by a hybrid security can be divided into two components: The fixed
income component (the bond part) and the variable income component (the equity part).
1. Fixed income component
Similar to most fixed-income instruments, hybrid securities typically pay a certain proportion
of the face value of the security as a return in each time period (usually annually) until the
security matures.
2. Variable income component
At maturity, the value of hybrid securities usually depends on the price of some other
underlying security or set of securities.
Unlike bonds, which return their full face value at maturity, hybrid securities usually return an
amount different from their initial face value.
This is why hybrid securities are considered riskier than pure fixed-income securities.
Examples of Hybrid Securities
1. Preferred stocks
• Holders of preferred stocks receive dividends before the holders of
common stocks. Also, the dividend received by the holders of preferred
stocks is usually different from the dividend received by the holders of
common stocks. Preferred stocks are considered safer than common
stocks but less safe than bonds.
• In case the business faces solvency issues, the holders of preferred stocks
are paid before the holders of common stocks. In addition, preferred
stocks can sometimes be converted to common stocks at a premium.
• 2. In-kind toggle notes
In-kind toggle notes are a form of hybrid security that allows cash-strapped
companies to raise additional capital to meet short-term liquidity needs.
An in-kind toggle note allows a company to pay interest in the form of
additional debt.
The company issuing the in-kind toggle note gives the holder of the note
more debt in place of interest payment.
In-kind toggle notes can be seen as an instrument to delay the payment of
interest to debtholders.
3. Convertible bonds
• Convertible bonds are fixed-income instruments with a call option on
some equity. The convertible bonds issued by a company can be
converted into a fixed number of stock shares of that company. In some
special cases, a convertible bond issued by a company comes with a call
option on the stocks of some other company. These special convertible
bonds are known as exchangeable bonds.
• The interest rates on convertible bonds are usually lower than the interest
rates on standard fixed-income bonds. The interest rate differential is the
“premium” convertible bondholders pay for the equity call option.
Secured Premium Notes
• To meet its long-term and short-term needs of finance, a company may
issue various kinds of securities to raise funds from the public.
• A company may decide to issue securities because it needs start-up
capital or to repay debts or even to expand. It may also need an infusion
of new management ideas and know-how.
• These can be had by a wider ownership base. When an investor buys
securities commonly referred to as shares he is enabling the company to
carry on its business using the funds provided with little stress.
• One such financial instrument through which a company can raise capital
is a secured premium note.
 Features of a SPN
• SPN instruments are issued with a detachable warrant.
• These instruments have a lock-in period for 4 to 7 years.
• No interest is paid during the lock-in period.
• After the lock-in period, the holder may sell back the SPN to the company.
• The detachable warrants are convertible into equity shares provided the secured premium
notes are fully paid. The conversion of detachable warrants into equity has to be done within
the specified time.
• After the lock-in period, the holder has the option to sell back the SPN to the company at par
value. If the holder exercises this option, no interest/premium is paid on redemption. In case
the holder keeps his investment further, he is repaid the principal amount along with the
additional interest/premium on redemption in instalments. SPN were so formulated that the
return on investment was treated as capital gain and not regular income. Consequently, the
rate of tax applicable was lower.
 Convertible Preference Shares
• Convertible shares are fundamentally those shares which enable holders to get them
converted into equity shares at a fixed rate. Notably, these shares can only be converted
after the expiry of a specified time and within a given period, as stated in the memorandum.
• Ideally, these shares are considered to be beneficial for those investors who intend to
receive preferred share dividends.
• It also proves rewarding for those who wish to partake in the change in the price of equity
shares. Thus, such shares help investors generate fixed earnings along with the opportunity
to accrue higher returns frequently.
 Goodwill

• Goodwill is an intangible asset associated with the purchase of one company by another.
Specifically, goodwill is recorded in a situation in which the purchase price is higher than
the sum of the fair value of all visible solid assets and intangible assets purchased in the
acquisition and the liabilities assumed in the process.

• The value of a company’s brand name, solid customer base, good customer relations,
good employee relations, and any patents or proprietary technology represent some
examples of goodwill.
 Factors Affecting Goodwill
1.Location of the business : A business which is located in a suitable location will have a
more favourable chance of higher goodwill than a business located in a remote location.
2.Quality of goods and services: A business which is providing a higher quality of goods
and services stands a great chance of earning more goodwill than competitors who
provide inferior goods and services.
3.Efficiency of management : An efficient management results in increase in profit of the
business which enhances the goodwill of the business.
4.Business Risk : A business having lesser risk has a better chance of creating goodwill
than a high risk business.
5. Nature of business: It means the type of products that business deals with, the level of
competition in the market, demand for the products and the regulations impacting the business.
A business having a favourable outcome in all these areas will have a greater goodwill.

6. Favourable Contracts: A firm will enjoy a higher goodwill if it has access to favourable
contracts for sale of products.

7. Possession of trademarks and patents: Firms that have patents and trademarks will enjoy a
monopoly in the market, which will contribute to the increase in the goodwill of the firm.

8. Capital: A firm with a higher return on investment along with lesser capital investment will
be considered by buyers as more profitable and have more goodwill.
 Methods of Valuation of Goodwill
Average Profits Method – This method is divided into two sub-division.
• Simple Average – In this process, goodwill evaluation is done by calculating the average
profit by the number of years it is called years purchase. It can be calculated by using the
formula.
Goodwill = Average Profit x No. of years’ of purchase.
• Weighted Average – Here, last year’s profit is calculated by a specific number of weights. It
is used to obtain the value of goods, which is divided by the total number of weights for
determining the average weight profit. This technique is used when there is a change in
profits and giving high importance to the present year’s profit. It is evaluated by using the
formula.
Goodwill = Weighted Average Profit x No. of years’ of purchase, where
Weighted Average Profit = Sum of Profits multiplied by weights/ Sum of weights
• Super Profits Method – It is a surplus of expected future maintainable profits over normal
profits. The two methods of these methods are.
• The Purchase Method by Number of Years – The goodwill is established by evaluating
super-profits by a specific number of the purchase year. It can be estimated by applying the
below formula.
Super Profit = Actual or Average profit – Normal Profit
• Annuity Method –Here, the average super profit is taken as an annuity value over a definite
number of years. A discounted amount of super profit calculates the current value of an
annuity at the given rate of interest. The formula to be used here is.
Goodwill = Super Profit x Discounting Factor
• Capitalisation Method – Under this method, goodwill can be evaluated by two methods.
• Average Profits Method – In this process, goodwill is measured by subtracting the
original capital applied from the capitalised amount of the average profits based on the
average return rate. The formula used is mentioned below.
Capitalised Average profits = Average Profits x (100/average return rate)
• Super Profits Method- Here, the super profit is capitalised, and the goodwill is calculated.
The formula applied is.
Goodwill = Super Profits x (100/ Normal Rate of Return)
Intellectual Property Rights

• Intellectual Property rights mean providing property rights through

patents, copyrights and trademarks.

• Holders of intellectual property rights have a monopoly on the usage of

property or items for a specified time period.

• The term intellectual property began to be used in the 19th Century. Only
in the 20th century did it become part of the world’s legal systems.
 Types of IPR

• The 4 main types of intellectual property are listed below.

1.Patents – It is used for protecting new inventions, ideas, or processes. Patent holders need to
pay periodic government renewal fees. An approved patent is for a limited time period. Know
more about Patents Act in India.

2.Copyrights – It protects the ideas, examples would be written works, music, art, etc.

3.Trademarks – It is something that protects the symbols, colors, phrases, sounds, design etc.

4.Trade Secrets – It may be strategies, systems, formulas, or other confidential information of

an organization that provides them a competitive advantage in the market.