MERCHANT BANKING

MERCHANTS?

Merchants are businessmen who trade in commodities that they do not produce themselves, in order to earn profit.

BANK AND BANKING?

A bank is a financial institution licensed by a government.

Its primary activities include borrowing and lending money.

BRIEF HISTORY

Merchant banks , now so called, are in fact the original “banks”. These were invented in the middle ages by Italian grain merchants.

Merchant banking grew and originated in Europe , developed by Americans, Dutch, Scottish traders, and professionalized in Britain.

MB ?

Merchant banking is the financial intermediation that matches the entities that need capital and those have capital.

Merchant bankers act as intermediaries between the issuers of capital and the ultimate investors who purchase these securities.

FUNCTIONS OF MB

Management of debt and equity offerings

Placement and distribution Corporate advisory services Project advisory services Loan syndication Providing venture capital and mezzanine

financing

MANAGEMENT OF DEBT AND EQUITY OFFERINGS This forms the main function of the

merchant banker. They assist the companies in raising funds from the market.

The main areas of work in this regard include: Instrument designing Pricing the issue Registration of the offer document Underwriting support Marketing of the issue Allotment and refund Listing on stock exchanges

PLACEMENT AND DISTRIBUTION

The merchant banker helps in distributing various securities like equity shares, debt instruments, mutual fund products, insurance products, commercial paper to name a few.

Private placement Direct placement

CORPORATE ADVISORY SERVICES MBs offer customized solutions to their

clients financial problems.The following are the main areas in which

their advice is sought: Financial restructuring Refinancing alternatives Sources of funds Rehabilitation and turnaround

management Design revival package (for sick units) Risk management

PROJECT ADVISORY SERVICES MBs help their clients in various stages

of the project undertaken by the clients. They assist them in conceptualizing the

project idea in the initial stage. Once the idea is formed, conduct

feasibility studies to examine the viability of the proposed project.

They also assist the client in preparing different documents like the detailed project report.

LOAN SYNDICATION MBs arrange to tie up loans for their clients.

This takes place in a series of steps. Firstly they analyze the pattern of the

client’s cash flows, based on which the terms of borrowings can be defined.

Then the merchant banker prepares a detailed loan memorandum, which is circulated to various banks and financial institutions and they are invited to participate in the syndicate.

The banks then negotiate the terms of lending on the basis of which the final allocation is done.

PROVIDING VENTURE CAPITAL MEZZANINE FINANCING

MBs help companies in obtaining venture capital financing for financing their new and innovative strategies.

REGISTRATION OF MERCHANT BANKERS WITH SEBI The applicant should be a body corporate. The applicant should not carry on any business other

than those connected with the securities market. The applicant should have necessary infrastructure

like office space, equipment, manpower etc. The applicant must have at least two employees with

prior experience in merchant banking Any associate company, group company, subsidiary

or interconnected company of the applicant should not have been a registered merchant banker.

The applicant should not have been involved in any securities scam or proved guilt for any offence.

The applicant should have a minimum net worth of Rs 5 crores.

SEBI GUIDELINES FOR MB Registration Grant of certificate Capital adequacy requirement Fee Code of conduct Registration Maximum number of lead managers Due diligence certificate Submission of documents Acquisition of shares Disclosure to SEBI Action in case of default

REGISTRATION

Merchant bankers required compulsory registration with the SEBI to carry out their activities.

GRANT OF CERTIFICATE SEBI grants certificate of registration to

applicant if it fulfills all the conditions like:

It is a body corporate and is not a NBFC It has got necessary infrastructure to

support the business activity It has appointed at least two qualified

and experienced (in merchant banking) persons

Its registration is in the general interest of investors

CAPITAL ADEQUACY REQUIREMENT

SEBI grants recognition to only those merchant banker who have paid up capital and free reserve of minimum Rs 1 crore

FEE

A merchant banker has to pay a registration fee of Rs 5 lakh and renewal fees of Rs 2.5 lakh every three years from the fourth year from the date of registration.

CODE OF CONDUCT

Every merchant banker has to abide by the code of conduct, so as to maintain highest standard of integrity and fairness, quality of services, due diligence and professional judgment in all his dealings with the clients and other people.

MAXIMUM NUMBER OF LEAD MANAGERS For an issue of size less than Rs. 50

crores, two lead managers appointed 50 to 100 crores and 100 to 200 crores,

the maximum permissible lead managers are three and four respectively.

A company can appoint five and five or more (as approved by SEBI) lead managers in case of issue sizes between Rs 200 to Rs 400 crores respectively.

PUBLIC ISSUE MANAGEMENT

DEFINITION The management of issues for raising

funds through various types of instruments by companies is known as ‘issue management’.

The function of capital issue management in India is carried out by merchant bankers who have the requisite professional skill and competence.

“MERCHANT BANKER” “any person who is engaged in the

business of issue management either by making arrangement regarding selling, buying or subscribing to securities as manager, consultant , advisor or rendering corporate advisory services to such issue management”

SEBI (merchant banker) rules and regulations, 1992

CATEGORIES OF SECURITIES ISSUE

Public issue Right issue Private placement

PUBLIC ISSUE OF SECURITIES

“When capital funds are raised through the issue of a prospectus, it is called ‘ public issue of securities’ it is the most common method of raising funds in the capital market”

RIGHT ISSUE When shares are issued to the existing

shareholders on a privileged basis, it is called as ‘ rights issue’.

The existing shareholders have pre- emptive right to the subscribe to the new issue of shares.

Rights shares are offered as additional issues by corporate to mop up further capital funds.

Such shares are offered in proportion to the capital paid – up on the shares held by them at the time of offer.

PRIVATE PLACEMENT When the issuing company sells

securities directly to the investors, especially institutional investors, it takes the form of private placement.

In this case, no prospectus is issued, since it is presumed that the investors have sufficient knowledge and experience and are capable of evaluating the risks of the investment.

PRIVATE PLACEMENT Raising of capital via private rather than

public placement. The results is the sale of securities to a relatively small number of investors.

“The sale of a security to one buyer or a few buyers, as opposed to offering the security to the public through a group of dealers”

Investor involved in private placements are usually large banks, mutual funds, insurance companies, and pension funds.

ABOUT PUBLIC ISSUE Corporate may raise capital in the

primary market by way of an initial public offer, right issues or private placement.

IPO – initial public offer is the selling of securities to the public in the primary market.

Initial public offering can be made through the fixed price method, book building method or both.

BOOK BUILDING Book building is essentially a process by

companies raising capital through public offerings- both IPO or follow – on public offers to aid price and demand discovery.

It is a mechanism where, during the period for which the book for the offer is open, the bids are collected from investors at various prices, which are within the price band specified by the issuer.

The process is directed towards both the institutional as well as the retail investors.

The issue price is determined after the bid closure based on the demand generated in the process.

THE BOOK BUILDING PROCESS The issuer who is planning an offer

nominates lead merchant as book runners. The issuer specifies the number of

securities to be issued and the price band for the bids.

The issuer also appoints syndicate members with whom orders are to be placed by the investors.

The syndicate members input the orders into an ‘electronic book’. This process is called ‘bidding’ and is similar to open auction.

The book normally remains open for a period of 5 days.

Bids have to be entered within the specified price band.

Bids can be revised by the bidders before the book closes.

On the close of the book building period, the book runners evaluate the bids on the basis of the demand at various price levels.

The book runners and the issuer decide the final price at which the securities shall be issued.

Generally, the number of shares are fixed, the issue size gets frozen based on the final price per share.

Allocation of securities is made to the successful bidders. The rest get refund orders.

ISSUE TYPE OFFER PRICE

DEMAND PAYMENT RESERVATIONS

FIXED PRICE ISSUES

Price at which the securities are offered and would be allotted is made known in advance to the investors.

Demand for the securities offered is known only after the closure of the issue.

100% advance payment is required to be made by the investors at the time of application.

50% of the shares offered are reserved for application below Rs.1 lakh and the balance for higher amount applications.

BOOK BUILDING ISSUES

A 20% price band is offered by the issuer within which investors are allowed to bid and the final price is determined by the issuer only after closure of the bidding.

Demand for the securities offered and at various price is available on a real time basis on the exchange website during bidding period.

10% advance payment is required to be made by the QIBs along with the application while other categories of investors have to pay 100% advance along with the application.

50% of shares offered are reserved for QIBs, 35% for small investors and balance for all other investors.

ACTIVITIES INVOLVED IN PUBLIC ISSUE MANAGEMENT

Pre - issue management Post – issue management

PRE – ISSUE MANAGEMENT Signing of MOU Obtaining appraisal note Optimum capital structure Convening meeting Appointment of financial intermediary Preparing documents Due diligence certificate Submission of collection centers Finalization of collection centers Filing with ROC Launching the issue Promoters’ contribution Issue closure

POST – ISSUE MANAGEMENT Finalization of basis of allotment. Dispatch of shares certificates Advertisement.

PUBLIC COMPANY VS. PRIVATE COMPANY Minimum paid-up capital : a company to be

incorporated as a private company must have a minimum paid – up capital of Rs 1,00,000 whereas a public company must have a minimum paid – up capital of Rs 5,00,000.

Minimum number of members : minimum number of members required to form a private company is 2, whereas a public company requires at least 7 members.

Maximum number of members : maximum number of members in a private company is restricted to 50, there is no restriction of maximum number of members in a pubic company.

Transferability of shares : there is complete restriction on the transferability of the shares of a private company through its article of association, whereas there is no restriction on the transferability of the shares of a public company.

Issue of prospectus : a private company is prohibited from inviting the public for subscription of its shares, i.e. private company cannot issue prospectus, whereas a public company is free to invite public for subscription i.e. a public company can issue a prospectus.

Number of directors : a private company may have 2 directors to manage the affairs of the company, whereas a public company must have at least 3 directors.

Consent of directors : there is no need to give the consent by the directors of a private company, whereas the directors of a public company must have file with the registrar a consent to act as director of the company.

Qualification shares : the directors of a private company need not sign an undertaking to acquire the qualification shares, whereas the directors of a public company are required to sign an undertaking to acquire the qualification shares of the public company.

Commencement of business : a private company can commence its business immediately after its incorporation, whereas a private company cannot start its business until a certificate to commencement of business is issued to it.

Shares warrants : a private company cannot issue share warrants against its fully paid shares, whereas a public company can issue share warrants against its fully paid up shares.

Further issue of shares : a private company need not offer the further issue of shares to its existing share – holders, whereas a public company has to offer the further issue of shares to its existing share - holders as right shares. further issue of shares can only be offer to the general public with the approval of the existing share – holders in the general meeting of the share – holders only.

Statutory meeting : a private company has no obligation to call the statutory meeting of the member, whereas of public company must call its statutory meeting and file statutory report with the register of companies.

Quorum : the quorum in the case of a private company is TWO members present personally, whereas in the case of a public company FIVE members must be present personally to constitute quorum. However the article of association may provide and numbers more than the required under the act.

Managerial remuneration : total managerial remuneration in the case of a public company cannot exceed 11% of the net profits, and in case of inadequate profits a maximum of Rs 87,500 can be paid. Whereas these restrictions do not apply on a private company.

Special privileges : a private company enjoys some privileges, which are not available to a public company.

INTERNATIONAL CAPITAL MARKET

HISTORY The genesis of the present international

markets can be traced back to 1960 , when there was a real demand for high quality dollar - denominated bonds from wealthy Europeans (and others) who wished to hold their assets outside their home countries or in currencies other than their own.

Until 1970 , the international capital market focused on debt financing and the equity finances were raised by the corporate entities primarily in the domestic markets.

This was due to the restrictions on cross – borders equity investments prevailing until then in many countries.

MARKET CLASSIFICATION The markets were classified into : Euro markets American markets other foreign markets.

GDRS GDRs stands for global depository

receipts. GDR is a negotiable instrument which

represents publicly traded local – currency equity shares.

GDR is any instrument in the form of a depository receipts or certificate created by the overseas depository bank outside India and issued to non – resident investor against the issue of ordinary shares or foreign currency convertible bonds of the issuing company.

A typical GDR is denominated in US dollars whereas the underlying shares would be denominated in the local currency of the issuer.

ADRS ADR is a dollar denominated negotiable

certificate, it represents a non –US company publicly traded equity.

It was devised in the 1920 to help Americans invest in overseas securities and to assist non – US companies wishing to have their stock traded in the American markets.

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