Merchant Banking-100 marks project

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CHAPTER 7

Services provided by Merchant Bankers

Public issue management 

Public issue management involves marketing of corporate securities and devolves upon the merchant bankers a responsibility to take all necessary steps to market the securities successfully. The basic objective behind the public issue remains the effective channellising of the savings into investment in corporate securities and enlistment of shares with stock exchanges or Over the Counter Exchange of India (OCTEI) for creation of transferability and liquidity in the secondary market.

Public issue – Public issue of corporate securities involves marketing of capital issues of new or existing companies, additional issues of existing companies including rights issues and dilution of shares by letter of offer. Marketing of new issues is done by issue of prospectus. Public issue by prospectus or otherwise are managed by the involvement, coordinated effort and co-operation of a number of agencies which take active part by rendering professional services in which they have their respective specialization. These agencies at apex level include managers to the issue i.e. the merchant bankers who plan, coordinate and control the entire issue activity and direct different agencies to contribute to the successful marketing of securities. Other agencies are underwriters, brokers, bankers, advertising agency, printers, auditors, solicitors/advocates/legal advisors, registrar to the issue and other government and semi-government authorities like Registrar of Companies, SEBI and the Stock Exchanges.

Assessment of going public- Incentives, advantages and disadvantages

Owners of ‘Closely-held-company’ may decide to offer their shares in the company to general public for subscription- this offer is called ‘going public’.

A company, whether private limited or public limited, who shares are not listed on  recognized  stock exchanges is included in the category of closely-held company.

A closely-held- company enjoys the advantages of complete control of the affairs, no answerability to any outsiders excepting its own share holders, freedom from various restrictions put under the Companies Act, 1956( like ceiling on managerial remuneration, publishing annual accounts etc.), lesser secretarial work due to absence of large number of share holders, lesser fear of takeover, etc.

Despite the above advantages, a closely held company remains under disadvantages for resource constrains and restricted growth. Particularly, it is deprived of, to some extent, the major advantages available to widely held listed public limited company which include tax benefits, liquidity to promoters’ holdings, visibility in the market to exert presence amid the competitors, etc.

Incentives for going public

Government had  realized that about 95% of registered companies are closely-held companies which are contributing to the underdeveloped state of the capital market in the country. With a view to attract such companies to go public, various steps were taken relaxing rules and regulations and causing incentives for them which inter alia included the following:-

1. Reduced minimum public offer- a closely-held company can offer 40% of its paid up capital (as against 60%) to the public for getting its shares listed under rule 19(2)(b) of the Securities Contract (Regulation) Rules, 1956.

The advantage of such an offer is that the promoters can retain 60% of the paid up capital without fear of diluting the control over the affairs of the company.

2. Two stages offered over a period of three years.- The minimum 40% of the paid up capital of the closely-held company can be offered to the public in two stages @ 20% of its paid up capital and 80% being retained by the promoters in the first stage. But the company will have to undertake to issue balance 20% of shares to the public within a period of three years so as to make the minimum public holding of 40%.
3. Simultaneous issue of debentures. – Relaxations have been made in debenture guidelines.

A closely-held company can also issue linking convertible or non-convertible debentures to its equity issue to the public. This will help the company to obtain balanced and appropriate debt-equity mix.

4. Liberal approach for fixing premium on shares.
5. Incentive to issue bonus shares.

1. For a closely-held company going public under above manner, the time period restrictions of 24 months in issuing bonus shares is not applicable. The period of 24 months now stands reduced to 12 months for subsequent bonus issues.
2. A closely-held company can capitalized its free reserves in the ratio of more than 1:1 prescribed for other companies for issue of bonus shares provided other norms in this regard are followed.

Advantages

The main advantages of going public from the corporate point of view are:-

1. Company is able to raise capital from public for meeting its working capital or finance its expansion/ diversification/ modernization programme or to facilitate merger acquisitions and future financing of its programmes;
2. Company broad-bases its capacity to borrow or raise loans to get a balanced mix of debt and equity to raise its earning capacity and profitability and benefit the owners by distributing higher dividend;
3. Broad-based company attracts income tax exemptions under the Income-tax Act.
4. Company gets better credit rating in the eyes of public by getting enlistment at stock exchanges and getting its shares traded and quoted to gauge and assess its own public image.
5. Company gets its business flared up with its public image and its products get go popularity in public with lesser use of publicity media.    

The advantages to the shareholders from investing in a public company are:-

1. Creation of public market for the securities provides liquidity, transferability and opportunities and diversification of investment.
2. Thus, investors can plan to avoid risk faced in a close held company
3. Opportunity to share in the growth of the company by getting bonus shares, rights shares, making capital gains in shares, etc.

Disadvantages

The main disadvantages of going public are as under:-

1. Going public involves cost – cost of public issue particularly for small issues are very high. Thus, the capitals raised from public issue carry high cost.
2. Pressure dividend distribution involve a drain on working capital funds of the company
3. Non-payment of dividend tarnish the public image of the company
4. The company is exposed to public disclosures under the Companies Act, 1956 particularly its prospectus may reveal its product, project, promoters and profitability prospects from marketing selling and distribution methods, manufacturing capacity, transactions with inside competition position in the industry, etc.
5. Listed company’s stock may be purchased by persons who are interested in takeover of the company and thus threat for management continues to exist despite protective provisions under Securities Control (Regulation) Act, 1956, the Companies Act, 1956, SEBI Act,1992 and SEBI (Insider Trading) Regulations,1992.

Procedure and steps for managing public issues could be discussed under two phases. They are:

(A) Pre-issue management

(B) Post-issue management

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(A) Pre-issue management – The various steps which are taken in managing capital issues in general are listed below. The coverage of these activities include all the activities beginning with the planning of bringing the capital issue till the opening of subscription list. The steps are as follows:

1. Steps to be taken by the issuing company.
2. Steps to be taken by lead manager to the public issue.

(I) Steps to be taken by the company:

Before going public the company has to take steps to ensure on its part compliance of certain formalities. These formalities are:

(1) Planning the capital issue – The company has to assess its requirements for the funds to be raised from the public. The requirement should be assessed with reference to the balanced capital mix between the owners’ funds and the borrowed funds and be based on the capital structure of the company. In case the company has availed of the services of merchant bankers for corporate counselling or project counselling then the merchant banker could advise the company over this aspect. Also a merchant banker who is rendering the service of loan syndication, in this regard, may be in a better position to help the company in guiding on this aspect without any difficulty. If a company has not approached any financial institution for borrowed funds to finance its proposed project, it is required to have its need for finance appraised by any one of the Indian financial institutions or banks. Another aspect to be taken care of while planning the capital issue is the type of securities to be issued. Trend of public response for equity capital and debenture should be considered.

(2) Choice of a merchant banker to act as a lead manager and selection criteria – The next step is to select a merchant banker to act as a lead manager and the selection criteria for this comprises of the following elements:

• The ability of the merchant banker to sell the issue to the investors.
• The status and organizational competence of the merchant banker and infrastructure available with it to manage the public issue effectively.
• The efficiency in service provide by the merchant bankers through well informed, skilled and expert man-power it employs.
• The confidence that a company can have in the merchant banker to avail of the assistance in the odd circumstances and unfavourable market situation.
• The merchant banker to be appointed as lead manager to public issue should be the one having authorization from SEBI.

Also the company will appoint the lead merchant banker to the proposed issue as per the provisions of SEBI (Merchant Bankers) Regulation. The issuer company is also required to enter into a formal agreement with the lead merchant banker as per the requirement of the regulation.

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(3) Number of co-managers to the issue – The number of lead merchant bankers should not exceed in case of any of the following issues:

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(II) Steps to be taken by lead manager to the public issue for new companies, rights issue or dilution shares for existing companies – Once the company has appointed lead manager to the public issue, its executives work in close coordination with the lead merchant banker. In case, there is more than one lead manager, the role to be played by each of the lead managers is discussed and the work relating to issue management could be allocated amongst them keeping in view their respective expertise and resourcefulness in the specific area. Such merchant banker will be responsible and accountable for all matters related to the specified and accepted roles. Lead merchant banker/s has/have to plan the public issue activities through a schedule listing the activities to be performed and the time-frame within which each activity has to be performed and completed. A specimen activity schedule which is generally prepared by lead managers to the issue is given as check-list. The major activities to be performed by the merchant bankers are as follows:

1. Stock exchange approval.
2. Considerations regarding the adequacy of capital, balanced capital structure, debt-equity ratio and preference equity ratio.
3. Taking action as per SEBI guidelines – Requirements for capital issues under the SEBI guidelines are listed below:

1. Fresh issue of capital to public: equity shares and preference shares.
2. Rights issue/public issue by existing listed companies.
3. Bonus issue.
4. Debenture issue.
5. Public sector bonds.
6. Public issues by financial institutions.

4. Finalising appointment of different agencies – The various agencies which are to be appointed for the management of capital issues are required to be registered with SEBI. The various agencies to be appointed by the lead managers are as follows:

1. Appointment of underwriters to the issue.
2. Appointing brokers for selling the issue.
3. Appointment of bankers to the issue.
4. Appointment of registrars to the issue.
5. Appointment of printers.
6. Appointment of advertising agency.

5. Appointment of other agencies – The merchant banks may also advise the company that in addition to the above agencies it may also appoint the following persons involved in the public issue:

1. Auditors of the company.
2. Solicitors/Advocate as legal advisors to the public issue/issue of prospectus.
3. Broad base the Board of Directors so as to nominate prominent parties in India or abroad on its Board.

6. Drafting of prospectus – Prospectus is an important document upon which the investors rely, repose confidence in the company and invest their savings in subscribing to the capital of such offering company.
7. Approval of prospectus by different agencies. They are as follows:

1. Legal advisor.
2. Auditors.
3. Co-managers to the issue.
4. Institutional underwriters.
5. SEBI clearance to prospectus.
6. Approval of stock exchanges to the draft prospectus.

8. Action to be taken by the company

1. Board of directors meetings.
2. Making application to stock exchanges for permission.
3. Filing prospectus with Registrar of Companies.
4. Forwarding copy of the prospectus to SEBI.
5. Appointment of underwriters/brokers by the board.

9. Printing and dispatch of issue material – On receipt of the acknowledgement of the prospectus from the Registrar of Companies the printing of prospectus, application forms, brochure, press release and other material should start. Both printers and advertising agency should coordinate to get efficiency and economy of time and money. The merchant bankers should go through the final proof of the entire issue material before printing starts. The application form, brochure and press releases as designed by advertising agency should be approved by       managers to the issue before the company gives print orders to avoid errors and discrepancies.
10. Publicity campaign – The publicity campaign for the public issue may be organized with a view to make the investors aware of the opening of the public issue, inform them about the company bringing out the public issue, its promoters’ background and creditability, status of the project to be financed out of the public issue, the marketability of the product to be manufactured or service to be provided by the company and the future profitability projection to enable the investors to make their independent judgements about the future of the company and the money they may decide to invest in the company by subscribing to its shares.

1. Advertisements.
2. Wirte-ups/reportings about the company/its promoters in economic journals.
3.  Holding press/brokers/investors conferences at prominent centres.

11. Instructions to bankers – bankers to the issue designate their branches, as collection centres keeping gin view the general response of the investors, location of the project, expectation of regional support from the public, their past performance in the area, facilities available in their branches to handle the collection of public issue applications. These branches work under the directions of a controlling branch or pooling centre. Also Registrars to the issue convey necessary instructions to all the bankers and their collecting centres/controlling centres when all is set for opening the subscription list.

12. Opening of the subscription list – All canvassing about the issue stops from the day of prospectus announcement in the newspapers which is done ten days before the issue is opens. All collecting centres display with posters and benners availability of application forms and make arrangements for the convenience of the investors to receive the application form with application money.    

(B) Post-issue management – General public becomes entitled to subscribe to the shares/debentures of the issuing company on the day the subscription list opens as announced in the prospectus or other offer documents and the statutory      advertisement.

1. First day response – The response on the first day is a fair indication of the success or failure of the public issue of securities. Good issues may get over-subscribed on the first day itself. But this will depend upon the efforts made to sell the issue, the investors mood with bullish spiral prevalent on the stock market on the opening day and the existing and near future economic, social, political and business environment.
2. Communication channels during the issue period – Merchant bankers. Brokers, underwriters, bankers and the company all are eager to know the exact figure of applications received for subscription and the money collected thereof. The collecting branches of the bankers which in turn provide the information to the Registrars, Managers and the company as per the communication channels depicted in the module given below: -

Brokers and underwriters are getting information from managers or the concerned company about the subscription to the issue. For effective and immediate collection of information the representatives of Registrars sit with the controlling branch and collect information from banks collection centres is passed on to controlling branch of the bank.

3. Information from the issue – Registrars, interact with merchant banks/managers and send centre-wise information to them from time to time.
4. Naïve analysis of collection – Merchant bankers managing the issue, make through estimate of the collections and assess the progress of subscription following the ABC analysis. For the purposes of the collection money the important towns which show better collections are put in category A. in these towns collection is made upto 80% of the total amount. These are five towns Delhi, Mumbai, Calcutta, Madras and Ahmedabad. If on the first day of opening of the issue collections come upto 20% in any of these towns then exploration is done to forecast the total subscription. This is done by multiplying the number of these five prominent centres by 20% i.e. 20% x 5 = 100. This shows that the issue will get over subscribed. Category B towns which contribute only 20% to the issue will collect some money too, that will be added to the figures. Category C towns may not collect any amount but if any amount is collected it will be further added to the total sum. Thus, the rough estimate is made about the collections. Registrar to the issue monitors progress in category A towns to pass on the actual collection figures to the managers.
5. Closure of the subscription list – Subscription list is open for minimum period of three days and maximum period of 10 working days as approved by the stock exchanges. The period is extended from minimum to maximum when the issue remains under-subscribed. In other words, the closure of the issue is made on the final date shown in the prospectus for closing of subscription list.
6. Over-Subscription – Retention of over-subscription of equity or debenture is now not allowed by SEBI. No doubt over-subscription reflects the popularity and image of the company in the eyes of investors, but it also adds to costs of handling of the issue. A company used to be allowed by the Controller of capital Issues to retain 25% of the over-subscription of equity and 50% of debentures if announced by it in the prospectus or statement in lieu of prospectus or letter of rights offer. This percentage was reduced on uniform basis to 15% both for shares and debentures in public and rights issue. The company could retain the over-subscription to the prescribed extent of the total share capital inclusive of the over-subscription, provided it did not exceed Rs.1 crore without permission of Controller of Capital Issues.
7. Minimum subscription in public/rights issues – The Central Government has decided that from April 9, 1990, a company making any rights or public issue of securities will be allowed to allot shares and debentures only if it has received a minimum of 90% subscription against the entire issue. If the required amount I not received, the application money will have to be refunded to the applicants at the end of 90 days from the closure of issue. This is one to protect the interest of investors particularly in under-subscribed capital issues.
8. Under-subscription – Under subscription does not render all persons happy. It causes devolvement upon underwriters/sub-underwriters. Having guessed under-subscription, underwriters, specially financial institutions should make application to popularize the issue and ensure maximum subscription from the public. According to the SEBI guidelines, if a company does not receive 90% of issued amount from public subscription plus accepted devolvement from underwriters, within 120 days from the date of opening of the issue, the company shall refund the subscription if the above conditions are not met.
9. Processing of data – Registrar to the issue or issue-house commences processing of the data on computer or manually as the case may be, on receipt of applications from different centres. Verification of each and every application is made with reference to the amount on application, correct name, age, address and occupation of subscriber, signatures of the subscriber(s). In the case of NRI subscribers verification is made with reference to Central Government stipulations under FERA. Applications made under power of attorney are accompanied with respective power of attorney document which has to be verified. No applicant, it is ensured is a fictitious person. Having ascertained and verified all these above facts, applications are serially numbered for quick identification and future reference. By using computer systems the processing is done fast. Applications can be sorted out and statements could be prepared for applicants’ underwriters, brokers, city-wise procurement, etc. Statement could also be prepared for applications to be rejected for reasons of non-receipt of application money. Statements could be prepared for applications received in the name of minors, partnership firms, foreign nationals, trust or nominees or any of them for consideration/ rejection by the company’s Board. With the use of computers, the broad list of the merchant bankers to plan marketing strategy, for future issues.
10. SEBI’s guidelines – To monitor the post-issue process, obligations have been placed upon lead merchant bankers to strictly supervise and follow-up the post-issue activities and periodically report to SEBI the progress in the matters of allotment and refunds as noted below: -

1. 7 days reporting from closure of issue – Lead managers to confirm to SEBI that the issue is subscribed to the extent of 90% within 7 days from the date of the closure of the issue.
2. 45 days reporting from closure of issue – This is compliance report to be sent to SEBI. In this report lead manager shall also include if the company was permitted by stock exchange to utilize the funds on receipt of 90% subscription.
3. Report on the basis of allotment.
4. 90 days final report – SEBI vide its letter to all merchant bankers on July 6, 1993 has amended the Compendium of Circulars wherein it has prescribed a complete reporting system for subscribed public issues, unsubscribed public issues, subscribed right issues and undersubscribed right issues in the prescribed performance.

11. Under-subscription and underwriters liability – Under-subscription of the issue causes difficulties for the company and underwriters. Registrars advise the company to call upon the underwriters to fulfill their commitments. Underwriters liability is decided by deducting the total number of shares underwritten to the extent of deficiency, he has to be liable. In case any particular underwriter has procured adequate number of shares, he incurs no liability; in case he has procured excess number of shares then excess of shares is taken to general pool. These excess shares are adjusted in proportion of underwriting commitment of those underwriters who could not fulfill their commitment to arrive at the net       figures of the devolvement liability.
12. Watch on defaulting underwriters – In order to keep a close watch over such underwriters who have failed to meet their underwriting devolvement and to consider penal action against such underwriters and debar them from underwriting public issues in future, the merchant bankers are required to provide information to SEBI in the below given format beginning from July, 1993:

• Name of the merchant banker
• Name of the issuer company
• Issue size

13. Bridge loan from institutional underwriters against public issue of shares – Financial institutions provide bridge loan to the company to the extent of 50% of their underwriting commitments which has demand character, to be adjusted on allotment. To avail of the amount of bridge loan the company has got to notify in the prospectus its intentions.
14. Devolvement and commitment of underwriters – Institutional underwriters including banks should be immediately contracted by the company through its Mangers to put in the application to the extent of devolvement. The underwriter Banks should be approached in writing with the following documents enclosed.

• Auditors Certificate showing that the promoters and their associates have contributed their share of contribution in the equity capital of the company in terms of the prospectus.
• Auditors’ Certificate explaining that the obligation of underwriters in respect of contingent underwriting have been duly fulfilled by the underwriters.
• Statement of underwriters obligations showing therein the extent of devolvement upon institutions/banks, which has also got to be verified by the auditors.

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Underwriting

Meaning

The word ‘underwriting’ was coined by British Merchants who used to write their names at the end of marine insurance document wherein each agreed to assure joint risk.

The dictionary meaning of underwriting is ‘to agree to sell bonds, etc. to the public, or to furnish the necessary money for such securities and to buy those which cannot be sold’.

Underwriting is an important primary market activity performed by stock brokers, merchant bankers and underwriters approved by SEBI for this purpose. It is related to marketing and merchant banking for an issue. The industry positions are measured by the amount of underwriting one does.

Underwriters are distributors for the financial products- assuring a sale and if the sale does not actually take place, they agree to pick up the residual. It is an assurance against the possible failure of the issue and the underwriters have to step in if the issue remains under subscribed to the extent of the amount underwritten. If the market does not take the share, it is an indication of overpricing of scrip. As such, the underwriter exposes himself to risk on account of fall in market price and blockening his funds.

Underwriting offer is similar to insurance business, where the insurer is exposed to risk to the extent of amount insured, but the only game is the insurance commission. In underwriting, the compensation is underwriting commission. The underwriting decision is evaluation of risk and probable loss which can also be reduced by sub-underwriting.

In India underwriting commission is regulated by statute at a maximum of 2.5%. Similarly, the entry into this business is also regulated by SEBI thereby only SEBI registered agencies can act as underwriters. These are:-

1. Category 1,2 & 3 Merchant bankers.
2. Underwriters.
3. Stockbrokers.

Underwriting and SEBI guidelines

According to SEBI guidelines on investor protection and disclosure dated 11/06/1992, underwriting was mandatory for the full issue amount for each issue of capital to the public. This has since been relaxed in view of high costs involved and now the underwriting is optional.

The lead managers are required to satisfy themselves that the financial of the underwriters are adequate for them to undertake their underwriting commitments, such opinion has to be included in the prospectus also.

Underwriting agreement

To avoid disputes between the underwriters and issuer company, SEBI has formulated a model underwriting agreement which seeks to standardize the legal relationship between the two parties. It provides clear guidelines for resolving the issues of disputes. It stipulates several norms for interest of both the parties including the time limit within which the issue should open from the date of agreement i.e. three months. It indicates that the time essence of agreement. Any failure on the part of any party to adhere to the time limits shall discharge the other party of his obligations. If the prospectus contains untrue statements, the underwriter can terminate the contract prior to the opening of the issue.

The practice in our country is that lead managers obtain blank and undated consents from the underwriters which the underwriters do in order to get the business and there have been cases where the issues really came even after one year of sending consents.

The underwriters shall be entitled to appoint sub-underwriters but the main underwriter will be primarily responsible. The underwriters are also asked to produce a statement of devolvement of issues and a statement of declaration of net worth alongwith Chartered Accountant’s Certificate at the time of sending consents. All underwriters who are members of recognized stock exchanges have also to obtain permission to act as underwriter from their Stock Exchange.

Underwriting agreement is a legally enforceable contract between a company or a issuer and the underwriter. There is no legal difference between underwriting and contingent underwriting as all underwritings are dependent on a contingency. Sometimes, a company enters into a standby arrangement whereby there is an agreement between the company and an undertaker who agrees to apply for shares, if not subscribed by public. This is also an underwriting agreement.

 The underwriting involves an offer and acceptance. The offer is made by company or on its behalf by the lead managers inviting underwriters to underwrite. The underwriters agree to underwrite and accepted by Board of Directors of a Company. The underwriting agreement can be withdrawn before the prospectus is filed with the Registrar of companies. The communication of acceptance is necessary.

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Evaluation by underwriter:

Since the underwriter’s contingent stake is involved in any issue, it is desirable for any underwriter to evaluate the project or issue before consenting to act as an underwriter. He should stress upon following points while deciding whether to underwrite and how much to underwrite.

1. Company’s standing and past track record
2. Management of the company, competence of promoters and professional approach.
3. Objects of the proposed issue.
4. Project details, means of finance, pricing and marketing.
5. Foreign participation in technology, finance and management.
6. Price of the issue and listed price of company’s shares or of other companies in industry.
7. Pending disputes and litigations.
8. Statutory clearances.
9. Financial institution’s loans and participation in equity.

What the company looks for in underwriters:

The companies or their lead managers appoint underwriters on the basis of their standing in the market and past experience as to procurement and honouring of commitments.

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The major points that are looked into are:-

1. Financial strength of the underwriters.
2. Experience in primary market.
3. Primary market network.
4. Past performance and procurements.
5. Outstanding underwriting commitments.

Sub-underwriting

The underwriter shall be entitled to arrange for sub-underwriting of his underwriting obligation on his own account with any person, broker or underwriter on terms and conditions to be agreed upon between themselves. Notwithstanding any such sub-underwriting arrangement, the main underwriter only shall be primarily responsible for sub-underwriting and any failure or default on the part of sub-underwriters to discharge their respective sub-underwriting obligation, shall not exempt or discharge the underwriter of his underwriting obligation to the company.

Wherever such arrangements are done, it should be informed to the company, lead managers and concerned stock exchanges.      

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Loan Syndication

Loan syndication or credit syndication refers to the services rendered by the merchant bankers in arranging and procuring credit from financial institutions, banks and other lending and investment organizations for financing the clients project cost or meeting working capital requirements. In other words, it is a project finance service. In sequence of merchant banking services it ranks next to project counselling.

Once the client company has decided about the project proposed to be undertaken. The next step is looking for the sources from where funds could be procured to implement the project. The responsibility of locating the sources of finance, approaching these sources by putting in requisite prescribed applications and complying with all formalities involved in the sanction and disbursal of loan rests with the merchant bankers who provide the service loan/credit syndication.

Steps in Loan syndication:

1. Preparing project details and estimating capital requirements of the applicant.
2. Locating sources of finance i.e. the lenders or supplier of funds.
3. Selection of suppliers of funds. Preliminary discussions with the suppliers of funds to ascertain possibilities of getting credit.
4. Preparation of loan application.
5. Filing the loan application with the financial institution/bank and follow-up action.
6. Rendering assistance in project appraisal with the financial institution/bank.
7. Obtaining sanction letter/letter of intent from the lenders.
8. Assistance in compliance of terms and conditions for the availment of the loan.
9. Assistance in documentation and creation of security.
10. Assistance in obtaining disbursement of loan.

Loan syndication in the case of domestic borrowing is undertaken with the institutional lenders and the banks. Amongst institutional lenders the following institutions are the main suppliers of the long and medium term funds with which the merchant bankers contact, liaison, and arrange loans for and on behalf of their clients.

1. All India Financial Institutions:

1. Industrial Finance Corporation of India (IFCI)
2. Industrial Development Bank of India (IDBI)
3. Industrial Credit and Investment Corporation of India Ltd. (ICICI)
4. Industrial Reconstruction Bank of India (IRBI)
5. Shipping Credit and Investment Company of India Ltd. (SCICI Ltd.)

2. State Level Financial Bodies:

1. State Financial Corporations (SFCs)
2. State Industrial Development Corporations (SIDCs)
3. State Industrial and Investment Corporations (SIICs)

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3. All India Level Investment Institutions:

1. Life Insurance Corporation of India (LIC)
2. Unit Trust of India (UTI)
3. General Insurance Corporation of India (GIC) and its subsidiary companies.

4. Commercial Banks:-- Commercial banks join consortium financing with all India financial institutions to provide medium term loan to industrial projects, otherwise they cater to the needs for working capital requirements.

5. Mutual Funds

6. Venture Capital Funds

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Project Counseling

Project counseling is very important and lucrative merchant banking service which only very few merchant bankers having advantages of knowledge, skills and experience over others are able to render satisfactorily.

Project report – its meaning and need

The dictionary meaning of the word ‘project’ is ‘plan’, ‘scheme’, ‘course of action’ etc.

The above meaning of the project is acceptable from merchant banking point of view. But merchant bankers may contribute to the basic idea which a promoter initially picks up for the proposed industrial activity. This idea is cautiously developed into a plan or scheme and given a shape as a ‘project’. The efforts that are made to convert an idea into a plan of action are expressed in project report.

Merchant bankers advise the clients on project preparation. Merchant bankers, on behalf of their clients, engage technical consultants specialized in the specific area and marketing experts to prepare technical feasibility report and market survey reports. Merchant bankers maintain the list of such experts approved by financial institutions and assign the work to these experts. Thus, two reports viz. technical feasibility report and the market survey report must be prepared separately. Various agencies, at different levels, evaluate these two reports to extract the desired information for taking decisions.

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Project report purposes – Preparation of project report is necessary for the following purposes –

For obtaining government approvals – Government has put restrictions on taking up certain economic activities without its prior approval. Most of these restrictions have been placed to ensure that economic activity conforms to the basic norm of planned way where scarce resources of the nation could be put to better utilization for producing goods and services required on priority basis to promote economic and social welfare and safeguard the interests of the citizens. This necessitates government approval for taking up certain economic activities. Project report about the proposed activity is prepared to obtain government approvals particularly in the following areas:

• Grant of industrial licence to undertake specified industrial activity.
• Foreign investment and technology tie-up.
• Grant of import licence for importing raw material, plant, machinery and equipments.
• Grant of foreign exchange allocation for import of capital goods or raw materials etc.
• Grant of subsidies and other concessions from the government at centre or state levels or from government sponsored agencies, etc.

For procuring financial assistance from different financial institutions, banks and public sources – Financial institutions and banks grant term loans and working capital limits respectively to the business enterprises on the basis of the requirements projected and justified in the project report. For procuring public subscription towards equity it is necessary to convince the investing public about the technical feasibility and economic viability of the project from practical as well as from legal angle to justify the financial requirements and comply with various statutory formalities for which the project report is needed.

For planned implementation of action plan or project – Project report enables a company for planned utilization of resources and implementation of the project within scheduled time.

For ensuring market for the proposed product – Project report presents integrated aspects about the product being proposed to be produced and to explore market for it. Market survey reports are part of the project report. Product, in real sense, is known only through market survey, which provides information about the existing as well as the future demand for the product. Success of any project depends on the marketability of the product undertaken to be produced. Such market explorations provide information about end users of the product, segments of the market for promotional efforts as well as for pricing decisions, market demand and state of competition, available price structure in the market for like, substitute or complementary products. Success of a project depends upon accurate market survey reports.

For ensuring specified technical process and engineering requirement for manufacture of the product – Cost of the project is affected by the technical process involved in production of the desired goods. Project report describes the technical process, requirements to implements the technical process by suggesting engineering needs, designs, specifications, plant, machinery and equipment, process manufacturing know-how, etc. Technical process suggests for suitable location of project site, size of plant, requirement of raw material, labour and skills, power, fuel, water, effluent treatment and degree of pollution control, transportation, etc. Project report provides all these details for taking quick decision on its implementations. It also suggests safeguard against possible technological obsolescence and new discoveries and innovations in the production process.  

For planning public issues – Preparation of project report was a mandatory requirement for obtaining consent for capital issues from the Controller of Capital Issues in those cases where the project was not being financed from term loans from the financial institutions/banks.

Scope of project counselling services – project counselling services are needed by industrial entrepreneurs in India in the following areas:-

1. Preparation of project report.
2. Deciding upon the financing pattern to finance the cost of the project.
3. Aspects of project appraisal with financial institutions/banks.

Preparation of project report:

Preparation of project report involves pre-investment study of the proposed production activity from different angles including the following:--

(1) Planning of objectives – Planning of objectives of the proposed activity is essential from different angles. For example, accomplishment of the above objectives should be viewed having scattered the dimensions into different directions of the activity viz. organizational objectives, performance objectives, marketing objectives, the end-product objectives, the customer benefit objectives and the social objectives, etc. in other words, desired targets aimed at in each or any of these directions should be evaluated in right perspective.

(2) Evaluating the plan objective – The above objectives and targets should be evaluate individually on consideration of the following aspects by the promoters of the project themselves or through the help of the merchant bankers or other professional consultants:

1. Collect qualitative and quantitative data available in each area of objectives.
2. Analyse the data using statistical tools and predict reliable results and values.
3. Compare the results and values in contemporary set up.
4. Choose the best alternative.
5. Such alternative should be selected on merit of tangibility, measurability, verifiability and risk bearing ability.

(3) Evaluate activity having identified the objectives – This is to be done with reference to requirements of the following elements:

1. Technical know-how and other requirements.
2. Plant and equipment.
3. Manpower requirements for both skilled and non-skilled.
4. Financial requirements.
5. Managerial competence and organizational set-up.

(4) Take a decision whether or not to undertake the project idea – Merchant bankers, wile giving suggestions or opinions on the above aspect are guided by their own experience and professional skills attained over the years of their practice and experience in the field work. Based on such experience, the following important suggestions accrue for the guidance of their clients serviced by merchant bankers:

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1. Plant size and location.
2. Project engineering aspect.
3. The market.
4. Organization and management.
5. Cost of the project and means of financing.

(5) Format of the project report – No format of project report is prescribed. Project report for different products involving different technical process will contain information best suited to the manufacturing process of each of such products. But there are certain aspects which are common in all project reports. These aspects are discussed below:

1. Product
2. Capacity
3. Technical process
4. Schedule of implementation
5. Cost of the project
6. Market study

(6) Deciding upon the financial pattern – Financing the project cost – Important aspects of project counselling is the planning for raising funds required to finance the project cost. Apparently there are two sources of funds available to finance the project cost viz. internal sources and external sources. In other words internal resources refer to owners’ funds whereas external sources are borrowed funds. Promoters’ contribution to the project cost in the form of equity is the only internal source for funds for a new company. But for an existing company, bringing up a project for implementation, internal source of funds could be the owners’ funds retained in the company in the form of reserves and surpluses or provision for depreciation or retained earnings.

External finance is in the form of loans from banks, private investors and financial institution. Loans may be short-term and long-term for periods of less than three years, three to seven years and more than seven years respectively. Short-term loans are granted by banks or raised by way of fixed deposits by the company for meeting its working capital requirements. Medium and long-term loans are used for financing acquisition of fixed assets and capital expenditure. These loans are raised as borrowings from the banks and term lending financial institutions. Company may burrow from public by way of public issues through prospects or private investment institution in the form of debentures at fixed rate with different conditions of convertibility, non-convertibility and redemption.  

Based on the above background the project cost of a company is financed as per the following pattern:

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Means of financing the project cost:

(1) Share capital (owners funds)

• Equity/Preferences shares
• Indian promoters
• Foreign collaboration
• State agency
• Non-resident Indians
• Public issue

(2) Term loans (borrowed funds)

• Rupee loan from financial institution/banks, foreign currency loan from financial institutions/banks; and/or
• Convertible debentures from public issue, non-convertible debentures from public issue or private placement with investment institutions; and/or
• Deferred payment guarantee to machinery suppliers for indigenous goods/imported goods; and/or
• Unsecured loans/deposits; Lease financing and/or

(3) Subsidies; and/or

(4) Internal cash accruals.

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Portfolio Management

Portfolio management is a way of handling clients investments in order to gain returns. The main objectives of portfolio management sought to be achieved by the merchant bankers for their clients include the following:

Safety of investment or funds – The investment should be preserved, not be lost and remain in a returnable position in cash or kind.

Marketability – the investment made in securities should be marketable i.e. the securities must be listed and traded at the stock exchange so as to avoid difficulty in their encashment.

Liquidity – the portfolio must consist of such securities which could be encashed without any difficulty or involvement of time to meet urgent need of funds. Marketability ensures liquidity of the portfolio.

Reasonable return – The investment should earn a reasonable return to upkeep the declining value of money and be compatible with opportunity cost of the money in terms of current income in the form of interest or dividend.

Appreciation in capital – the money invested in portfolio should grow and result in capital gains.

Tax planning – Efficient portfolio management is concerned with composite tax planning covering income-tax, capital gains tax and wealth-tax.

Risk avoidance – Risk avoidance and minimization of risk are important objectives of portfolio management. Portfolio managers achieve these objectives by effective investment planning and periodical review of the market situation and economic environment affecting the financial market.  

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Functions of Portfolio managers

Merchant bankers and portfolio managers rendering the services of portfolio management to their clients in different categories viz. individuals, resident Indians and non-resident Indians, firms, association of persons, like joint Hindu family, trust, society, corporate enterprises, provident fund trustees, etc. have to enquire of their respective individual objectives, need pattern for funds, perspective towards growth and attitude towards risk before counselling them on the subject and acceptance of the assignment. Nevertheless, the portfolio managers in the wake of rendering this service perform following set of functions:--

1. Doing complete study of economic environment affecting the capital market in the country covering important aspects of international economic situation likely to affect the home, money, capital or securities markets.
2. Studying the securities market and evaluate price trends of different types of securities quoted at stock exchange and identify the blue-chip companies securities where investors could be advised to invest their money for better and safe investments.
3. Maintaining complete updated financial performance data of the blue-chip companies and other good companies where investment could be made. Record should be maintained in a systematic way with ratio analysis about debt-equity, interest coverage assets coverage, rate of profitability and dividend payout ratio, earning per share, dividends during the past two years, retained income growth rate, capital nature of securities issued, bonus and right issue details, market performance of securities and current prices, inside trading practices, speculative nature of the security, etc
4. Keeping record of latest amendment in government guidelines, stock exchange regulations, RBI regulations over bank lending against security of shares, loans to invest in shares of new companies, tax incentives for investment in corporate securities, policy towards NRI’s investments, foreign capital inflow and repatriation restrictions, etc.
5. Studying problems of industry affecting securities market attitude of investors.
6. Studying the behaviour pattern of financial/investment institutions and banks, their policy structure towards investment, and off-loading in the securities market, their funds position and liquidity requirements. Keeping latest and detailed information about the moves of these institutions will help in managing risk of investment or price change of securities affected by sale and purchase activities to these financial institutions.
7. Studying the attitude and behaviour pattern of brokers’ community dealing in different stock exchange, their expectations, manipulative practices, etc.
8. Counselling the prospective investors on share market and suggest investments in certain assured securities.
9. Carrying out investment in securities or sale or purchase of securities on behalf of their clients to attain maximum return at lesser risk.

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Obligations of portfolio managers

1. The main task of the portfolio manager is to invest clients’ money. He must accept money or securities from the client for a period of more than one year each time the client avails the services either as a fresh placement or on renewal of existing funds for a further period on continual basis. However, the client can withdraw his funds subject to the terms and conditions of agreement between portfolio manager and the client in the following circumstances:

1. Voluntary or compulsory termination of portfolio management services by the portfolio manager.
2. Suspension or termination of registration of portfolio manager by the SEBI
3. Bankruptcy or liquidation in case the portfolio manager is a body corporate.
4. Permanent disability, lunacy, or insolvency in case the portfolio manager is an individual.

2. A portfolio manager while investing clients funds as specified in the agreement shall not deploy the funds in bill discounting, badla financing or for the purpose of lending placement with corporate or non-corporate bodies. He can invest the funds in money market instruments like commercial paper, trade bill, treasury bills and certificates of deposits.
3. A portfolio manager shall not indulge in speculative activities with the client’s funds.
4. A portfolio manager may sell or purchase securities for different clients in aggregate looking into his transactions convenience and economies but he shall do interse allocation on a pro rata basis and weighted average price of the day’s transactions. He shall not keep any open position in respect of allocation of sales or purchases affected in a day. Such transactions shall be at the prevailing market price. He shall segregate each client’s funds and portfolio of securities and keep them separately from his own funds and securities and be responsible for safe keeping of clients funds and securities. He may hold the securities of clients portfolio accounts in his own name on behalf of the clients only if the contract so provides and in such cases he shall send the report to the client indicating the securities held by him in the above manner.
5. He shall maintain the books of accounts, records etc. as specified in the SEBI (Portfolio Managers) Regulations, 1993 thereof viz. a copy each of the balance sheet, profit and loss account and auditors’ report for each accounting period, a statement of financial position and records in support of every investment transaction or recommendation which will indicate the data facts and opinion leading to that investment decision. He shall submit to SEBI copies of the balance sheet, profit and loss account and such other documents as may be required under these regulations at the end of each accounting period for a period of five years as and when required by SEBI.
6. He shall submit half yearly-unaudited financial results to SEBI as when required with a view to monitor his capital adequacy.
7. He shall furnish periodical reports to the clients as per regulation 21.
8. He shall rectify the deficiencies made out in the auditors report within two months from the date of audit reports.
9. He shall make full disclosures of the portfolio to SEBI as when required by it under regulation 23, of the Regulations, 1993.

General responsibilities of Portfolio Manager

The general responsibilities for the discretionary portfolio manager as well as the portfolio manager have been specified in regulation 15 of the SEBI (Portfolio Management) Regulations, 1993 that are summarized below:

1. For the discretionary portfolio manager, funds of each client shall be managed individually and independently in accordance with the needs of the client in a manner, which does not partake character of a mutual fund. The non-discretionary portfolio manager shall manage the funds in accordance with the directions of the client; He shall in a fiduciary with regard to the client’s funds;
2. He shall transact in securities within the limitations placed by the client himself with regard to dealing in securities under the provisions of the Reserve Bank of India Act,1934 (2 of 1934);
3. He shall not derive any direct or indirect benefit out of the clients funds or securities;
4. He shall not pledge or give on loan securities held on behalf of clients’ to a third person without obtaining a written permission from his client;
5. He shall ensure proper and timely handling of complaints from his clients and take appropriate action immediately;
6. He shall abide by the code of conduct..

Basic principles of portfolio management

There are two basic principles, given below, for effective portfolio management:

1. Effective investment planning, and
2. Constant review of investment.

1. Effective investment planning

Merchant bankers rendering the service as portfolio managers plan for the investment in securities by considering the following factors:

1. Fiscal, financial and monetary policies of the Central Government or Reserve Bank of India.
2. Industrial and economic policy of the Government and their impact on industry prospects in terms of prospective technological change, competition in the market, capacity utilization in the industry, demand prospects, etc.

2. Constant review of investment

Merchant bankers/ portfolio managers should constantly review their investments in securities and continue selling and purchasing to change investments in more profitable avenues. For this purpose it is necessary to carry on the following analysis:-

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1. Assessment of quality of management of the companies in which investment has already been made or is planned to be made;
2. Financial analysis and trend analysis of companies balance sheets/profit and loss accounts to choose more sound companies with optimum capital structure and better performance and off-load investment made in companies with slackening performance;
3. Analysis of securities market trend be done on a continuous basis.  

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Mergers and Acquisitions

Business combinations are known by different names viz. mergers, consolidations, takeover, amalgamations, and acquisitions. Meanings of these terms should be understood as some of these terms carry different meanings in different situations. For example, the meaning of the word “combination” it refers to mergers and consolidation as a common term used interchangeably but carrying legally distinct interpretation. All mergers, amalgamations and acquisitions are business combinations.

Meaning of terms:

Merger – Mergers is defined as a combination of two or more companies into a single company where one survives and the others lose their corporate existence. The survivor acquires the assets as well as the liabilities of the merged company or companies. Generally, the company which survives is the buyer which retains its identity and the seller company is extinguished. Merger is also defined as amalgamation. Merger is the fusion of two or more existing companies. All assets, liabilities and stock of one company stand transferred to transferee company in consideration of payment in the form of equity shares of transferee company or debentures or cash or mix of the two or three modes.

Amalgamation – Ordinarily amalgamation means merger. Both the terms are used interchangeably.

Consolidation – Consolidation is known as the fusion of two existing companies into a new company in which both the existing companies extinguish. Thus, consolidation is mixing up of the two companies to make them into a new one in which both the existing companies lose their identity and cease to exist. The mix-up assets of the two companies are known by a new name and the shareholders of two companies become shareholders of the new company. None of the consolidating firms legally survive. There is no designation of buyer and seller. All consolidating companies are dissolved. In other words, all the assets, liabilities and stocks of payment in terms of equity shares or bonds or cash or combination of the two or all modes of payments in proper mix

Holding Company – Mergers and consolidations are distinct business combinations which differ from a holding company. The relationship of the two companies when combine their resources are differently known as parent company which holds the equity stock of the other company known as subsidiary and controls its affairs. The main criteria of becoming holding company is the control in the composition in the Board of Directors in another company and such control should emerge from holding of equity shares and thereby more than 50% of the total voting power of such company.  

Acquisition – In the context of business combinations, an acquisition is the purchase by one company of a controlling interest in the share capital of another existing company. An acquisition may be affected by:

1. Agreement with the persons holding major interest in the company management like members of the board or major shareholders commanding majority of voting power.
2. Purchase of shares in open market.
3. Takeover offer to the general body of shareholders.
4. Purchase of new shares by private treaty.
5. Acquisition of share capital of one company either by all or any one of the following form of considerations viz. means of cash, issuance of loan capital, or insurance of share capital.

Takeover – A ‘takeover’ is acquisition and both the terms are used interchangeably. Takeover differs from merger in approach to business combinations i.e. the process of takeover, transaction involved in takeover, determination of the share exchange or cash price and the fulfillment of goals of combination all are different in takeovers than in mergers. For example, process of takeover is unilateral and the offeror company decides about the maximum price. Time taken in completion of transaction is less in takeover than in mergers.

Purpose of merger and amalgamation

Merger of two companies is motivated to achieve specified objectives viz. procurement of supplies and revamping production facilities, market expansion, financial strength and general gains, like:

• To improve its own image and attract superior managerial talents to manage its affairs.
• To offer better satisfaction to consumers or users of the product.

The purpose of merger is basked by the offeror company’s own development plans. A company thinks in terms of acquiring the other company only when it has arrived at its own development plan to expand its operations having examined its own internal strength where it might not have any problem of taxation, accounting, valuation, etc. but might feel resource constraint with limitation of funds and lack of skilled managerial personnel. It has to aim at suitable combination where it could have opportunities to supplement its funds by issuance of securities; secure additional financial facilities eliminate competition and strengthen its market position. The purpose and the requirements of the offeror company go a long way in selecting a suitable partner for merger or acquisition in business combinations.  

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Role of Merchant Bankers in Merger

Merchant bankers are middlemen in settling negotiations for merger between the offeree and the offeror. Their role is specific and specialized in handling the merger and takeover assignments. They have to take care and observe some professional standards assumed in the role to play, briefly listed below.

Merchant bankers assistance is useful for both the companies i.e. the acquirer as well as the amalgamated company. Being a professional expert, merchant banker is apt to safeguard the interest of the shareholders in both the companies. This role covers all the four areas in the merger. They are listed below:

(I) Observance of professional norms

Observance of secrecy – Strict secrecy of the deal is to be maintained till final settlements are reduced to writing to avoid intervention of other parties as hostile bidder, to avoid disruptive transactions in the stock market, to obviate insider trading in the stocks and prevent proxy wars at the shareholders meeting. Merchant bankers should take all precautions to prevent leakage of information through the stock exchanges, and other information sensitive areas viz. Office of Registrar of Companies, Bankers to the companies, institutional creditors, Government departments, or Securities and Exchange Board of India where the concerned officials are approached for compliance of formalities in connection with merger like obtaining their consents, approvals or acknowledgements, etc.

Compliance of legal formalities – Statutes, laws and the procedures laid down by the statutes should not be bypassed by the offeror or offeree because violation of law on the part of the seller or target company at times devolves upon the buyer and the merchant banker could also be held for abetment. Apart from the above, there are other legal formalities to be complied with in issuing shares in exchange, safeguard pre-emptive rights of existing shareholders, checking minutes book, stock books of the target company or its subsidiaries, locating pending litigation against target company or its subsidiaries.

Completion of financial arrangements – Completion of financial arrangements shall depend upon the following two aspects:

1. Prepare checklist by making assessment of target company’s outstanding preference shares/debentures or any other instrument to be settled, to be redeemed or kept outstanding as per terms of agreement between the parties.
2. Checklist of the lenders formalities to be complied with so as to conclude loan transactions for financing the acquisition by raising credit from banks, financial institutions or the private lenders or management.

Closing of the transaction – Merchant banks should prepare a schedule and the checklist of formalities to be completed to conclude the transaction of merger or takeover. In this connection, the following points are important which deserve enlistment:

1. For cash transactions, the format of contents of the certificate or letters to be signed by the acquiring company and the target company.
2. For sale of assets, the documents like bill of sale, agreements, sale deed for transferring the freehold immovables like real estate, etc. deed of assignment of lease in the case of leasehold properties, or deed of assignment for patent rights, trademarks or copy rights, title to motor vehicles, etc. be drafted for finalization.
3. Settlement documents for retrenchment or unemployment compensation.
4. Documents for transfer of deposits from target company’s account to buyer’s account.
5. Delivery of comfort letter on completion of transaction which must spell out that the account procedures have been adhered to, the information has been as per books of accounts and records maintained by the target company.

(II) Steps to be taken: Primary investigations about proposed merger partner

     company:

Purchase investigation before merger – It is the fundamental task of the merchant banker/consultant or the financial executives of the company to carry out following type of analysis before starting negotiations with the proposed merger partner company or vice versa

1. Industry analysis
2. Accounting and financial analysis
3. Management analysis
4. Marketing analysis
5. Manufacturing and distribution: Engineering analysis.
6. Miscellaneous information analysis.
7. Economic analysis.
8. Non-balance sheet factory analysis  

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(III) Selection of methods of merger:

Mode of payment – The following methods are in vogue by which merger or takeover can be affected. Selection should be made of one or more methods on the basis of the information received about the target company and the means available with the acquirer:

1. Acquisition (for cash) of the shares or assets of one company by the other.
2. Acquisition (in exchange for shares or other securities in the acquiring company) of shares or assets of one company by another.
3. Acquisition of undertaking or shares of both companies by a new company in exchange for shares or other securities.
4. Acquisition of minority held shares of a subsidiary by parent company.

(IV) Follow the check list for completing preliminary investigation for merger

1. Memorandum and articles of association of the company.
2. Management agreement and documents relating to succession, etc.
3. Shareholding pattern, agreement between shareholders.
4. Directors loan to the company.
5. Information for preliminary investigation.

1. Audited accounts for 5 years and current year.
2. Cash flow and ratio analysis for 5 years with projections for 5 years.
3. Recent valuation report on land, building, plant and machinery, leases, stocks, etc.
4. Financial analysis for last 5 years covering turnover and profit margins product-wise, market-wise with projections for 5 years with comments of management about continuation of present policy or addition of alternatives.
5. Budgeted accounts and management accounts for past 5 years covering current year with comments of management.
6. Departmental analysis for past 5 years commenting on staff, workload, output, suggested changes.
7. Production costs for current year and projection for 5 years.
8. Requirement of funds for investment in capital assets, working capital, replacements, expansion, etc. for next 5 years.
9. Financial forecasts for 5 year, repayments of loans, interest payments, liquidity with reference to debtors and creditors.
10. Depreciation policy.
11. Dividend policy.
12. Expected profits and use of profits with reference to dividends, bonuses, pensions, gratuity or provident funds.

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6. Production

1. Different products and techniques of production.
2. Plant location, deficiency of labour on plant.
3. Total number of companies in industry and the position of the target company in the industry – production-wise.
4. Product research or technological obsolescence.

7. Sales

1. Product performance in the market vis-à-vis competition or market share.
2. Image of the company.
3. Probability of product substitutes and replacements.

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Mutual Funds

Portfolio classification of mutual funds

Different mutual funds are designed to meet the objectives of different types of savers viz:

1. Bonds funds provide fixed return for those who desire safety. Stock funds for those who are willing to accept significant risks in the hope of a very high return. These are called Common Stock Funds also whereas the assets held are entirely the Common Stocks of diversified list of industrial corporations. These may be further classified as “growth funds” or go-go funds which resume high risk to obtain stocks expected to yield high return. When these funds are invested in stocks which pay consistently high dividend like blue-chips company then it is known as ‘Income Funds’.
2. Income Fund is established to maximize the current income of the investors. There are two aspects of income funds viz. low investment risk generating constant income, and high investment risk generating maximum income.
3. Money Market Funds – There are still other funds which are used much the same as interest bearing checking account i.e. Money Market Funds. These funds are used in short-term liquid assets like Certificate and Deposit or Commercial papers and for them capital is raised by selling shares to the investing public at a price equal to the asset value of then existing shares outstanding plus a loading fee for service charge. This is known as liquid assets funds also.
4. Balanced Funds – Some Mutual Funds are called as ‘Balance Funds’ where assets are a judicious mixture of industrial stocks and bonds.
5. Specialized Funds – Specialized Mutual Funds envisage to specialize investment in securities of firms of certain industries or specific income producing securities. Such funds carry more risk for lack of diversification approach.
6. Leveraged Funds – Leveraged Finds or borrowed funds are used in order to increase the size of the value of the portfolio and benefit the shareholders by gains exceeding the cost of the borrowed funds. Funds are used in speculative and risky investments like short sale to take advantage of declining market to realize gains in the portfolio. Short sales decrease loss of the portfolio in a declining market and vice-versa in rising market.
7. Dual Purpose Fund – Income and growth are two objectives which are achieved by offering half of the amount of funds to those investors who wish regular income and half to those who wish growth. The funds thus received are pooled together and used for investment. Any income derived from the portfolio goes to the investors who hold income shares. The investors who hold capital shares receive no income. Instead they receive capital gains or losses that result from investments of total portfolio.
8. Real Estate Fund – Real Estate Fund is of closed-end type. The fund is named so because of primary investment in real estate ventures. Such funds are of various types depending upon real estate transactions.
9. Performance Funds – The investment in buying equity shares of small unseasoned companies with relatively high price earnings ratio and higher price volatility. Such funds were setup in USA in 1960s to seek large profits in high-flying common stocks.
10. Speciality Funds – The investment is made in good track record companies which offer long-term capital growth and provide handsome dividend income.

Thus, the type of mutual funds depends upon the nature of securities they issue or sell and purchase. In this way, it is observed that a mutual fund can be named keeping in view the immediate objective behind its creation.

Functional classification of mutual funds: -- Any mutual fund could be of either of the following two kinds viz.

• Open-end Fund
• Close-end Fund

(1) Open-end fund – The holders of the shares in fund can resell them to the issuing mutual fund company at any time. They receive in turn the net assets value (NAV) of the shares at the time of resale. Such mutual fund companies place their funds in the secondary securities market. They do not participate in new issues market as do pension funds or life insurance companies. Thus, they influence market price of corporate securities. Open-end investment companies can sell an unlimited number of shares and thus keep going larger. The open-end mutual fund companies buy or sell their own shares. These companies sell new shares at NAV plus a loading or management fee and redeem shares at NAV. In other words, the target amount and the period, both are indefinite in such funds. UTI’s Unit Scheme 1964 is an example of such funds.

(2) Close-end fund – Close end mutual funds are different to the open- end mutual fund in the following respect:-

1. Close-end fund investment company has a definite target amount for the funds and cannot sell more shares after its initial offering. Its growth in terms of number of shares is limited. Its shares are issued like any other companies new issues listed and quoted at stock exchange.
2. The shares of closed-end funds are not redeemable of their NAV as are in open-end fund. On the other hand, these shares are traded in secondary market on stock exchanges at market price that may be above or below their NAV.
3. The objectives of closed-end funds may differ as compared to open-end fund.
4. Close-end funds channelise funds in secondary market in acquisition of corporate securities.  
5. The prices of close-end mutual fund shares are determined by demand and supply and not by NAV as in the case of open-end mutual fund shares.

The examples of close-end funds are Canstock, canshare etc.

Geographical classification of mutual funds 

Mutual funds can be classified from the angle of territorial jurisdiction of operations in two types:

1. Domestic Mutual Funds (DMFs) – DMFs launch schemes which are operational within political territorial limits of a country for the residence or non-residence.

(2) Offshore Mutual Funds (OMFs) – OMFs are cross border funds meant to attract foreign savings for investment in India.

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Advantages of mutual funds – Advantages of mutual funds over direct investment are noted below:

1. Reduce risk – Mutual fund provides small investors access to reduced investment risk resulting from diversification, economies of scale in transaction cost and professional finance management.
2. Diversified investment – Small investors participate in larger basket of securities and share the benefits of efficiently managed portfolio by the experts and are freed of keeping any records of share certificates, etc. of various companies, tax rules, etc.
3. Botheration-free investment – Investors get freedom from emotional stress involved in buying or selling securities. Mutual funds relieve them from such stress as it is managed by professional experts who act scientifically with right timings in buying and selling for their clients.
4. Revolving type of investment – Automatic re-investment of dividends and capital gains provides relief to the members of mutual funds.
5. Selection and timings of investment – expertise in stock selection and timing is made available to investors so that invested funds generate higher returns to them.
6. Wide investment opportunities – Availment of wider investment opportunities that create an increased level of liquidity for the funds holders become possible because of package of more liquid securities in the portfolio of mutual funds. These securities could be converted into cash without any loss of time.
7. Investment care – Care for securities is available through mutual fund to the investors relieving them of various rules and regulations.

Mutual fund returns – Holders of mutual funds get return in the following forms:

1. Dividends – The dividend income to mutual fund company from investments in shares, both equity and preference are passed on to holders. These dividends are subject to tax deduction as per Income-tax laws.
2. Capital gains – Mutual fund holders or owners also get benefits of capital gains which are realized and distributed to them in cash or kind. These are subject to tax in the same way as gains or losses of directly held securities.
3. Increase or decrease in net assets value – The increase or decrease in net assets value are the results of unrealized gains and losses on portfolio holdings. They are not taxed until realized.

Sale and purchase of mutual funds shares:

Mutual fund shares may be easily purchased or sold directly through the management company’s sales offices/agents or through stock brokers who are dealing in such shares as commission agents or as brokers. A loading fee is usually charged (in the case of open fund mutual funds) for the initial purchase. The fee is added to the NAV of shares in order to arrive at the purchase price. This loading fee goes to the sales representatives. Such a loading fee reduces the quantity of funds invested. The fee range may differ as per prevalent practices in different countries and usually range between 4% to 9% of the total purchase. Such mutual funds are called ‘load mutual funds’ where no load fee is charged, are called “non-load mutual funds”. Non-load mutual funds will have higher management fee to off set the absence of the load fee. A small fee is charged on redemption for non-load mutual fund shares when redemption occurs within 6 months of the purchase date. The fee is 11/2% and is meant to discourage trading of the shares on stock exchanges. A high load charge on purchases discourages investor to put their money in mutual fund shares.

Close-end mutual fund shares are sold through underwriters, like equity shares offerings, load mutual fund shares are bought and sold through dealers at their bid and ask price. The bid price represents the current pro rata market value of the assets backing each share. The ask price reflects the bid price plus a commission. The commission which may be as high as 81/2% goes to the dealer or underwriter who sells the shares to cover expenses. On the other hand, non-load mutual funds buy and sell their shares at the same price without charging any additional sum towards fee or load charges.      

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Factoring

Factoring , a  sort of suppliers’ credit , is  understood  by  the  services  an agent  renders  to its  principal  by  managing   the  latter’s’ scales  ledger , realizing  the book debts or bills receivables against a  pre-determined  commission  known  as  ‘commercial  charge’.  For example, the  manufacturer  or  trader  sells the goods directly  or through  agent  and  advises  the  details  of  the  sale  to  the factory  to  realize  the  credits. Thus, the factors responsibility is contractual with the privity of contract with   the seller. Depending  upon  the  terms of the  contract, the factor  may assume risk  for  non-payment  by  the  customer also.  The  need  for  factor services  is felt  in view  of expanding  sales  by  the manufacturer  suppliers  so as to  manage  the sales  realization of books debts. Thus, reducing   dependence upon bank  credit  for  working  capital  requirements. Factoring  firms have professional  skills  and use  complete system to handle sales ledger  for  different  clients  in  different  trade  for  better credit  control and management .

The above service of factoring is different what merchant bankers used to render in the early part of nineteenth century. Then, the mercantile agent had full control of his principal goods i.e. he used to sell and invoice the goods in his own name either on term cash or credit depending upon the nature of transaction. The buyer seldomely knew about the seller and was left to believe supplier of the foods as owner seller. Such type of factoring was in practice in coastal and overseas export trade particularly in the Western European nations within themselves and also with the respective colonies in Asian and African nations.

Mechanisms of factoring

Credit sales generate the factoring business in ordinary course of business dealings. Realization of credit sales is the main function of factoring services. Once sale transaction is completed the factor steps in and takes course to realize the sales. Thus, factor works between the seller and the buyer and sometimes with sellers banks together. The following figure presents a schematic view of factoring mechanism explaining therein the interaction between the different parties and flow of information between them:

  (1) The buyer:

1. Buyer negotiates terms of purchasing plant and machinery or other material with the seller.
2. Buyer receives delivery of goods with invoice and instructions by the seller to make payment to the factor on due dates.
3. Buyer makes payment to factor in time or gets extension of time or in the case of default is subject to legal process at the hands of factor.

(2) The seller:

1. Memorandum of understanding with the buyer in the form of letter exchanged between them or agreement entered into between them.
2. Sells goods to the buyer as per memorandum of understanding.
3. Delivers copies of invoice, delivery challan, memorandum of understanding, instructions to make payment to factor given to buyer.
4. Seller receives 80% or more payment in advance from factor on selling the receivables from the buyer to him.
5. Seller receives balance payment from factor after deduction of factor’s service charges, etc.

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(3) The factor:

1. The factor enters into agreement with seller for rendering factor services to it.
2. On receipt of copies of sale documents as referred to above makes payment to the seller of the 80% of the price of the debt.
3. The factor receives payment from the buyer on due dates and remits the money to seller after usual deductions.
4. The factor also ensures that the following conditions should be met to give full effect to the factoring arrangements:

1. The invoice, bills or other documents drawn by seller should contain a clause that these payments arising out of the transaction as referred to or mentioned therein might be factored.
2. The seller should confirm in writing to factor that all the payments arising out of these bills are free from any encumberances, charge, lien, pledge, hypothecation or mortgage or right of set-off or counter-claim from another etc.
3. The seller should execute a deed of assignment in favour of factor to enable the latter to recover the payment at the time or after default.
4. The seller should confirm by a letter of confirmation that all conditions to sell – buy contract between the buyer and him have been complied with and the transaction is complete.
5. The seller should procure a letter of waiver from the bank in favour of the factor in case the bank has a charge over the assets sold out to buyer and the sale proceeds are to be deposited in the account of the bank.

Main terms and conditions of factoring – the main terms and conditions of factoring which are included in the agreement to be entered into between the supplier and factor are precisely listed below:-

1. Assignment of debt in favour of factor.
2. Selling limits and the conditions with which the factor will have no recourse to the supplier on non-payment from the customer and in what circumstances the factor will turn to recourse to the supplier.
3. Selling out details of the payment to the factor for his services known as service charge or commercial charge which is usually a percentage on turnover.
4. Selling out details of the interest to be allowed to the factor on the accounts where credit has been allowed/to be allowed to the supplier. The rate of interest is to vary depending upon the money market conditions and is commonly fixed at 2 and a half to 4 percent per annum above the base rate so as to give a better margin to the factor.
5. Agreement should set the limit of any overdraft by the supplier and the rate of interest to be charged by the factor on such overdrafts.
6. The agreement should specify that the amount to be paid by the factor to the supplier should be net of the service charge.
7. The percentage of the amount of the invoice value to be received from the factor by the supplier be specified in the agreement. Usually, about 80% of the invoice value of the amount is provided by the factor to the supplier.
8. Specific schedule be provided in the agreement setting out special terms for the factor to handle accounts of different customers.    

Types of factoring:

The factor could be of three broad types i.e. (1) domestic factoring, (2) export factoring, (3) cross border factoring.

(1) Domestic factoring – Domestic factoring could be again sub-divided into three main principle types viz.:

(i) Disclosed factoring – In disclosed factoring the name of the factor is disclosed in the invoice by the supplier manufacturer of the goods asking the buyer to make payment to the factor so named therein. The supplier may continue to bear the risk of non-payment by the buyer without passing it on to the factor. In such cases the factor is said to have “recourse” arrangements. The limit within which the factor works as non-recourse is laid down in an agreement beyond which the dealings are done on recourse basis.

(ii) Undisclosed factoring – The name of the factor is not disclosed in the invoice although factor maintains the sales ledger of the supplier manufacturer. The entire realization of the business transaction is done in the name of the supplier company but controls of all moneys remain with the factor. This type of factoring is much in vogue in UK.

(iii) Invoice discounting – The factor could be a bank or the supplier of funds which discounts the invoices of the supplier at a pre-agreed credit limit providing finance to the supplier against the security in the form of a charge on the book debts of the supplier on a specific cash receivables.

(2) Export factoring – In export factoring, banks play an important part. The export company obtains finance from the bank by virtually selling the export document to it on a reasonable basis i.e. if the claims are not honoured by the importers bank the exporter shall repay the bank the amount received. The factor bank usually advances 75%--50% of the export claims of the supplier exporter. This advance is on both recourse as well on non-recourse basis. If the factoring covers risk of non-payment on non-recourse basis, it creates more attractive proposition.

(3) Cross border factoring – Export factoring is also known as cross border factoring when import factor at the debtor’s place is engaged by export factor. Import factor has knowledge of local conditions and provides help in realization as well as reduction of commercial risk. Export factor takes over the commercial risk from the exporter on the assurances given by import factor. This may also be of ‘recourse’ and ‘non-recourse’ type. In non-recourse type factoring, disputed claims even if taken over by factor are suspended till settlement is arrived at between the exporter and importer. After final settlement, the factor takes over back the claims in question and renders factoring services.  

Benefits of factoring:

1. Factoring makes through discounting the bills, the funds available to business enterprises which do not carry legal strings like loans or fixed deposits as the former one is neither a loan nor a deposit.
2. Since factoring makes available to the firm short-term money, the firm’s needs for funds is satisfied without recourse to borrowing. Thus, factoring helps in avoiding increased debts.
3. Since the finds are easily made available by factors to the extent of 80% of the invoices, the firm can easily meet its liabilities. This enables the firm to reduce in balance sheet the realizations from debtors and also the elimination of current liabilities to the same extent. Thus, the current assets are flexibility managed by the firm reducing current ratio as well as the working capital requirements.
4. Factoring services assist in improving the financial position of the enterprise and avoidance of sickness for want of realization of sales.

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CHAPTER 8

Research Methodology

Collection of Data

For the purpose of my study I have collected the relevant data keeping in mind the aim of my research. I have collected the data from different sources namely primary and secondary sources.

Primary Data

The primary data related to the study was collected from the office of SBI Capital Markets Limited located at Cuffe Parade, Mumbai. The relevant information was given to me by Mr. Supratim Sarkar, Vice-President (Project Advisory and Structured Finance)

Secondary Data

Besides primary data, I have also collected the secondary data. And the secondary data was collected from different sources, which are given below:

• Books
• Websites

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CHAPTER 9

Case Study on SBI Capital Markets Limited (SBICAP)

At SBI Capital Markets Limited (SBICAP), they have a dedicated team of professionals with vast experience in a wide range of investment banking services. They have consistently been ranked as the number one fund-raiser in the domestic market both for public issues and private placements.

They pride theirselves as solution providers with wide experience in executing large offerings and the capacity to play the role of an advisor and arranger to a number of infrastructure projects (Power, Telecom, Railways, Ports) and Government agencies.

The services offered at SBI Capital Markets Limited are:

• Mergers and Acquisitions and Advisory
• Project Advisory and Structured Finance
• Capital Markets
• Treasury and Investment Group
• Broking

They are the Investment Bank of choice for issuers desirous of raising funds through the public issue route and have been ranked as the No. 1 Lead Manager in 6 out of the last 9 years.  

SBICAP has with its innovative structuring skills many firsts to its credit in the field of Capital Markets:  

• The first Floating Rate Bonds, issued by SBI in 1993.
• First to introduce price discovery through "Dutch Auction" in Indian markets in the HPCL issue in 1995.
• Structuring and management of the first retail offering of Tax-free Bonds for Konkan Railway Finance Corporation Ltd. in 1997.  
• First domestic disinvestment through a public offer by Government of India - Offer for sale of shares in Videsh Sanchar Nigam Limited in 1999.

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SBICAP offers comprehensive range of solutions for fund raising from Domestic & International markets. With their deep understanding of client needs & extensive relationships with institutional investors, they are able to syndicate resources through private placements.

SBICAP is also active in the field of assisting its clients in buyback programmes. SBICAP has already completed 8 such transactions in the past and is currently working on a few more deals. With the recent addition of the Broking Services, SBICAP is in a position to offer comprehensive solutions to accomplish Buyback programmes.

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Mergers and Acquisitions and Advisory:

The Mergers and Acquisitions and Advisory group of SBICAP was set up in June 1990 and has handled a variety of assignments over the years. The group is staffed with bright young finance executives from reputed Institutes of Business Management and Chartered Accountants and has been able to bring high standards of professionalism to its work.

SBICAP is the leading domestic player in the privatisation business, with more than 7 years of experience in this field. They started with being the sole advisors to the first privatisation attempt made by GOI with Indian Iron and Steel Company Ltd.

Over the years, their relationship with the Central and the State Governments has strengthened manifold. They advise the Government of India and various State Governments for restructuring their companies and inviting private participation in the State-owned enterprises.

With time, SBICAP has also strengthened its presence in private sector M&A transactions. Besides handling several open offer transactions SBICAP has successfully completed certain high value and complex private sector M&A transactions.

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Project Advisory and Structured Finance Group:

Project Advisory & Structured Finance (PA&SF) Group of SBICAP undertakes a wide range of project related financial advisory and fund arranging activities.

Increasingly, corporates are requiring a comprehensive choice of products, specialist skills and excellence of service both locally and globally. The PA&SF Group, with its unmatched reputation, credibility and wide acceptability, meets this demand by integrating corporate and investment banking activities and offering highly-specialised financial services and solutions aimed to meet the financial needs of our clients.

Their leading position in the industry gives them the appropriate scale and stature to guarantee the excellence of service expected by their clients. By combining their banking parentage with in-depth product knowledge in both corporate and investment banking, they deliver a broad range of benefits, including:

• Sector Expertise
• Integrated Product Offering
• Local Presence
• Innovative and Bankable Product Structuring

With its impressive array of prestigious domestic and foreign clients, SBICAP is not only the leading financial advisor / arranger for infrastructure projects, but also a prominent name in India and overseas in project advisory.

The PA&SF Group, has over the years, maintained a formidable presence in infrastructure development in the Country. The services rendered include Restructuring and Privatisation Advisory for Public Utilities, Policy Advisory to Central and State Governments, Regulatory Bodies and Govt. Departments/Organisations, Project Structuring Advisory to Private Sector Entrepreneurs and Arranging of Finance for the Projects

The PA&SF Group provides services in the following broad sectors:

• Power
• Transportation
• Telecom
• Hydrocarbons
• Urban Infrastructure
• Miscellaneous

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Capital Markets:

The Capital Markets handles fund raising for Corporate, Banks, Financial Institutions, PSUs, State Govt. Undertakings etc. both from the domestic as well as international capital markets.

They have been ranked as the No.1 Fund Mobiliser in terms of total funds raised through private placement, public issues of debt and equity on a consistent basis for the last few years. They have mobilised funds in excess of Rs. 1050 bn. through public, rights issues and private placement of debt during the past 5 years.

• Public Issues and Rights Issues.
• Advisory services for GDRs.
• Private placement of equity.
• Buy back of securities.

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Treasury and Investment Group:

The Group manages the proprietary investments of the Company in the equity, debt and money markets. Resource mobilization and management is also undertaken by the Group.

SBI Capital Markets Limited has obtained the following credit ratings from ICRA.

* Rating "A1+" / "LAAA" indicates highest safety. The prospect of timely payment of debt/obligation is the best.

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Broking:

SBI Capital Markets Limited is a member of the National Stock Exchange of India Ltd. in the Capital Markets as well as the Wholesale Debt Market segment and is also a member of The Stock Exchange, Mumbai in the Capital Markets segment.

The Broking Group has been set up to cater to the secondary market needs of Financial Institutions, Foreign Institutional Investors, Mutual Funds, Banks, Corporate's, High Net Worth Individuals, Non resident Investors and retail investors.

Services Currently Offered :-

1) Equity Broking
2) Debt Broking

Services envisaged in future:-

1. Derivates Trading
2. E-Broking
3. Equity /Debt for HNI, Corporate's, Retail

Percentage Share of Major Services in the Revenues of SBI CAPITAL MARKETS

(1 Unit = 1 Percent)

Comments by Mr. Supratim Sarkar of SBICAPS

• Greenfield projects are not being underwritten by SBI CAPS as most of the Merchant Bankers had lost a substantial amount in the early 90’s due to this reason. Also the number of Greenfield Projects have reduced over the years.
• Underwriting is slowly going out of fashion due to the fact that it is no longer compulsory and most of the issues are over-subscribed.
• The functions of the lead managers for issue management are divided according to their area of specialization. For example, as SBI CAPS have good relations with SEBI they are entrusted with the functions related to statutory requirements and ENAM Securities are entrusted with the functions related to listing because of their relation with the stock exchange.
• SBI CAPS revenue flow does not fluctuate a lot due to a major presence in functions like project advisory an treasury management which are not market  driven.

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CHAPTER 10

Recommendations

1. Indian public issues are characterized for their high cost on expenses like advertisement, stationery, and commission to intermediaries. Dual payment to underwriters on same issue one as underwriting commission and other as brokerage should be curtailed as such type of overlapping payments enhances cost of the issues. With increased competition the merchant banker should be allowed to negotiate their issue management fees instead of having fixed fees. Due to this the merchant bankers will have to offer comparable services at lower cost. This also means that public sector banks may face difficulties if they do not become cost effective. Cost reduction would also be possible by restoring to the maximum use of non-traditional practices of raising the equity and debenture capital in the market viz. offer for sale without prospectus, offer for sale by tender, public issue by tender, private placement of shares etc.
2. There have been a large number of investors who have come in capital markets through primary markets. These investors are in majority not exposed to stock market operations. They remain in a state of uncertainty about the marketability of their stock. The merchant banker in future can play an active role in establishing a link between primary market investors and stock exchanges. This would remove uncertainty from the minds of investors about marketability of their security holding and also create a balance in bullish and bearish forces by attracting their attention to these transactions. Stock exchange introduction would be made more prominent and be frequently permitted as a less costly way for obtaining quotation and making the shares familiar with the investing public. This may help those companies who have widespread of shareholders but could not obtain a quotation from stock exchanges. Shareholders would be able to transfer their shares and wide base facility on the part of merchant banker would increase their reputation among companies and also among investors.
3. The traditional process of issue management takes between three to four months on an average causing in uncertainty and delay in raising funds. The issue becomes risky as for a new company its success also depends on success of issue. It increases company’s stake and thus the cost of issue. Merchant banks can provide a permanent solution to the problem by buying the entire issue at a discount from the company and encash it at a premium in the market when the company’s project goes into production after gestation period.  SBI Capital Market Ltd. has taken the first step in this direction. The company will pick up entire equity issue of small companies and later on sell the shares in phases through private placement and through stock exchanges.
4. The real threat to the merchant bankers functioning in the country is from the entry of international investment bankers. Managing rural surplus can be an area in which Indian Merchant Bankers can have an edge over the foreign counter- parts. Indian merchant bankers seem to have some glamorous attraction for NRI’s Funds and they are not giving due attention to the vast resource of indigenous sources should not go untapped. In this area merchant banks have to put their efforts in moping up the rural surplus and channelise it into corporate securities. This is an open field and the Indian merchant bankers can explore it instead of concentrating on NRI Funds.  

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Bibliography

Books:

• Manual of Merchant Banking – J. C. Verma

• Manual of Indian Capital Market – Sanjeev Agarwal

• Financial Services – Jiwatesh Kumar Singh

• Merchant Banking in India: The Present Scenario – Sanjay Srivastava

• Indian Financial System

• SEBI Manual for Merchant Bankers

Websites: