Systems; Corporate Finance: Money (That's what I want)

GENERATION 21X SPEAK : CORPORATE FINANCE
Money ( That's what I want )

By A. Vishwanathan

Stability is certainly not the mother of innovation. Today, at the start of a new century, it is uncertainty that is driving business in general, and finance in particular. And this age of uncertainty raises the basic query: what will the finance manager do to cope in the new era? Ignore what has been happening? Or manage the volatility and unpredictability that results from uncertainty?

The underlying theme is uncertainty. Risk can be hedged against, uncertainty cannot. To cope, innovative financial management is imperative. And the key driver will be a host of new tools which the finance managers have to use to ride uncertainty.

UNCERTAINTY OF OWNERSHIP. Ownership carries with it the risks of property, title, and possession. Leasing may be a solution. The lessee/user of the asset does not own the property/equipment and, hence, is insured against the associated risks.

UNCERTAINTY OF OPERATIONS. Traditionally, servicing the debt component of the financing mix hampers operational efficiency as the servicing is undertaken irrespective of the operating cash inflow. Variable- rate debt, where debt servicing is linked to a variable such as interest rates in the market or the price of the product, may help here. Another debt innovation can be in the form of project finance. Instead of financing projects, finance managers can undertake project finance which, basically, treats the project as the sole source of cash-flow and makes the structuring of the debt customised and project-specific.

UNCERTAINTY OF COUNTRIES. With the opening up of the economy, investments and operations have become global. Thus, far, the currency involved was driven by the source rather than the need, exposing companies to exchange-rate volatility. Here, innovations like Euro-debt can be immensely helpful. Euro-debt is denominated in foreign currency and can be used, as per the existing regulations, abroad or for operations based on imports. Euro-debt may be based on floating rates to facilitate hedging against risks and uncertainties.

REPAYMENT STRUCTURING. The repayment of the principal installments creates a drain on cash-flows available to the shareholders. Now, companies are going in for unorthodox repayment patterns like convertibility and perpetuity. Century Bonds are an example of perpetuities. These are typically issued at floating rates.

RISK MANAGEMENT. The focus of financial management will be on managing uncertainty. One important area here is derivatives and risk management in this century. While the derivatives market is not sufficiently developed to allow active hedging and arbitraging, interest swaps and futures have just been introduced, and are likely to emerge as the backbone of financial-risk management in this century. Currency derivatives could help manage the exposure to foreign exchange risk. By locking in to a set of prices, these tools will infuse certainty into the entire function.

SECURITISATION.Asset-based financing is out, and cash-flow based financing is in. And the best manifestation is the securitisation of assets and their cash-flows, that is, borrowing from an intermediary against cash flow-generating assets pledged or sold to that intermediary. Indian companies can now raise funds with higher credit-rating as the evaluation is on the assets rather than on the company. This translates into cheaper funds. Securitisation is just emerging of a viable option in the housing mortgage and credit-cards sector. Variants in securitisation include pass-throughs, and collateralised mortgage obligations which involve permutations in the nature, timing, and extent of matching of asset cash-flows and servicing of the borrowings.

SPARCS AND SWORDS. These are instruments in the form of special purpose vehicles for R&D. Companies can treat each R&D venture as a project and borrow funds separately against it through an intermediary called the Sparc (Special Purpose Accelerated Research Company).

The company may also issue share warrants (Swords-Share Warrant Offerings For Research & Development), which allow the lenders to the Sparc to buy shares in the parent company if the R&R project fails. This mechanism allows R&D activity to be separated from mainstream business and, hence, allows markets to value the firm solely on business risk, and at a lower cost of capital. It allows healthier balance-sheets as R&D activities are carried out by the Sparc and sold to the parent only on success. And the uncertainty associated with R&D is managed better.

VENTURE CAPITAL. The uncertainties associated with small-scale businesses have led to the emergence of venture capitalists who finance the promoters' stakes in the equity contribution of a start-up. Typically, venture capitalists earn by way of interest, profit on buy-back, and dividends on investments.

WORKING CAPITAL FINANCE. The standard practice in working capital finance has been to rely on the banking sector. But now, there is a perceptible shift in the instruments used to new-age ones like Commercial Papers, Inter-Corporate Deposits, and Public Deposits. The financing arrangements themselves have changed too. Banks no longer look at current assets as a basis for lending and go for need-based or cash-flow based financing instead.

ZERO CASH-FLOW EXPOSURE. Uncertainties associated with cash-flows from operations have deterred the growth of cash-flow intensive instruments. But zero coupon debt, which involves redemption as the sole cash outflow, can be a way out. Zero coupon debt may also be derived from existing debt by coupon stripping.

The agenda is clear. The Indian company of the millennium cannot afford to treat finance as a support function. It must be aligned with the business strategy and integrated into the management framework with the help of technology. The millennial finance function must be strategy-driver rather than a mere resource-provider and resource-monitor. The finance manager needs to understand this.

Anand Vishwanathan is a second-year MBA student at the IIM, Calcutta

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