Long Term Financing

Long-term Financing
B.B.CHAKRABARTI PROFESSOR OF FINANCE IIM CALCUTTA
Chapter Overview

Capital market instruments Issue of long-term Securities Issue of debt instruments Book Building of Securities Offer for Sale Employee Stock Options (ESOPs) Sweat Equity Shares Euro - Issues Term Loan Venture Capital
B.B.Chakrabarti: bbc@iimcal.ac.in 2
Capital Market Instruments
Equity Shares Preference Shares Debentures
B.B.Chakrabarti: bbc@iimcal.ac.in
Equity Shares
Share capital other than pref. share capital is known as equity share capital. Equity shareholders have the following rights: a) Voting rights at the general meetings of the company b) Rights to share in the profits of the company in the form of distribution of dividend and bonus shares However, in the event of closing of the company, equity share capital is repayable only after repayment of claims of all the creditors and preference shareholders.
Preference Shares
In the case of a company limited by shares, preference shareholders get preferential rights to payment of dividend and are to be repaid on closing down. Preference shares may be either cumulative Or non-cumulative. Preference shares can also be convertible or redeemable.
Debentures
A debenture is a certificate issued by a company acknowledging indebtedness. It provides for payment of interest at a fixed rate and repayment of principal at fixed dates. Usually, registering the charge with the Registrar of Companies for securing the debenture holders creates a charge on specific assets. In addition, a trusteeship is created in favor of one or more persons in case of secured debentures.
Debentures

According to convertibility, debentures can be classified into three categories: Fully Convertible Debentures (FCD) Partly Convertible Debentures (PCD) Non-Convertible Debentures (NCD)
Equity Warrants
Both convertible and non-convertible debentures may be issued along with a detachable warrant. The warrant gives a right to the debenture holder to obtain equity shares of the company at a specified period at a price not exceeding the cap price specified in the warrant. Equity Warrant is generally attached to nonconvertible debentures and even with convertible debentures or equity shares as a carrot to improve their marketability. The warrant is a tradeable negotiable instrument and is listed on the stock exchanges for trade.
Issue of long-term Securities

If a company intends to raise new share capital, it can do so in many ways: a) Offer new shares to existing shareholders on a pro rata basis through a rights issue. b) Offer new shares to the general public through a public offer of new shares.
Issue of Long-term Securities

c) Offer to a single or a very small number of investors in a private placement. d) Offer new shares to employees/directors through Employee Stock Option Schemes and Sweat Equity shares.
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Private Placements
In
a private placement, securities are sold to one or a few investors, generally, institutional investors. Private placements are common with debt instruments. Private placements are usually less costly and can be undertaken in a short time.
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Issue of Long-term Securities to the Public
A company can raise long-term resources from the public by issuing equity shares, preference shares, debentures or convertible bonds. The guidelines for issuing securities in India have been issued by Securities and Exchange Bond of India (SEBI) and are called the Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2000.
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The major steps involved in issuing securities are as follows: a) An approval of the board of directors is required for making an issue of securities. Shareholders' approval has to be taken. The project for which funds are required should also be appraised. b) The company has to appoint a lead merchant banker.
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c) The lead merchant banker will have to submit a draft offer document and other documents to SEBI for seeking permission to issue securities. The offer document or Prospectus shall contain all material information, which shall be true and adequate so as to enable the investors to make informed decision on the investments in the issue.

d) After the prospectus is ready and duly approved by SEBI and permission from ROC and Stock exchanges obtained, the issue can be opened for subscription by public by announcing in newspapers, directing them to deposit money in the specified branches of selected banks. e) Later, an allotment of securities has to be made to the subscribers to the issue. If excess money has been received, the same has to be refunded to the subscribers.

The other issues pertaining to the issue of securities to public are as follows: a) The issue of securities should be in dematerialized form. b) Differential pricing A public issue of equity shares or securities convertible at a later date into equity shares can be made to applicants in the firm allotment category at a price higher than the price at which securities are offered to the public.

c) Price Band Issuer company can mention a price band of 20% (cap in the price band should not be more than 20% of the floor price) in the offer document filed with SEBI and actual price can be determined at a later date before filing the offer document with the Registrar of Companies (ROC). d) The issuer company has the freedom to determine the denomination of shares for public/rights issues and to change the denomination of existing shares but at any given time, there shall be only one denomination for the shares of a company.

e) A composite issue means an issue of securities by a listed company on a public cum rights basis through a single offer document wherein the allotment for both public And rights components are proposed to be made simultaneously. f) Promoters Contribution The promoters shall contribute not less than 20% of the post issue capital. Promoters shall bring in the full amount of the promoters contribution including premium at least one day prior to the issue opening date.
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g) Lock-in Requirements The promoters contribution shall be locked in for a period of 3 years. (h) Due Diligence The lead merchant banker shall exercise due diligence to satisfy himself about all the aspects of offering, veracity and adequacy of disclosure in the offer documents. The lead merchant banker will have to furnish a Due Diligence Certificate.

i) Firm Allotment An issuer company can make allotment on a firm basis in public issues to Indian and Multilateral Development Financial Institutions, Indian Mutual Funds, Foreign Institutional Investors including NRIs, Overseas Corporate Bodies, Employees of the issuer company and Scheduled banks.

j) Green-shoe Option Option to allot excess subscribed shares to the extent of 15% to stabilize post-listing price. k) Red Herring Prospectus It is a prospectus which does not have details of either price or number of shares being offered or the amount of issue.

The intermediaries in the issue of securities to the public are as follows:a) Merchant Banker b) Co-Managers of the issue c) Underwriters d) Brokers e) Bankers to the issue
Major Contents of the Prospectus

a) Capital structure of the company b) Particulars of the proposed issue c) Objects d) Project cost e) Means of financing f) Deployment of funds in the project g) Terms of the present issue e) Terms of payments f) Arrangement and disposal of odd lots
Major Contents of the Prospectus

g) Company management and project h) Management discussion and analysis of the financial condition and results of operations. i) Financials of group companies j) Promise vis--vis performance Projections k) Basis for issue price l) Outstanding litigations or defaults m) Disclosure on investor grievances and redressal system
Issue of Debt Instruments

Some additional guidelines for offering convertible/non-convertible debt instruments through an offer document are: a) Credit Rating of Debt Instruments b) Debenture Trustee c) Debenture Redemption Reserve (DRR) d) Creation of Charge
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Book Building of Securities
Book building means a process undertaken by a company by which demand for the securities proposed to be issued is elicited and built up. The price for such securities is assessed for the determination of the quantum of such securities to be issued. A company can undertake book building of 75% or 100% of the proposed capital issue.
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Offer for Sale

Offer
for sale means offer of securities by existing shareholders of a company to the public for subscription, through an offer document. In offer for sale, fresh capital is not raised but many shareholders substitute some of the existing shareholders.
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Employee Stock Options (ESOPs)
Under ESOP, key employees are given options to purchase equity shares of the company based on a plan of service to the employer. The employees can get equity shares at a specified future period at a predetermined price. The plan of service could include completion of a specified service period and/or on achieving a specified performance goal.
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Sweat Equity Shares

Sweat
equity shares mean equity shares issued by a company to its employees or directors at a discount or for consideration other than cash for providing know-how or granting rights in the nature of intellectual property rights or value additions. These shares are allotted to such employees for rewarding exceptional services to the company.
Euro - Issues
Since
1992, Indian companies are permitted to issue Global Depository Receipts (GDR) or American Depository Receipts (ADR) abroad to raise equity share capital. They can also raise debt capital abroad by issuing Foreign Currency Convertible Bonds (FCCB).
Global Depository Receipt (GDR)

A GDR is a dollar denominated instrument in the form of a Depository receipt or certificate created by the Overseas Depository Bank outside India and issued to non-resident investors against the issue of ordinary shares or Foreign Currency Convertible Bonds of issuing company in India.
Features of GDR
a) GDRs are denominated in a foreign currency (say dollar). b) GDR holders have rights to dividend, rights issues and bonus issues pertaining to the underlying equity shares of the issuer company. c) GDR holders have no voting rights in the meetings of the issuer companys shareholders. d) Issuer company does not bear any foreign currency exchange risk. The same is borne by the GDR holders.
Features of GDR
e) GDRs are fungible both ways. A GDR holder has the option to surrender the GDRs and hold equity shares of the issuer company instead. Also, the underlying equity shares received on redemption of GDRs can be reconverted into GDRs again. f) There is no lock-in period for GDRs. An investor who wants to cancel a GDR may do so immediately after allotment of GDR and receive equity shares.
Pricing and Marketing of GDRs

GDRs
are marketed by private placement through the lead manager of the issue. The lead manager forms a syndicate along with various overseas underwriters. The lead manager is responsible for preparing the offer document after undertaking due diligence. The lead manager advises the issuer on timing and pricing of the GDRs.
The GDR issue is marketed by organizing road shows in various overseas locations in Europe, North America and other places. During the road show, the management of the issuer company makes presentation to the prospective investors about the plans and performance of the issuer company. An initial offer document is also circulated along with minimum acceptable offer price of GDRs.

Then Book running is undertaken which means obtaining written response of the prospective investors on the number of GDRs and the price at which they would like to invest. Then the final offer price is calculated depending on investor response and the GDR issue is opened for subscription. After collection of the issue proceeds, the issuer company issues its equity shares in the name of the Overseas Depository Body who subsequently issues GDRs to the investors.
Creation of GDR
Ind. CO. Equity Shares INR USD Overseas Depository Body Stock Exchange
Domestic Custodian
GDR
Investor
American Depository Receipt
American Depository Receipts (ADR) is listed in an American stock exchange and primarily aims at investors in America. ADRs and corresponding dividends are denominated in dollars. The accounting statements of the issuer company have to comply with the stringent requirements of Securities and Exchange Commission of USA and US GAAP (Generally Accepted Accounting Principles).
Foreign Currency Convertible Bonds (FCCB)

The features are: a) These are quasi-debt securities denominated in a foreign currency. b) These are convertible into equity shares of the issuer company or into depository receipts on the expiry of a minimum lock-in period. The exchange rate for the conversion and the conversion price are fixed.
Foreign Currency Convertible Bonds (FCCB)

c) These bonds are with put and call options. Investors can exercise the put option after the expiry of a certain period whereby the investors can receive the principal and the due interest amounts. The issuer can exercise the call option and can redeem the bonds by payment of the principal and the accrued interest.
Term Loan
Companies
can raise Term loans from financial institutions and banks. Term loans are direct business loans. The maturity period of loan is usually long term (more than one to around ten years). The loans carry market interest rate and the principal is repaid in installments after a period of moratorium.
Venture Capital
Promoters without any track record of performance but with good project ideas can approach venture capital funds to raise capital for launching and developing a business. Venture capital (VC) funds invest in long-term equity and debt capital in risky projects with expectation of high return. The underlying sources of funds for them are from high net worth individuals, pension funds, insurance companies, banks, large corporations and others.
Venture Capital
VC funds usually provide financing in stages. At each stage, they invest enough money to reach the next stage. For example, they may provide seed capital or first stage financing to build a prototype. If that is successful, then they may provide second stage financing to buy plant and machinery for commercial manufacturing and marketing. Some VC funds specialize in certain stages of funding. Some even actively participate in running the business. At present, many VC funds operate in India.
Multiple Choice Question - 1

True or False? a) A company pays preference shareholders after payment of dividend to equity shareholders. b) In case of cumulative preference shares, dividends if not paid in a particular year are paid in a subsequent year before payment of equity dividends. c) Equity shareholders lose all their money in case of winding up of a company. d) A debenture is a debt instrument. e) Partly convertible debentures are converted into equity shares in full at a pre-specified time.
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f) Equity warrants are equity shares. g) A company can raise equity capital by issuing employee stock options. h) SEBI is the regulator for all capital market issues in India. i) Equity shares issued to the public need not be listed in a stock exchange for trading. j) Credit rating of a debt instrument issued to public is a must.

k) Book building of shares is done to issue shares at a fair value to both investors and issuer. l) Offer for sale of shares to public is undertaken to increase share capital. m) GDRs are listed in an Indian stock exchange to provide liquidity to investors. n) ADRs can be issued if the accounting statements are prepared conforming to US GAAP. o) A start-up software company can approach VC funds for initial capital.

Ans. (a) False (b) True (c) False (d) True (e) False
(f) (g) (h) (i) (j)
False False True False True
(k) (l) (m) (n) (o)
True False False True True
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Issue costs for debt issues are generally less than those for equity issues because: a) Debt issues are generally privately placed. b) Debt issues are fixed period instruments. c) Debt capital is raised after raising equity capital. d) Debt issues carry regular interest payments.

Ans. (a)
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Cost of ADR/GDR issue is less than the same for equity issues in India because: a) Size of ADR/GDR issue is usually large. b) The issues are privately placed by road shows. c) ADR/GDR issues are listed in overseas stock exchanges. d) Large companies undertake these issues.

Ans. (a) and (b)
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ESOPs are issued primarily: a) To raise equity capital. b) To provide incentives to employees. c) To reduce taxes on perquisites given to employees. d) To increase the market value of equity shares of a company.
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Ans. (b)
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Book-building of equity shares is undertaken: a) To create demand for the equity shares of the company. b) To raise capital speedily. c) To determine the fair market price of the equity shares of the company. d) To prepare a list of prospective subscribers who may be approached later to raise capital.
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Ans. (c)
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Long Term Financing

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Long-term Financing

B.B.CHAKRABARTI PROFESSOR OF FINANCE IIM CALCUTTA

Capital Market Instruments

Equity Shares Preference Shares Debentures

Issue of long-term Securities

Issue of Long-term Securities

Issue of Long-term Securities to the Public

Issue of Long-term Securities to the Public

Issue of Long-term Securities to the Public

Issue of Long-term Securities to the Public

Issue of Long-term Securities to the Public

Issue of Long-term Securities to the Public

Issue of Long-term Securities to the Public

Issue of Long-term Securities to the Public

Issue of Long-term Securities to the Public

Issue of Long-term Securities to the Public

Issue of Long-term Securities to the Public

Major Contents of the Prospectus

Major Contents of the Prospectus

Issue of Debt Instruments

Book Building of Securities

Offer for Sale

Employee Stock Options (ESOPs)

Sweat Equity Shares

Global Depository Receipt (GDR)

Pricing and Marketing of GDRs

Pricing and Marketing of GDRs

Pricing and Marketing of GDRs

American Depository Receipt

Foreign Currency Convertible Bonds (FCCB)

Foreign Currency Convertible Bonds (FCCB)

Multiple Choice Question - 1

Multiple Choice Question - 1

Multiple Choice Question - 1

Multiple Choice Question - 1

(f) (g) (h) (i) (j)

False False True False True

(k) (l) (m) (n) (o)

True False False True True

Multiple Choice Question - 2

Multiple Choice Question - 2

Multiple Choice Question - 3

Multiple Choice Question - 3

Multiple Choice Question - 4

Multiple Choice Question - 4

Multiple Choice Question - 5

Multiple Choice Question - 5

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