Académique Documents
Professionnel Documents
Culture Documents
1.1 An Introduction
Finance is the life blood of trade, commerce and industry. Now-adays, banking sector acts as the backbone of modern business. Development of any country mainly depends upon the banking system. The term bank is derived from the French word Banco which means a Benchor Money exchange table. In olden days, European money lenders or money changers used to display (show) coins of different countries in big heaps (quantity) on benches or tables for the purpose of lending or exchanging. Its and advances and other related services. It receives money from those who want to save in the form of deposits and it lends money to those who need it. A bank is a financial institution and a financial intermediary that accepts deposits and channels those deposits into lending activities, either directly or through capital markets. A bank connects customers that have capital deficits to customers with capital surpluses.[citation needed] Due to their critical status within the financial system and the economy[citation needed] generally, banks are highly regulated in most countries. Most banks operate under a system known as fractional reserve banking where they hold only a small reserve of the funds deposited and lend out the rest for profit. They are generally subject to minimum capital requirements which are based on an international set of capital standards, known as the Basel Accords.
The oldest bank still in existence is Monte dei Paschi di Siena, headquartered in Siena, Italy, which has been operating continuously since 1472.
Bank is an organization whose principal operations are concerned with the accumulation of the temporarily idle money of the general public for the purpose of advancing to others for expenditure. ----Kent Prof.
Bank are institutions whose debts are usually referred to as bank deposits are commonly accepted in final settlement of other peoples debts. ---- R.S.Sayers
/ Features of a Bank
Bank is a financial institution which deals with other people's money i.e. money given by depositors.
9. Connecting Link
A bank acts as a connecting link between borrowers and lenders of money. Banks collect money from those who have surplus money and give the same to those who are in need of money.
1. Accepting Deposits
The bank collects deposits from the public. These deposits can be of different types, such as :a. Saving Deposits b. Fixed Deposits c. Current Deposits d. Recurring Deposits
1. Agency Functions
The bank acts as an agent of its customers. The bank performs a number of agency functions which includes :a. Transfer of Funds b. Collection of Cheques c. Periodic Payments d. Portfolio Management e. Periodic Collections f. Other Agency Functions
2.1 Types of Financial Market:The financial markets can be divided into three parts Money market Capital market Forex market
MONEY MARKET:Money market is the market for short term financial assets which are near substitutes for money. Money markt instruments are liquid and can be turned over quickly at low transaction cost and without loss.The money market is a wholesale market. The volumes are very large and generally transactions are settled on daily bases. Trading in the money market is conducted over the telephone followed by written confirmation from both the borrowers and lenders. There are large numbers of participants in the money market : commercial banks, mutual funds, investment institutions, financial instutions and finally RBI. Money market performs the crucial role of providing an equilibrating mechanism to evenout short term liquidity and in the process, facilitating the conduct of monetary policy. Short term surpluses
8
and deficits are evenedout. The money market is the major mechanism through which the reserve bank of india influences liquidity and the general level of interest rates.
FOREX MARKET:Eevey sovereign nation has its own currency. Theoretically the monetary unit of a country can be exchnged with any other currency of any other country. Most of the international financial transactions involve an exchange of one currency for another. The ratio in which they are exchanged, or prices in terms of each other are known as exchange rate. Countries when they trade with each other require money flows. Foreign exchange markets provides the mechanism for exchanging different monetary units for each other. Sometimes, nationals of one country may prefer to hold financial assets in a foregin or dominated in a foregin because Domestic currency may be subject to variable and high inflation, rendering it a poor store of value; Foreign currency balance may reduce risks; Foreign currency assets help hedge anticipated foreign currency liabilities. The efficiency of the internation financial system and its degree of integration with individual sovereign financial system depends to a large extent on how cheaply and quickly, foregin exchange transaction can be effected.
2.2 AN INTRODUCTION TO CAPITAL MARKET:The capital markets consist of primary markets and secondary markets. Newly formed (issued) securities are bought or sold in primary markets. Secondary markets allow investors to sell securities that they hold or buy existing securities.
SECONDARY MARKET
10
Secondary Market:The capital market apart from the primary market also includes the secondary market where existing issues are traded. These secondary market also referred to as stock markets predominantly deal in the stock or equity shares. They enable shareholders to sell their holdings readly thereby ensuring liquidity. Any trading of a share subsequent to its primary offering, is the secondry transection. The initial buyer (in the primary market) may reoffer the securities to an intrested buyer at a price which is mutually satisfectory. An active secondary market in fact promotes the growth of the primary market and aids capital formation. For the general investors, the secondary market provides an efficient platform for trading of a securities
11
The indian security market, in the last decade, witnessed a significant transformation in the market design, to a paperless market characterised by a transparent screen-based trading system with complete restructuring of the trading, clearing and settelement infrastructure. The indian securities market has developed and grown voluminously on several counts such as the number of stock exchanges, intermediaries and institutional investors, the number of listed stock, market captilisation, trading volumes and turnover on stock exchanges. The two major stock exchange in india are BSE (Bombay Stock Exchange) and NSE (National Stock Exchange).
1.
2.
3.
Results in raising fresh resources Facilitate transfer of securities from one for the corporate sector. corporate investor to another.
4.
All companies enter primary Securities of only listed companies can market. be traded at stock exchanges.
12
5.
No
tangible
form
administrative setup. Recognised a tangible form. only by the service it renders. 6. Subjected to outside control by Subjected to control both from within SEBI, stock exchange and the and outside. companies act.
phenomenon.
13
Other types of securities, besides shares, can be offered publicly. Bonds, warrants, capital notes and many other kinds of debt and equity vehicles are offered, issued and traded in public capital markets. A private company, with no shares listed publicly, can still issue other securities to the public and have them traded on an exchange. A public company, of course, may also offer and list other securities alongside its shares. Most public offerings are in the primary market, that is, the issuing company itself is the offerer of securities to the public. The offered securities are then issued (allocated, allotted) to the new owners. If it is an offering of shares, this means that the company's outstanding capital grows. If it is an offering of other securities, this entails the creation or expansion of a series (of bonds, warrants, etc.). However, more rarely, public offerings take place in the secondary market. This is called a secondary market offering: existing security holders offer to sell their stake to other, new owners, through the stock exchange. The offerer is different from the issuer (the company). A secondary market offering is still a public offering with much the same requirements, including a prospectus. The services of an underwriter are often used to conduct a public offering. An initial public offering (IPO) or stock market launch is a type of public offering where shares of stock in a company are sold to the general public, on a securities exchange, for the first time. Through this process, a private company transforms into a public company. Initial public offerings are used by companies to raise expansion capital, to possiblymonetize the investments of early private investors, and to
15
become publicly traded enterprises. A company selling shares is never required to repay the capital to its public investors. After the IPO, when shares trade freely in the open market, money passes between public investors. Although an IPO offers many advantages, there are also significant disadvantages. Chief among these are the costs associated with the process, and the requirement to disclose certain information that could prove helpful to competitors, or create difficulties with vendors. Details of the proposed offering are disclosed to potential purchasers in the form of a lengthy document known as a prospectus. Most companies undertaking an IPO do so with the assistance of an investment banking firm acting in the capacity of an underwriter. Underwriters provide a valuable service, which includes help with correctly assessing the value of shares (share price), and establishing a public market for shares (initial sale). Alernative methods, such as the dutch auction have also been explored. The most notable recent example of this method is the Google IPO. China has recently emerged as a major IPO market, with several of the largest IPO offerings taking place in that country. When a company lists its securities on a public exchange, the money paid by the investing public for the newly issued shares goes directly to the company (primary offering) as well as to any early private investors who opt to sell all or a portion of their holdings (secondary offering) as part of the larger IPO. An IPO, therefore, allows a company to tap into a wide pool of potential investors to provide itself with capital for future growth, repayment of debt, or working capital. A company selling common shares is never required to repay the capital to its public investors. Those investors must endure the unpredictable nature of the open market to price and trade their shares. After the IPO, when shares trade freely in the open market, money passes between public investors.
16
For early private investors who choose to sell shares as part of the IPO process, the IPO represents an opportunity tomonetize their investment. After the IPO, once shares trade in the open market, investors holding large blocks of shares can either sell those shares piecemeal in the open market, or sell a large block of shares directly to the public, at a fixed price, through a secondary market offering. This type of offering is not dilutive, since no new shares are being created. Once a company is listed, it is able to issue additional common shares in a number of different ways, one of which is the follow-on offering. This method provides capital for various corporate purposes through the issuance of equity (see stock dilution) without incurring any debt. This ability to quickly raise potentially large amounts of capital from the marketplace is a key reason many companies seek to go public.
17
Disadvantages of an IPO
There are several disadvantages to completing an initial public offering: Significant legal, accounting and marketing costs, many of which are ongoing Requirement to disclose financial and business information Meaningful time, effort and attention required of senior management Risk that required funding will not be raised Public dissemination of information which may be useful to competitors, suppliers and customers.
18
months from the last date of dispatch of letters of allotment to enable the investors to approach the registrars for redressal of their complaints.
The Underwriters
Underwriting is a contract by means of which a person gives an assurance to the issuer to the effect that the former would subscribe to the securities offered in the event of non-subscription by the person to whom they were offered. The person who assures is called an underwriter. The underwriters do not buy and sell securities. They stand as back-up supporters and underwriting is done for a commission. Underwriting provides an insurance against the possibility of inadequate subscription. Underwriters are divided into two categories: Financial Institutions and Banks Brokers and approved investment companies. The company after the closure of subscription list communicates in writing to the underwriter the total number of shares/debentures under subscribed, the number of shares/debentures required to be taken up by the underwriter. The underwriter would take up the agreed portion. If the underwriter fails to pay, the company is free to allot the shares to others or take up proceeding against the underwriter to claim damages for any loss suffered by the company for his denial.
appointed as bankers to the issue. The number of collection centers is specified by the central government. The bankers to the issue should have branches in the specified collection centers.
Advertising Agents:
Advertising plays a key role in promoting the public issue. Hence, the past track record of the advertising agency is studied carefully. Tentative program of each advertising agency along with the estimated cost are called for. After comparing the effectiveness and cost of each program with the other, a suitable advertising agency if selected in consultation with the lead managers to the issue. The advertising agencies take the responsibility of giving publicity to the issue on the suitable media. The media may be newspapers/ magazines/
21
telecommunication sectors this stipulation is reduced subject to the conditions that: Offer to the public is not less than 10% of the securities issued. A minimum number of 20 lakh securities is offered to the public and Size of the net offer to the public is not less than Rs. 30 crores.
22
3. Promoter Contribution
Promoters should bring in their contribution including premium fully before the issue Minimum Promoters contribution is 20-25% of the public issue. Minimum Lock in period for promoters contribution is five years Minimum lock in period for firm allotments is three years.
Net Offer to the General Public has to be at least 25% of the Total Issue Size for listing on a Stock exchange.
It is mandatory for a company to get its shares listed at the regional stock exchange where the registered office of the issuer is located.
In an Issue of more than Rs. 25 crores the issuer is allowed to place the whole issue by book-building
23
Minimum of 50% of the Net offer to the Public has to be reserved for Investors applying for less than 1000 shares.
There should be at least 5 investors for every 1 lakh of equity offered (not applicable to infrastructure companies).
Quoting of Permanent Account Number or GIR No. in application for allotment of securities is compulsory where monetary value of Investment is Rs.50,000/- or above.
Indian development financial institutions and Mutual Fund can be allotted securities upto 75% of the Issue Amount.
A Venture Capital Fund shall not be entitled to get its securities listed on any stock exchange till the expiry of 3 years from the date of issuance of securities.
Allotment to categories of FIIs and NRIs/OCBs is upto a maximum of 24%, which can be further extended to 30% by an application to the RBI - supported by a resolution passed in the General Meeting.
A rights issue has to procure 90% subscription in 60 days of the opening of the issue. Allotment has to be made within 30 days of the closure of the Public Issue and 42 days in case of a Rights issue. All the listing formalities for a public Issue has to be completed within 70 days from the date of closure of the subscription list.
Underwriting is not mandatory but 90% subscription is mandatory for each issue of capital to public unless it is disinvestment in which case it is not applicable.
If the issue is undersubscribed then the collected amount should be returned back (not valid for disinvestment issues).
If the issue size is more than Rs. 500 crores voluntary disclosures should be made regarding the deployment of the funds and an adequate monitoring mechanism to be put in place to ensure compliance.
There should not be any outstanding warrants or financial instruments of any other nature, at the time of initial public offer.
25
In the event of the initial public offer being at a premium, and if the rights under warrants or other instruments have been exercised within the twelve months prior to such offer, the resultant shares will not be taken into account for reckoning the minimum promoter's contribution and further, the same will also be subject to lock-in.
Firm allotments to mutual funds, FIIs and employees not subject to any lock-in period.
Within twelve months of the public/rights issue no bonus issue should be made.
Maximum percentage of shares, which can be distributed to employees cannot be more than 5% and maximum shares to be allotted to each employee cannot be more than 200.
10.
Relaxations
to
public
issues
by
infrastructure
companies.
These relaxations would be applicable to Infrastructure Companies as defined under Section10(23G) of the Income Tax Act, 1961, provided their projects are appraised by any Developmental Financial Institution (DFI) or IDFC or IL&FS. The projects must also have a participation of at least 5% of the project cost (in debt and/or equity) by the appraising institution.
The infrastructure companies will be exempted from the requirement of making a minimum public offer of 25 per cent of its securities.
26
The requirement of 5 shareholders per Rs. 1 lakh of offer is also waived in case of offerings by infrastructure companies.
For public issues by infrastructure companies, minimum subscription of 90% would no longer be mandatory provided disclosure is made about the alternate source of funding which the company has considered, in the event of under subscription in the public issue.
Infrastructure companies are permitted to freely price the offerings in the domestic market provided that the promoter companies along with Equipment Suppliers and other strategic investors subscribe to 50% of the equity at the same or a higher price than what is being offered to the public. Adequate disclosures about the justification for the pricing will be required to be made in the offer documents.
27
the stakes are automatically higher. So, an error even on a miniscule level can have drastic repercussions.
1. Choosing the Perfect Time Before even plunging into the intricacies of the pre-IPO arrangements, choosing the ideal time to go public is of core importance. The timing of going public is very crucial in the pre-IPO process. One should look into many aspects before the plungelike looking into the prevailing market sentiment. In the 1980's and early 1990's when branding and marketing were non-existent, liquidity in the market, behavior of the secondary market and merchant bankers' advice were instrumental in deciding the right time for the IPO.
Apart from the CFO and the Company Secretary, choosing appropriate auditors makes a world of difference. Unlike other members of the team, the auditor has the additional job of assessing whether the entire accounting system is in order, is transparent and analyzing whether the numbers and projections as shown in the Excel sheet are realistic and practical. If you have a good auditor, half your battle is won. In fact, one should employ auditors at least one or two years before the IPO is launched. When the company goes public, it must make a note of disclosures about the company operations and past records. It can't afford to make any observations which are incorrect or not backed by strong evidence. You should have a team who can strategies and can plan the inflow and outflow of resources and money.
29
5. Capital Restructuring
Companies should decide on the ways to deploy their capital, namely capital restructuring. Companies should be clear about the debt and equity ratio. This boils down to setting the ideal Debt-Equity Ratio (DER), which can vary from 1:1 to 2:2. "You have to work out your ratio according to the cash and the growth rate, so that they can accordingly structure their profits. In capital restructuring, you have to be sure of the DER maintained, what are the facilities you are planning to set up and what is the land value you are going to purchase. The way you are going to deploy your capital is also very important. You have to be very careful while deploying the resources and forecast the profit you will incur in three-four years' time."
30
6. Creating Investor Interest Confidence building and generating investor interest should be on the priority list for a company. A Company must project an image of transparency and good governance to the investors. Infosys should be the role model for all companies going in for an IPO. Many of the experts agree that IT giant Infosys is a role model because their balance sheet is very clear, they value their managers as assets and year after year they expand rapidly. A company is accountable to its investors, which is why when they go public they have to disclose company projectionspast, present and future prospects. This is where the team of advisors, consultants and legal experts comes into the picture. IPO is all about building investors' confidence so we over perform to hike up investor confidence. If you raise the expectations and do not meet them, then investors will not excuse you for the next two-three years. Infosys, for instance, follows this strategy and gets higher multiples because they understate their plans.The projections given to the public should be realistic. The excel sheet might project rosy details of growth, but if they do not live up to the expectations then public confidence is sure to plummet to the lowest level.
7. Media Campaigns
A few years ago, marketing and media campaigns were considered a luxury, but today they are absolutely necessary. They contribute to the relative success of an IPO venture. The campaigns can be in the form of road shows and extensive investor meetings. They are required because the investors need to be made aware of the company and its past performances and any important projects undertaken/completed. During the campaigns, various facets related to company performance, the need to raise money and future plans are disclosed, information that investors
31
seek. A successful media campaign ensures complete participation in the IPO by one and all. In fact, recently when a bigwig real estate company went public, a few crores went in media campaigns alone. However, there is no short cut to success. A step-by-step approach always pays in the end.
listed at, highlights and risk factors, capital structure, board of directions, registered office of the company, brokers to the issue, brief description of the issue, cost of the project, projected earnings and other such details. The board, lending financial institutions and the stock exchanges in which they are to be listed should approve the prospectus. Prospectus is distributed among the stock exchanges, brokers and underwriters, collecting branches of the bankers and to the lead managers.
PRIVATE PLACEMENT
In this method the issue is placed with a small number of financial institutions, corporate bodies and high net worth individuals. The financial intermediaries purchase the shares and sell them to investors at a later date at a suitable price. The stock is placed with issue house
33
client with the medium of placing letter and other documents which taken together contribute a prospectus, giving the information regarding the issue. The special feature of the private placement is that the issues are negotiated between the issuing company and the purchasing intermediaries. Listed public limited company as well as closely held private limited company can access the public through the private placement method. Mostly in the private placement securities are sold to financial institutions like Unit Trust of India, mutual funds, insurance companies, and merchant banking subsidiaries of commercial banks and so on. Through private placement equity shares, preference shares, cumulative convertible preference shares, debentures and bonds are sold.
BOOK BUILDING
Book building is a mechanism through which the initial public offerings (IPOS) take place in the U.S. and in India it is gaining importance with every issue. Most of the recent new issue offered in the market has been through Book Building process. Similar mechanisms are used in the primary market offerings of GDRs also. In this process the price determination is based on orders placed and investors have an opportunity to place orders at different prices as practiced in international offerings. The recommendations given by Malegam Committee paved way for the introduction of the book building process in the capital market in Oct 1995. Book building involves firm allotment of the instrument to a syndicate created by the lead managers who sell the issue at an acceptable price to the public. Originally the potion of book building process was available to companies issuing more than Rs.100 cr. The restriction on the minimum size was removed and SEBI gave impression to adopt the book building method to issue of any size. In the prospectus, the company
34
has to specify the placement portion under book building process. The securities available to the public are separately known as net offer to the public. Nirma by offering a maximum of 100 lakh equity shares through this process was set to be the first company to adopt the mechanism. Among the lead managers or the syndicate members of the issue or the merchant bankers as member. The issuer company as a book runner nominates this member and his name is mentioned in the draft prospectus. The book runner has to circulate the copy of the draft prospectus to be filed with SEBI among the institutional buyers who are eligible for firm allotment. The draft prospectus should indicate the price band within which the securities are being offered for subscription. The offers are sent to the book runners. He maintains a record of names and number of securities offered and the price offered by the institutional buyer within the placement portion and the price for which the order is received to the book runners. The book runner and the issuer company finalize the price. The issue price for the placement portion and offer to the public should be the same. Underwriting agreement is entered into after the fixation of the price. One day earlier to the opening of the issue to the public, the book runner collects the application forms along with the application money from the institutional buyers and the underwriters. The book runner and other intermediaries involved in the book building process should maintain records of the book building process. The SEBI has the right to inspect the records. Book building as discussed is a process of offering securities in which bids at various prices from investors through syndicate members are collected. Based on bids, demand for the security is assessed and its price discovered. In case of normal public issue, investor knows the price
35
in advance and the demand is known at the close of the issue. In case of public issue through book building, demand can be known at the end of everyday but price is known at the close of issue. An issuer company proposing to issue capital through book building has two options viz., 75% book building route and 100% book building route. In case of 100% book building route is adopted, not more than 60% of net offer to public can be allocated to QIBs (Qualified Institutional Buyers), not less than 15% of the net offer to the public can be allocated to non-institutional investors applying for more than 1000 shares and not less than 25% of the net offer to public can be allocated to retail investors applying for up to 1000 shares. In case 75% of net public offer is made through book building, not more than 60% of the net offer can be allocated to QIBs and not less than 15% of the net offer can be allocated to non-institutional investors. The balance 25% of the net offer to public, offered at a price determined through book building, are available to retail individual investors who have either not participated in book building or have not received any allocation in the book built portion. Allotment to retail individual or non-institutional investors is made on the basis of proportional allotment system. In case of under subscription in any category, the un-subscribed portions are allocated to the bidder in other categories. The book built portion, 100% or 75%, as the case may be, of the net offer to public, are compulsorily underwritten by the syndicate members or book runners. Other requirements for book building include: Bids remain open for at least 5 days. Only electronic bidding is permitted. Bids are submitted through syndicate members.
36
Bids can be revised. Bidding demand is displayed at the end of every day. Allotments are made not later than 15 days from the closure of the issue etc. The SEBI guidelines for book building provides that the company should be allowed to disclose the floor price, just prior to the opening date, instead of in the Red herring prospectus, which may be done by any means like a public advertisement in newspaper etc. Flexibility should be provided to the issuer company by permitting them to indicate a 20% price band. Issuer may be given the flexibility to revise the price band during the bidding period and the issuers should be allowed to have a closed book building i.e. the book will not be made public. The mandatory requirement of 90% subscription should not be considered with strictness, but the prospectus should disclose the amount of minimum subscription required and sources for meeting the shortfall. The Primary Market Advisory Committee recommended the practice of green-shoe option available in markets abroad which is an over allotment option granted by the issuer to the underwriter in a public offering. This helps the syndicate member to over allocate the shares to the extent of option available and to consequently purchase additional shares from the issuer at the original offering price in order to cover the over-allotments.
37
bookrunner, typically the underwriter selling the largest proportions of the IPO, takes the highest portion of the gross spread, up to 8% in some cases. Multinational IPOs may have many syndicates to deal with differing legal requirements in both the issuer's domestic market and other regions. For example, an issuer based in the E.U. may be represented by the main selling syndicate in its domestic market, Europe, in addition to separate syndicates or selling groups for US/Canada and for Asia. Usually, the lead underwriter in the main selling group is also the lead bank in the other selling groups. Because of the wide array of legal requirements and because it is an expensive process, IPOs typically involve one or more law firms with major practices in securities law, such as the Magic Circle firms of London and the white shoe firms of New York City. Public offerings are sold to both institutional investors and retail clients of the underwriters. A licensed securities salesperson (Registered Representative in the USA and Canada) selling shares of a public offering to his clients is paid a portion of the selling concession (the fee paid by the issuer to the underwriter) rather than by his client. In some situations, when the IPO is not a "hot" issue (undersubscribed), and where the salesperson is the client's advisor, it is possible that the financial incentives of the advisor and client may not be aligned. The issuer usually allows the underwriters an option to increase the size of the offering by up to 15% under certain circumstance known as the greenshoe or overallotment option. This option is always exercised when the offering is considered a "hot" issue, by virtue of being oversubscribed.
39
In the USA, clients are given a preliminary prospectus, known as a red herring prospectus, during the initial quiet period. The red herring prospectus is so named because of a bold red warning statement printed on its front cover. The warning states that the offering information is incomplete, and may be changed. The actual wording can vary, although most roughly follow the format exhibited on the Facebook IPO red herring.During the quiet period, the shares cannot be offered for sale. Brokers can, however, take "indications of interest" from their clients. At the time of the stock launch, after the Registration Statement has become effective, indications of interest can be converted to buy orders, at the discretion of the buyer. Sales can only be made through a final prospectus cleared by the Securities and Exchange Commission. Before legal actions initiated by New York Attorney General Eliot Spitzer, which later became known as the Global Settlement enforcement agreement, some large investment firmshad initiated favorable research coverage of companies in an effort to aid Corporate Finance departments and retail divisions engaged in the marketing of new issues. The central issue in that enforcement agreement had been judged in court previously. It involved the conflict of interest between the investment banking and analysis departments of ten of the largest investment firms in the United States. The investment firms involved in the settlement had all engaged in actions and practices that had allowed the inappropriate influence of their research analysts by their investment bankers seeking lucrative fees. A typical violation addressed by the settlement was the case of CSFB and Salomon Smith Barney, which were alleged to have engaged in inappropriate spinning of "hot" IPOs and issued fraudulent research reports in violation of various sections within the Securities Exchange Act of 1934.
40
the top end of the underwriter's range, would likely achieve that objective. From the viewpoint of the investor, however, the Dutch Auction would be more effective at price discovery, and potentially result in a lower offering price.
significant gains for investors who have been allocated shares of the IPO at the offering price. However, underpricing an IPO results in lost potential capital for the issuer. One extreme example is theglobe.com IPO which helped fuel the IPO "mania" of the late 90's internet era. Underwritten by Bear Stearns on November 13, 1998, the IPO was priced at $9 per share. The share price quickly increased 1000% after the opening of trading, to a high of $97. Selling pressure from institutional flipping eventually drove the stock back down, and it closed the day at $63. Although the company did raise about $30 million from the offering it is estimated that with the level of demand for the offering and the volume of trading that took place the company might have left upwards of $200 million on the table. The danger of overpricing is also an important consideration. If a stock is offered to the public at a higher price than the market will pay, the underwriters may have trouble meeting their commitments to sell shares. Even if they sell all of the issued shares, the stock may fall in value on the first day of trading. If so, the stock may lose its marketability and hence even more of its value. This could result in losses for investors, many of whom being the most favored clients of the underwriters. Underwriters, therefore, take many factors into consideration when pricing an IPO, and attempt to reach an offering price that is low enough to stimulate interest in the stock, but high enough to raise an adequate amount of capital for the company. The process of determining an optimal price usually involves the underwriters ("syndicate") arranging share purchase commitments from leading institutional investors. Some researchers (e.g. Geoffrey C., and C. Swift, 2009) believe that the underpricing of IPOs is less a deliberate act on the part of issuers
43
and/or underwriters, than the result of an over-reaction on the part of investors (Friesen & Swift, 2009). One potential method for determining underpricing is through the use of IPO Underpricing Algorithms.
44
debt funds for corporate sectors and ultimately helping establishing favorable economic environment. Merchant banker renders services to meet the needs of trade and industry and investors, by performing as intermediary, consultant and a liason. Companies raise capital by issuing securities in the market. Merchant bankers act as intermediaries between the issuers of capital and the ultimate investors who purchase these securities. Their primary sources of income are PIPE financings and international trade. Their secondary income sources are consulting, Mergers & Acquisitions help and financial market speculation. Because they do not invest against collateral, they take far greater risks than traditional banks. Because they are private, do not take money from the public and are international in scope, they are not regulated.
In channelising the financial surplus of the general public into productive investment avenues.
To coordinate the activities of various intermediaries to the share issue such as the registrar, bankers, advertising agency, printers, underwriters, brokers etc.
To ensure the compliance with rules and regulations governing the securities market
45
substitute one kind of capital for another - sometimes utilizing internal sources by way of either asset or corporate repositioning or equity creation. Above all, a merchant banker fully comprehends the "risk" versus "return" element necessary to complete the capital procurement process.
Modern practices
The definition of merchant banking has changed greatly since the days of the Rothschilds. The great merchant banking families dealt in everything from underwriting bonds to originating foreign loans. Bullion trading and bond issuing were some of the specialties of the Rothschild family. The modern merchant banks, however, tend to advise corporations and wealthy individuals on how to use their money. The advice varies from counsel on Mergers and acquisitions to recommendation on the type of credit needed. The job of generating loans and initiating other complex financial transactions has been taken over by investment banks and private equity firms. Today there are many different classes of merchant banks. One of the most common forms is primarily utilized in America. This type initiates loans and then sells them to investors. Even though these companies call themselves "Merchant banks," they have few if any of the characteristics of former Merchant banks.
A bank that deals mostly in (but is not limited to) international finance , long-term loans for companies and underwriting. Merchant banks do not provide regular banking services to the general public.
47
Management of debt and equity offeringsThis forms the main function of the merchant banker. He assists the companies in raising funds from the market. The main areas of work in this regard include: instrument designing, pricing the issue, registration of the offer document, underwriting support, marketing of the issue, allotment and refund, listing on stock exchanges.
Placement and distributionThe merchant banker helps in distributing various securities like equity shares, debt instruments, mutual fund products, fixed deposits, insurance products, commercial paper to name a few. The distribution network of the merchant banker can be classified as institutional and retail in nature. The institutional network consists of mutual funds, foreign institutional investors, private equity funds, pension funds, financial institutions etc. The size of such a network represents the wholesale reach of the merchant banker. The retail network depends on networking with investors.
Financial structuringFinancial structuring includes determining the right debt-equity ratio and gearing ratio for the client, the appropriate capital structure theory is also framed. Merchant bankers also explore the refinancing alternatives of the client, and evaluate cheaper sources of funds. Another area of advice
48
is rehabilitation and turnaround management. In case of sick units, merchant bankers may design a revival package in coordination with banks and financial institutions. Risk management is another area where advice from a merchant banker is sought. He advises the client on different hedging strategies and suggests the appropriate strategy.
Project advisory servicesMerchant bankers help their clients in various stages of the project undertaken by the clients. They assist them in conceptualising the project idea in the initial stage. Once the idea is formed, they conduct feasibility studies to examine the viability of the proposed project. They also assist the client in preparing different documents like the detailed project report.
Loan syndicationMerchant bankers arrange to tie up loans for their clients. This takes place in a series of steps. Firstly they analyse the pattern of the clients cash flows, based on which the terms of borrowings can be defined. Then the merchant banker prepares a detailed loan memorandum, which is circulated to various banks and financial institutions and they are invited to participate in the syndicate. The banks then negotiate the terms of lending on the basis of which the final allocation is done.
Providing venture capital and mezzanine financingMerchant bankers help companies in obtaining venture capital financing for financing their new and innovative strategies.
49
The applicant should be a body corporate The applicant should not carry on any business other than those
The applicant must have at least two employees with prior experience in
merchant banking
company of the applicant should not have been a registered merchant banker
The applicant should not have been involved in any securities scam or
50
If they succeed, they will exercise a 15% overallotment option, called a greenshoe, which is named after the Green Shoe Company, the first issuer of such an option. This permits the underwriters to increase the number of new shares issued by up to 15% (from the number stated in the prospectus) without going through any additional registration. The new issue market is called the primary market. The Securities and Exchange Commission (SEC) registers the securities prior to their primary issuance, then they start trading in the secondary market on the New York Stock Exchange, Nasdaq or other venue where the securities have been accepted for listing and trading.
5.2 SOME EXAMPLE OF BANKS HAVING MERCHANT BANKING DIVISION FOR IPO MANAGMENT
A) PUNJAB NATIONAL BANK
Punjab National Bank, Indias one of the Leading Nationalized Bank established in 1895, serving over 3.5 crore customers through 4520 branches and 439 extension counters is the largest amongst Nationalized Banks. The Bank has recently been ranked 21st among top 500 companies and 9th among top 50 brands by the Economic Times. All the Branches of the Bank have been computerized. The Bank has a concept of "Any Time, Any Where Banking" through the introduction of Centralized Banking Solution (CBS) and over 2511 offices have already been brought under its ambit. The Bank is registered with SEBI as Category I Merchant Banker for providing all the major Merchant Banking services.
52
Issue Management Services to act as Book Running Lead Manager/Lead Manager for the IPOs/FPOs/Right issues/Debt issues Project appraisal Corporate Advisory Services Underwriting of equity issues Banker to the Issue/Paying Banker Refund Banker Monitoring Agency Debenture Trustee Marketing of the issue through a strong network of
QIBs/HNIEs/Corporates and Retail investor. The Bank itself is one of the major investor in the market having a treasury of 45000 crores.
Depository Services Bank offers Depository Services to its clients and has designated large network of branches to cater to their demat requirements through Depository Participant of NSDL and CDSL depositories. We also provide the Speed e facility to demat account holders to submit their delivery instructions through Internet. The Bank has recently launched online securities trading facility in strategic alliance with IDBI Capital Market Services Ltd.
53
54
6. Loan Syndication
55