BY : PUNEET CHADHA 26 MBA 10

Merchant Banking
A merchant bank is defined as a financial institution or an organization that underwrites corporate securities and advises such clients on issues like corporate mergers etc. involved in the ownership of commercial ventures, etc. This organization may be a Bank, Corporate body, a firm or a proprietary concern.

Birds eye view of Merchant Banking :

Merchant Banking is a fee-based service. It arranges funds rather than providing them. Originally Merchant Banking business was started in Italy and France.

Later on, it came into existence in the U.K., and the U.S.A. In India, it has become popular from 1983-84.

Merchant Banking In India

The Grindlays Bank initiated the merchant banning activity in Indian Capital Market in 1969.

Its business forms was on the management of Public Issues and Financial Consultancy. City Bank introduced its merchant banking division in 1970.

STEPS FOR SETTING UP MERCHANT BANKS

Formation of the business organization.

Adoption of a viable business plan

Seeking SEBI registration as a merchant banker.

Essentials for commencement of business.

Organizational Set Up Of Merchant Bankers In India

Instituti onal base

Private base

Banker base

Broker base

Merchant Bankers Core Business Portfolio

1. Issue Management 2. Private Placements 3. Underwriting 8. Financial Restructuring 9. Factoring & Forfaiting 10. Hire Purchase & Leasing

4. Mergers & Acquisitions

5. Syndicated loans

11. Buyback & Delisting

12. Project Counselling

6. Portfolio Management
7. Offshore finance

13. Corporate Restructuring

BOOK BUILDING
Book-building is a process of price discovery used in public offers. The issuer sets a base price and a band within the investor is allowed to bid for shares. The investor has to bid for a quantity of shares he wished to subscribe to within this band. Book building is basically a capital issuance process used in Initial Public Offer (IPO) which aids price and demand discovery. It is a process used for marketing a public offer of equity shares of a company. It is a mechanism where, during the period for which the book for the IPO is open, bids are collected from investors at various prices, which are above or equal to the floor price. The process aims at tapping both wholesale and retail investors. The offer/issues price is then determined after the bid closing date based on certain evaluation criteria. Book building is basically the process of generating a book of investor demand for an IPO for efficient price discovery.

BOOK BUILDING PROCESS

The Issuer who is planning an offer nominates lead merchant banker(s) 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.

BOOK BUILDING PROCESS

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.

Objective Of Private Placement

Fund Raising

Strategic Objective

Advantages Of Private Placements

From Issuers Perspective

Faster access to funds Less market uncertainties Cost efficiency Less paperwork

Advantages Of Private Placements

From Investors Perspective

Less Transparency Interaction with Issuer Co.s mgmt. Liquidity & price validation on a continuous basis

Private Placement Of Equity

Venture Capital (VC)

Private Equity (PE)

QIBs & Non-Institutional Investors

Venture Capital

Financing Of Innovation High Risk High Return E.g. Apple Computer.

Private Equity

Later stage Financing Good Investment Opportunities in well performing Cos. Large deal sizes Moderate return expectations

QIBs & Non-Institutional Investors

QIBs(Qualified Institutional Buyers) (Mutual Funds, FIIs, Banks, Insurance Cos.)

Non-Institutional Investors (Family sources/Associates of Promoters, Stock Broking Cos., Non-Residents, etc.)

Merchant Bankers Role In Private Placements

Business Advisory Formulation of the Transaction Valuation Deal Structuring Offer Literature Transaction Advisory

Types of Syndicated Loans

Loan for Expansion Investment in Corporate Securities Consortium Loan

Function OF Merchant Banker in Portfolio Mgt

Risk Diversification
Efficient Portfolio Asset Allocation Rebalancing Portfolios

Services Provided by Merchant Bankers

Long Term Foreign Currency Loan Joint Venture Financing Exports and Imports

Foreign Collaboration Arrangement

Financial Restructuring
It is the art of restating the financial position of a company as reflected by its balance sheet as on a given date. In order to achieve such restatement, a complex financial and legal process is involved as it concerns several conflicting interest.

Types of Financial Restructuring

Debt Restructuring: - It refers to that part of the reconstruction of a balance sheet insofar as it relates to the borrowing obligations of the company. Equity Restructuring / Capital Reduction: - it is the re organization of the share capital and / or reserves appearing in the balance sheet of a company.

Ways in which DRS takes Place

Interest rate relief Deferment of Past interest due

Waiver of Penalties for Non payment

Re schedulement of Loan One Time settlement

Role of Merchant banker in DRS

formulate Viability Plan, assess borrowing cost, carrying cost, future opportunities To Develop a DRS complying with statutory norms and guidelines issued by RBI Make presentation in front of the lenders and represent on behalf of the company.

To facilitate transaction services once the DRS Plan gets approvals from all lenders.

Methods of Equity Restructuring

Share capital can be restructured by repurchase of shares from the share holders for cash to convert the equity capital into loans or redeemable preference shares, so as to be paid off at a later date. writing down the equity share capital through appropriate accounting entries. Expansion of share capital by conversion of convertible instruments such as convertible debentures, convertible preference shares, equity warrant and others.

Cancellation of unissued capital

Conversion of loan into equity.

Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business

Factoring Process
Basically there are three parties to the

factoring services as depicted below:

Buyer Credit sale of goods Client Invoice customer

factor

What is Forfaiting???

The purchasing of an exporter's receivables (the amount importers owe the exporter) at a discount by paying cash. The forfaiter, the purchaser of the receivables, becomes the entity to whom the importer is obliged to pay its debt.

Forfaiting is generally extended for export of capital goods, commodities and services where the importer insists on supplies on credit terms.

Mechanism

negotiate the proposed export sale contract exporter approaches the forfaiter to ascertain the terms for forfeiting. forfaiter collects all the relevant details of the proposed transaction in order to ascertain the country risk and credit risk involved in the transaction Depending upon the risk Forfaiter quotes discount rates

Exporter quote a contract price to the overseas buyer by loading the discount rate, commitment fee, etc., on the sale price of the goods to be exported.

Contd..

If the deals go through, the exporter and forfaiter sign a contract Export takes place against documents guaranteed by the importers bank. The exporter discounts the bill with the forfaiter and the forfaiter presents the same to the importer for payment on due date or even can sell it in secondary market.

What is Hire Purchase???

An agreement under which goods are let on hire and under which the hirer has an option to purchase them in accordance with the terms of the agreement Specifics: 1. Payment of periodic instalments 2. Immediate possession of goods by the buyer 3. Ownership of goods remaining with the vendor until the payment of the last instalment 4. Vendors right to repossess the goods in the event of default committed by the buyer 5. Treatment of each instalment as hire charge till the payment of the last instalment

What is Leasing???

A lease is an agreement whereby the lessor conveys to the lessee, in return for rent, the right to use an asset for an agreed period of time. Lessor is a person who conveys to another person (lessee) the right to use an asset in consideration of a payment of periodical rental, under a lease agreement. Lessee is a person who obtains from the lessor, the right to use the asset for a periodical rental payment for an agreed period of time.

Types of Leasing
Finance Leasing: It is a close alternative to Hire purchase Lessor agrees to transfer the title of the asset at the end of the lease period Lessee has most of the risk and rewards associated with the ownership It is used for heavy capital goods like aircrafts, ships etc.

Operating Lease

Lessee has limited right to use the asset Lessor is responsible for upkeep and maintenance of the assets Lessee does not have the option to purchase the asset at the end of the lease period Such type of leasing is suitable for small equipments like computer hardware, vehicles, Mines etc. Lease period is generally short.

Sale and Lease Back

In this lease agreement the seller sells his asset to the party and lease the same asset back from the buying party.

Assets are not physically exchanged, its only paper transaction. seller assumes the role of a lessee and the buyer assumes the role of a lessor.

Leveraged Leasing

Third Party called as lender is involved. Lessor borrows the money from lendor keeping the leased asset as collateral security and pay the lender back through the rent proceeds collected from the lessee.

What is buyback?

Unused cash / over capitalized Under valuation of shares Tax gains Market Perceptions Exit option Escape monitoring of accounts and legal control To show better Ratios Increase promoter stake

What is De-listing?

It includes preparation of project reports, deciding upon the financing pattern, appraising the project relating to its technical, commercial and financial viability. It includes filling up of application forms for obtaining funds from financial institutions.

Private

sector involvement in infrastructure demand for innovative financial structure to deal with the multitude of political, market and credit risk.
Build

credible Structures to ensure that project are economically, socially, environmentally, politically viable

To appraise the project To finance the project To make the project report

To create long term holding structures. To attain better utilize tax shields and tax writeoffs. To facilitate distribution of assets and family settlement. To exit non-core business.

Certificate from SEBI is a must. They are of four types:

Category I merchant bankers : Can act as Issue managers

Category II merchant bankers : can act only as co-managers Category III merchant bankers : can act as co-managers but cannot undertake portfolio management Category IV merchant bankers :can merely act as consultant or advisor to issue of capital

CAPITAL ADEQUACY NORMS :

Category I Category II : Rs. 5 crores : Rs.50 lakhs

Category III : Rs.20 lakhs

Category IV : Nil

GUIDELINES FOR MERCHANT BANKERS :

SEBIs authorization is a must to act as merchant bankers.Authorisation criteria include

Professional qualification in finace,law or business management

Infrastructure like office space,equipment and man power

Capital adequacy Past track of record,experience,general reputation and fairness in all

transactions
Every merchant banker should maintain copies of balance sheet,Profit and loss account,statement of financial position

Half-yearly unaudited result should be submitted to SEBI

Merchant bankers are prohibited from buying securities based on the unpublished price sensitive information of their clients

SEBI has been vested with the power to suspend or cancel the authorisation in case of violation of the guidelines Every merchant banker shall appoint a Compliance Officer to monitor compliance of the Act

SEBI has the right to send inspecting authority to inspect books of accounts,records etc of merchant bankers
Inspections will be conducted by SEBI to ensure that provisions of the regulations are properly complied An initial authorisation fee,an annual fee and renewal fee may be collected by SEBI A lead manager holding a certificate under category I shall accept a minimum underwriting obligation of 5% of size of issue or Rs.25 lakhs whichever is less

CODE OF CONDUCT :

Should make all efforts to protect the interest of investors Should maintain high standards of integrity,dignity and fairness in conduct of business Should fulfill all obligations in a professional and ethical manner Should not discriminate among the clients Should ensure that prospectus, letter of offer etc.. is available to investors at the time of issue Should render best possible advice to its clients Any penal action taken by SEBI should be informed to its clients

Should inform the board about any legal proceedings initiated against it Should abide by the rules of Securities and Exchange Board of India Regulations,2003 Shall develop its own internal code of conduct for governing its internal operations Should ensure that any person it employs should have the capacity to be a merchant banker It is responsible for the act of its employees and agents Should not create false market

SOME PROBLEMS OF MERCHANT BANKERS

SEBI stipulates high capital adequacy norms for authorisation which prevents young,specialised professionals into merchant banking business

Non co-operation of the issuing companies in timely allotment of securities and refund of application of money etc.. is another problem