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The need for funding is a cycle in any organisation. Companies require funds to develop, market, and launch new products, expand their reach, and seize new opportunities. The most common ways to raise funds, which you should be aware of, are initial public offerings (IPOs), bonds, and loans from banking institutions.
Did you know there are several other ways to inject capital into a business? Among them is Secured Premium Notes.
What are Secured Premium Notes?
Secured Premium Notes or SPNs are non-convertible debentures that come with detachable warrants. Companies issue SPNs to meet various financial needs, such as startup capital, debt repayment, or expansion.
SPNs have a lock-in period ranging from four to seven years. During the lock-in period, you won’t receive any interest. However, once this period ends, you can either sell back the SPN to the issuing company at par value or convert the detachable warrants into equity shares within a specified time.
If you choose to hold onto your investment beyond the lock-in period, you will be repaid the principal amount along with additional interest or premium in instalments.
In India, TISCO (Tata Iron and Steel Company) was the first to issue Secured Premium Notes with a mega rights issue in July 1992, aggregating to Rs. 1,212 crores.
Advantages of Secured Premium Notes
SPNs offer several advantages over direct financing from lending institutions. Here are some:
- SPNs allow companies to diversify their capital structure. They can be structured as a hybrid of debt and equity, which can be more flexible than traditional loans.
- The cost of issuing SPNs can be lower than borrowing from banks or other lending institutions, especially when interest rates are high.
- The returns on SPNs can be treated as capital gains rather than regular income, which is often taxed at a lower rate.
- Direct borrowing can come with regulatory constraints and compliance requirements that are more stringent than those for issuing SPNs.
- The market can perceive Issuing SPNs positively as a sign of a company’s strength and ability to raise funds independently.
- SPNs can be designed to avoid diluting the existing shareholders’ control of the company, which can happen with equity financing.
- Companies can secure SPNs against assets, which can efficiently use the company’s asset base.
- Through attached warrants, SPNs can attract investors looking for a fixed-income investment with a potential equity upside.
- Companies can issue SPNs when market conditions are favourable, and investor demand for such instruments is high.
- SPNs can be structured with a lock-in period, which can help companies plan their financial obligations and cash flows more effectively.
Risks Associated with Secured Premium Notes
Despite many positive features of secured premium notes, these investment avenues have several.
1. Credit risk
If the issuing company faces financial difficulties, it may default on its obligations, which can result in a capital loss. Therefore, it is recommended that you assess the issuer’s creditworthiness and the financial risk involved.
2. Interest rate risk
SPNs are sensitive to changes in interest rates. When market interest rates rise, the present value of future cash flows falls. This makes existing notes less attractive as new issues offer higher yields. Conversely, when rates fall, the value of these notes increases.
3. Liquidity risk
Liquidity risk can affect the returns of SPNs by limiting the investor’s flexibility to sell the notes at a fair price when needed. The reason for this is the lock-in period associated with this investment avenue.
4. Market risk
Changes in investor sentiment, driven by many factors, can cause shifts in the demand for SPNs. These factors include geopolitical events or monetary policy changes.
How to evaluate Secured Premium Notes?
It is essential to review this investment option to ensure it does not negatively impact your portfolio in future.
- Always check the issuing company’s balance sheet, income statement, and cash flow statement. These documents assess the company’s revenue streams, profitability, debt levels, and operational efficiency. A solid financial position suggests a higher likelihood of the SPN’s terms being honoured.
- The company’s credit rating is a critical factor. A high credit rating implies a lower risk of default and assures investors of the company’s ability to fulfil its financial obligations.
- Since SPNs are secured, the quality and value of the underlying collateral are vital. Evaluate the assets pledged as collateral to ensure they provide adequate security against the SPN.
- Carefully read the terms of the SPN, including the interest rate, premium, redemption process, and the rights attached to the detachable warrants. The terms should align with the investor’s risk appetite and investment goals.
- Ongoing market interest rates and economic conditions can influence the attractiveness of SPNs. Due to their higher potential returns, they might be more appealing in a low-interest-rate environment.
- Look at the historical performance of similar instruments the company or its peers issued. While past performance is not indicative of future results, it can provide insights into how such securities have fared.
- Check if the company complies with all legal and regulatory requirements for issuing SPNs. Non-compliance can lead to legal issues that might affect the security’s value.
- Assess the liquidity of the SPN and the options available for exiting the investment.
- The overall sentiment of investors towards the company and its industry can impact the decision to invest in SPNs. Positive sentiment can drive demand, while negative sentiment can deter investors.
Conclusion
Bond Secured Premium Notes offer companies an alternative means of raising capital. They benefit issuers by offering flexibility, potentially lower costs, and favourable tax treatment. However, as an investor, be mindful of associated risks such as credit, interest rate, liquidity, and market risks.
Comparing SPNs with other investment options is also vital for informed decision-making. To learn more about such investment options, read blogs on StockGro.
FAQs
SPNs are financial instruments issued by companies to raise capital. They come with detachable warrants and are non-convertible debentures (NCDs). SPNs are redeemable after a lock-in period, typically 4 to 7 years.
Investors purchase SPNs with a lock-in period during which no interest is paid. After the lock-in period, the principal amount is repaid with interest in instalments. The attached warrants give the holder the right to convert them into equity shares within a specified time.
If you choose to sell back your SPN to the issuing company after the lock-in period, you will receive the par value of the SPN. However, no additional interest or premium is paid upon this redemption.
Since SPNs are a hybrid of debt and equity, they carry the risk of market fluctuations and the financial stability of the issuing company.
SPNs can only be issued by listed companies after obtaining approval from the central government, which ensures regulatory oversight and compliance.
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