Equity Flow in Primary Market

Initial Public Offering

In business, finance plays a crucial role. Every business enterprise requires a lot of funds for expansion and to grow in order to spearhead itself with the competing market. At this stage, there comes the word IPO enabling such companies to generate funds.

In broader sense, an IPO (Initial Public Offering) is a method of going into the public through a stock exchange with the help of institutional investors. IPO is generally done by companies in order to involve public in the process of fund generation, for which they are benefited with returns. The process of IPO is also known as “going public.”

Why IPO?

A business can be started up with minimum capital where only the proprietor is termed as the owner. After setting up of a business, the proprietor tries to sustain in the market and with full of dedication, decides to expand with the help of existing profits itself. He may sacrifice his own needs and luxuries, thereby re-investing all his profits back into his business. He may also approach angel investors. But still from some corner, this profit cannot be proved sufficient to the business enterprise for high level of expansion. Well, now its the right time to think of IPO. Before IPO, the business should contact a recognized stock exchange and fulfill the quoted eligibility norms. Once this is achieved, the company gets ready for going public. IPO can happen only once in a lifetime of a company and is considered as a primary market operation. During IPO, the company gets maximum subscriptions from potential investors thereby leading to growth of fund and in return, growth of the company.

Hence, it can be said that IPO plays a vital role for a fresh company to grow and expand. Some of the recent IPOs of upcoming companies existing in India are Coffee Day Enterprises, Adlabs Entertainment Ltd, Inox Ltd, etc.

Process of IPO

The IPO process involves the following steps which are to be followed religiously by any company opting to do so.

1. A thought of expansion:

The first thought that should psychologically arrive is, a trigger of expansion in the minds of the promoters of the company. Only then, an IPO could be executed. Once all the analysis of capital, profits, reports, etc are done, the company can set its target to go public.

2. Appointment of Merchant Bankers:

For an IPO to be successful, it is very much essential to appoint a Merchant Banker registered with SEBI for providing services. A merchant banker plays the role of a lead manager, underwriter and adviser to the issuing company.

3. Appointment of other intermediaries:

a.         Registrar:

The issuing company and the merchant bank should then appoint registrar as per SEBI rules, to avail administrative support during the issuing process. The duty of the  registrar is to help the merchant bank (lead manager) in selecting bankers for the issue, centers for preparing application and allotment forms, collection of application and allotment money, reconciling bank statements, listing of securities to be issued and solving grievances.

b.        Bankers:

A scheduled bank registered with SEBI should be appointed as the banker to the issuing company. Their duty is to collect application forms with money, maintaining reports and forwarding application money to the registrar.

c.         Underwriters:

Underwriting is a guarantee given by the underwriter to subscribe the shares, in case of under-subscription. An underwriter should have a minimum Net Worth of Rs. 20 Lakhs. Commission is paid to the underwriters by the issuing company for taking up such risks.

d.        Broker:

A broker is then appointed to promote market building and making investors aware about the shares ready for issue.

4.  Registration of Offer Documents:

A company is required to submit 10 copies of the draft prospectus to the SEBI, which is treated as a public document. The merchant banker then files all the reports and documents with the stock exchange. It should be seen that the promoter’s contribution is 20% or more of the issued capital. Also, their contributions shall be locked in for a period of 3 years.

5.  Marketing:

Once documents are registered with SEBI and stock exchanges, its now time for the actual execution. At this stage, factors such as proper timing of issue, advertising and creating awareness about the issue and reservation of issue to mutual funds, banks, Foreign Institutional Investors (FIIs), employees, etc are worked upon. The total offer made to the public should be 25% or more of the total issue.

6.  Post Issue Work:

Details of subscription should be reported by the merchant bank to the company to make it out whether there is under-subscription or over-subscription. Accordingly, underwriters shall play their role within 60 days (in case of under-subscription) and surplus receipt should be refunded with letter of regret within 30 days (in case of over-subscription). Also, all the formalities associated with the SEBI must be fulfilled by the issuing company to avoid any fraudulent activities.

7.  Allotment of shares

Once the issue process is over, all the bids are aggregated category wise namely, Qualified Institutional Buyers (QIBs), Non-Institutional Buyers (NIBs), Retail, etc. Later, allotment is made based on subscription and on proportionate basis to the investors, category-wise.

Types of IPOs

There are generally two types of Public Offerings that have been extensively used and are still in use. They are discussed below:

I. Fixed Price Issues:

This is a method of IPO where the company issuing shares has got the right to fix the price of the share before offering. This issue price is disclosed in the offer documents including the number of shares to be issued. Here, the investors come to know well in advance about the share price that the company is offering. So, demand for shares cannot be expected by the company or its merchant banker and the response is known only after the issue. Such issue requires complete advance payment by the investors at the time of application. It attracts reservations worth 50% for applications less less than Rs. 100000 and the balance 50% for the rest.

Features of Fixed Price Issue:

1. Fixed Price Offering:

As the name represents, fixed price offering is an IPO method where the price of the shares to be issued by the company is pre-determined. This price is not changed at the time of offering.

2. Price Discovery:

In case of fixed price issue process, no price-demand analysis is done to determine the appropriate price to be quoted for shares. Thus, prices are simply fixed based on the net worth, without any analysis.

3. Undesirable Response:

Under fixed system, the prices fixed for shares can either go high or be less. This disables the company to understand public response to the offering. There can be too much subscription in case of under-pricing or under-subscription due to over-pricing. This may substantially affect the company and the promoter’s value.

4. Payment of full price:

Under this system of IPO, the investor must pay the full amount of share price while making the application, unlike other methods.

5. Period:

Fixed price IPO’s generally takes around a month for allotment of shares and further 3 to 5 days for receiving the same. This is more time consuming.

6. Allotment:

Allotment of shares to various types of investors are done on a proportionate basis. Over-subscriptions and under-subscriptions are taken fully taken care of while allotting.

II. Book Building Issue:

This is one of the most widely used mechanism all over the globe for raising finance. What happens under this method is unlike that of fixed price offering, the price of an issue is discovered on the basis of demand quoted from the potential investors category-wise at various price levels. To be precise, a price range of equity shares is declared by the company that is to be offered. Interested investors can bid within this specified price range for the amount of shares they want to purchase. This quantum can be revised by the investors during the bidding period. Generally, a bid must be for minimum 500 equity shares and further, in multiples of 100. These bids received from the investors are recorded in a book and the issuing company analyses the demand quoted by the prospective investors, with reference to price and number of shares. In the end, the merchant banker of the company and the company officials fix the final issue price and decide upon the allocation of shares to the applied investors. This whole process is called “book building”, which apparently helps the company to discover the optimum price for its equity shares through bid/demand analysis.

Features of Book Building Process

Following are some of the features of Book Building Process

1. Price Discovery:

The process of book building offers proper price discovery based on the demand quoted by the investors. Generally, after obtaining applications from various investors for various prices, the company then looks out for that price having maximum demand. This price is then finalized on discussion with the book runner (merchant banker).

2. Open Book Building:

In book building issues, it is compulsory for every company to display the demand and bids online, during the bidding period. On the other hand, the closed book system does not allow this rule and so, a company does not display bids to the public. As per SEBI, only electronic means are allowed to be used during book building.

3. Price Band:

The offer document consist of a price range, which is called “price band.” The investors are allowed to choose any price as per their discretion within the price band. The difference between the higher and the lower end (floor price) can be maximum upto 20% of floor price. This price band can be altered by the company considering SEBI norms, wherein information should be widely passed on to the respective stock exchange, press release to be issued and changes to be made on the relevant website, thereby intimating members. The minimum price through which the bidding starts is called “Floor Price.”

4. Cut-off Price:

During Book Built IPO, a price is discovered between the floor price and maximum band price. This price is called cut-off price. This price is decided by the issuing company and its book runner. As per SEBI guidelines, only retail investors can apply at cut-off price.

5. Final Issue Price:

This is the final price which is fixed by the issuing company and its book runner based on the price bidding analysis. This bidding is made available on the website of the stock exchange till the entire bidding period.

6. Subscription Period:

As per SEBI rules, such public issues for equity subscriptions must be open for minimum 3 working days but not exceeding 10 working days.

7. Additional Book Building Mechanism:

This is a mechanism recently introduced, but only for FPOs (Follow-On Public Offers) where allotment is made on the basis of price selection by the investors. For example, if an investor has bid for higher price, then he will be allotted the number of shares that he has applied for and so on. In short, allotment is done on price priority basis. This is applicable only for QIBs. Whereas, in case of other investors like retail or non-institutional, allotment is made purely on proportionate basis.

Types of Investors Involved

There are generally three types of investors involved in a book-building issue. They are Qualified Institutional Buyers (QIBs), Retail Individual Investor (RIIs) and  Non-Institutional Investors (NIIs)

a.         Qualified Institutional Buyers:

These are those institutional investors who are experts and financially sound for investing in capital markets. It can be some public financial institution, scheduled commercial banks, Foreign Institutional Investors (registered with SEBI), Mutual Funds, Venture Capital Funds, State Industrial Developmental Corporations, Insurance Companies, Provident Fund (Corpus of Rs. 25 Crores or more) and Pension Funds (Corpus of Rs. 25 Crores or more).

b.        Retail Individual Investors:

A Retail Individual Investor can be a person purchasing shares for his own personal effect rather than for any company or organization. They basically trade on small volume as compared to other institutional investors. Retail investors cannot apply for shares more than Rs. 200000.

c.         Non-Institutional Investors:

These are those investors (individuals) who possess high net worth than other retail investors. Any application for shares more than Rs. 200000 makes an individual to be called non-institutional investor.

The Book Building Procedure

For a company to raise capital through book building mechanism, following procedures are applicable.

1. Appointment of Book Runners:

The issuing company should first appoint merchant bankers who shall act as book runners.

2. Details in the Offer Document:

The issuing company should specify the number of securities to be issued along with the price band for bidding in the offer document.

3. Appointment of Underwriters:

The issuing company should also appoint syndicate members (intermediaries who are permitted to carry out underwriting activities) with whom investment orders are placed.

4. Book Building:

These members pass entries of all the orders into a book in an electronic form that is made visible to the public on stock exchange’s website for a period of 5 days.

5. Bidding:

Bids should be quoted only within the specified price band that starts from floor price.

6. Alterations:

Any kind of revisions to be made in the price band can be made possible, but only before closure of the bidding.

7. Evaluation:

On closure of book building period, the book runners evaluate the bids as per demand within the price range.

8. Price Discovery:

The book runners with the issuing company decide the final price at the which the equity shares are issued.

9. Allotment:

Successful applicants get allotted on a proportionate basis, whereas others are subject to refund of application money.

Book Building in India

In India, Book Building is a recent concept that is strongly being followed. Let’s study something about (BSE) Bombay Stock Exchange’s Book Building System.

BSE offers a stage for book building through its Book Building software that runs on its own private network.

BSE’s system is one of the largest in the world covering about more than 300 Indian cities through more than 7000 Trade Work-stations via VSATs (Very Small Aperture Terminals) and Campus LANs.

The software operation is done by leading book runners and syndicate members, for analyzing electronic bids throughout the bidding period.

To enable transparency, visual graphs indicating price v/s quantity is displayed on the website.

Internal Equity Issues

Companies may issue further shares to its existing shareholders to not only raise additional fund, but also to maximize their wealth. A company can also issue shares to its hardworking employees, thereby maximizing employee participation and interest towards work. Some of such instances are sweat equity issue, employee stock options, bonus and rights issue, that are discussed below.

Sweat Equity

Sweat equity shares are generally those equity shares which are issued by a company to its high valued employees at a discount or for consideration, other than cash. Here, employee should be a permanent employee either working in India or abroad or a director of the company. This is applicable only to those employees and directors who share or contribute any kind of technical know-how or special rights such as patent, intellectual property, etc., with the company for its greater performance.

Thus, a compensation made to those respectable employees by the company is at times, in the form of shares rather than cash.

Following are the conditions as per section 54 of the Companies Act, 2013 that should be fulfilled by any company which is issuing sweat equity to its employees:

1. Special Resolution:

The issue should be authorized by passing a special resolution by the company. This resolution should should clearly specify the number of shares, current market price, any consideration and the class of employees or directors to whom such shares are to be issued. This resolution is valid only for one year.

2. Timing:

Issue of sweat equity shares can be made by the company only after completing  one whole year from the commencement of business.

3. Regulations:

The sweat equity shares should be issued in accordance with the regulations made by SEBI and the stock exchange, where the existing shares are listed.

4. Case of an Unlisted Company:

In case of an unlisted company, it is mandatory to pass a special resolution at the general meeting.

5. Explanatory Statement:

As per provisions of section 102 of Companies Act, 2013; an explanatory statement should be annexed with the notice of the general meeting containing the following details:

a.         Date of the board meeting on which proposal for sweat equity was approved.

b.        Reason for the issue of sweat equity.

c.         Class of shares under which the sweat equity shares are intended to be issued.

d.        The total number of shares to be issued.

e.         The class of employees or directors to whom such shares are to issued.

f.          The principal terms and conditions to the issue including valuation.

g.        The tenure of employment of such employee or director, with the company.

h.        Details of the employee or the director to whom such issue is to be made along with a statement of relation with the promoter, if any.

i.          The price at which sweat equity shares are proposed to be issued.

j.          The consideration including consideration other than cash, if any to be levied on the share receiver.

k.        Statement ensuring adherence to the applicable accounting standards.

l.          Diluted Earnings Per Share considering sweat equity issue.

6.  Limit on Issue of Sweat Equity Shares

a.         A company can issue sweat equity shares upto 15% of the existing paid up equity share capital during a year or sweat equity shares valuing Rs. 5 Crores, whichever is higher.

b.        Again, the final issue of such shares should not cross 25% of the total paid-up share capital of the company.

7.  Lock in Period

The sweat equity shares issued to the employees or the directors shall be locked in (made non-transferable) for a period of 3 years from the date of allotment of such shares.

8.  Valuation

The shares to be issued under sweat equity scheme should be valued by a registered valuer for providing a fair and justifiable value. Valuation of intellectual property rights, technical know how and value additions should also be done by the registered valuers. This valuation report is then sent by the valuer to the Board of Directors with sufficient justification.

9.  Provision for non-cash consideration

In case sweat equity shares are issued for a consideration other than cash, the so non-cash consideration shall take the form of a depreciable or amortizable asset that shall be put up in the Balance Sheet.

10.  Director’s Report

In the end, the Board of Directors disclose their report considering class of employee/director, class of share, number of sweat equity share issued, justifiable reason, terms and conditions, pricing formula, percentage of sweat equity shares as to total paid-up share capital, consideration and diluted EPS.

11.  Post Issue Work

The company that has issued sweat equity shares should maintain a Register of Sweat Equity Shares in Form SH 3 and should enter all particulars pertaining to sweat equity issue. All the entries passed should be authenticated by the Company Secretary of the issuing company. This register should be maintained at the company’s registered office.

Benefit of Sweat Equity Shares to the holders

The rights, limitations, restrictions and provisions that are currently applicable to the equity share holders shall be applicable to the sweat equity share holders too.

ESOP

ESOP refers to Employee Stock Option. Its a scheme undertaken by companies that has always been a very popular tool to attract the best of the talents of the employees. Generally, ESOPs never put load on the company for fund raising and on the other hand, it proves to be a substantial reward for the employees. Thus, when a company progresses, it enhances the employees also to spearhead their wealth. ESOP requires a great amount of planning that could not only help the company to achieve its objectives, but also the employees to fulfill their financial goals.

Many people mis-conceptualize the terms Sweat Equity and ESOP and assume both to be same. But in real sense, there is a difference among the two. Sweat equity is basically issued to those high valued or senior employees or directors who contribute with additional values, know how, rights, etc. On the other hand, ESOPs are issued at the discretion of the company which normally focuses on general employees who are working with the company on a full time basis. ESOPs can be in the form of ESOS (Employee Stock Option Schemes), ESPP (Employee Stock Purchase Plans), Compensation Plans, Incentive Plans, SAR (Share Application Rights), Phantom ESOPs, etc.

Types of ESOPs

1. Employee Stock Option Scheme (ESOS):

In this scheme, the company offers an option to its employees to acquire shares at a pre-determined price at a future date. Employees who are eligible can acquire these shares on vesting within the exercise period. Employees are allowed to dispose off the shares subject to any lock-in-period. Generally, the exercise price (price at which shares are offered to the employees) is lower than the current market price.

2. Employee Stock Purchase Plan (ESPP)

This is generally applicable in listed companies, where the employees are given the right to acquire shares instantly and not at a future date like that of ESOS. Again here, the shares are offered at a price lower than the existing market price. Shares issued by listed companies under ESPP are subject to lock-in-period, wherein the employee cannot sell the shares and they have to continue with the company for a certain number of years.

3. Share Appreciation Rights (SAR)/Phantom Shares

Unlike other schemes, this scheme is little differentiated. Here, no shares are offered or allotted to the employees or directors. Rather, they are paid based on the appreciation in the value of shares between two specific dates, which becomes an incentive or performance bonus.

General Features of ESOP

1. ESOP Policy: For every company going ahead with ESOP, it is very much essential for them to have a well framed ESOP policy. The policy covers the entire operation of ESOP like structure, size of the issue issue, class of employees to whom issue is to be made, valuation, selling and transfer options, exit clauses, etc. In short, all the terms and conditions related to ESOP is governed by the ESOP policy.

2. Vesting Period:

Vesting period is the time period through which the company continues to issue stocks to its employees. For example, 2 years to 5 years or so, stating that if the employee works for that much period, then a particular amount of sum shall be payable by the end of the term.

3. Vesting Schedule:

Vesting schedule is a table showing the frequency of making ESOP available within the vesting period. For example, if the vesting period is for 5 years, the vesting schedule may be on monthly, quarterly, half yearly or annual basis.

4. Exercise Period:

Generally when a company issues ESOPs, it is not actually giving equity, but only options are given. It ultimately depends on the discretion of the employee whether to accept or not. The period given to the employee for making this decision on exercising his option for ESOP is exercise period. During the exercise period, the options are actually converted into stocks.

5. Cliff:

Cliff is generally a part of vesting period. Cliff refers to the first allotment of employee stocks. It is the base term for which an employee should have rendered services to the company, say for example, one year. This means, only after working for a year, the employee can avail vesting options.

6. Grant Letter:

It is a letter given to the employees showing out key terms of the options such as price, number of shares, vesting period, schedule and other terms and conditions. Once this grant letter is acknowledged positively by the employee, he becomes eligible for ESOPs.

7. Limit on issue of ESOP:

There are basically not many rules abiding working of ESOP but in a nutshell, there are some few that focuses on the maximum amount of ESOP that can be issued by a company. It should not cross 15% of the total paid up equity share capital, same like that of Sweat equity.

8. ESOP to employees abroad:

When it comes to issuing ESOPs to employees of a particular company residing abroad, certain guidelines as per FEMA and FDI must be adhered. Foreign country rules pertaining to such investments should also be followed.

9. Tax Implications: When ESOP options are quoted by a company, there are no taxes associated to it. But when the employees exercise these options, the savings benefit enjoyed by the employees (difference between the discounted issue price and the current fair market value of the share) is considered as a perquisite, taxable under income from salary. Further, when the employees sell these shares in the future at higher values, it is accountable for capital gains, that can be either long term or short term which is again taxable.

Following are the conditions as per section 62 of the Companies Act, 2013 that should be fulfilled by an unlisted company issuing stock options to its employees:

1. Special Resolution:

The ESOP Scheme should be approved by the shareholders of the company by passing a special resolution about the same.

2. Applicability:

ESOP Schemes are offered only to permanent employees of the company either working in India or abroad, directors (whole time, but not independent director) or an employee of a subsidiary or holding company. This clause excludes employees from the promoter group or a director holding more than 10% of equity shares of the company.

3.  Explanatory Statement:

The company should annex the following key details with the notice of passing resolution:

a.         Total number of stock options to be grated to the employees.

b.        Class of employees who are eligible for stock options.

c.         Process of appraisal for determining employee eligibility for issuing stock options.

d.        Vesting period and its requirements.

e.         Maximum period of vesting or vesting schedule.

f.          Exercise price (discounted price of shares offered to employees)

g.        Exercise period and process.

h.        Lock-in period, if any.

i.          Maximum number of options to be granted per employee.

j.          Method of valuation of options.

k.        Conditions under which vesting options may come to end.

l.          Statement stating compliance to accounting standards.

4. Period:

 There should be a minimum period of one year between the grant of options and vesting of options.

5. Transferability:

 The stock options granted to employees cannot be transferred to any other person. Such options cannot even be pledged, hypothecated or mortgaged.

6. Director’s Report:

 The Board of Directors disclose their report containing information about options granted, options vested, options exercised, total number of shares for option, options lapsed, exercise price, option terms, money realized, employee details, etc.

7. Post Issue Work:

 The company should maintain Register of Employee Stock Option in Form SH 6 and should enter all the particulars relating to options granted. These entries are then authenticated by the Company Secretary of the company. This register should be maintained at the company’s registered office.

Note: In case of a listed company under a recognized stock exchange, the Employee Stock Option Scheme can be issued only in accordance to the rules and regulations of SEBI.

Rights Issue

A company raises capital through its share holders. There can be a situation where the company wants to raise additional fund by way of additional equity shares. This can be done by offering rights issue to the existing equity shareholders. A rights issue is an offer of equity shares directly made by the company only to its existing equity shareholders. Companies generally pursue rights issue to raise funds for enormous reasons like expansion, growth and also to leverage debt.

Following are the conditions as per section 62 of the Companies Act, 2013 that should be fulfilled by a company that is desired for rights issue:

1. Issued to whom:

Equity shares under rights issue can be offered by a company only to its existing equity shareholders, in the proportion of their current holding. This is done by sending a letter of offer, which can be accepted by the shareholders. This acceptance is totally upon the discrete of the shareholders.

2. Letter of Offer:

The offer is made by a notice through the letter of offer that specifies the number of shares that are being offered, price and renunciation rights. A time gap of 15 to 30 days is provided to the shareholders for acceptance. If the offer isn’t accepted within the stipulated time, it will be considered to have been declined.

3. Rights:

Rights issue, as per the provisions of articles of associations of the company give rights to the shareholder to renounce (refuse the right) the shares offered to him and pass on in favour of some other person.

4. Post Notice:

In case of refusals from the shareholders on accepting rights issue, the Board of Directors can dispose them off in such a manner which is harmless to the shareholders as well as the company.

Legal Procedures to be followed while allotting shares on rights issue basis:

a.         Board Meeting with a 7 days prior notice.

b.        Passing of Resolution for approving “Offer Letter” including renouncing rights.

c.         Dispatching of offer letter to the shareholders.

d.        Receiving acceptances, renunciations and rejections from the shareholders.

e.         Pass Resolution by the Board for approving the rights issue allotment.

f.          Filing return of allotment with the Registrar in Form PAS 3 within 30 days of such allotment, which includes board resolution, letter of offer and details of allottees.

g.        File Form MGT 14 with 30 days from the date of issue of such rights issue.

Merchant Bankers

The term “merchant banking” is been used enormously in different parts of the world. In U.K. merchant banking refers to the “accepting and issuing houses”, whereas in U.S.A. it is known as “investment banking”. The word merchant banking is  so widely used that it may include banks who are not merchants, merchants who are not banks and sometimes, those intermediaries who are neither merchants not banks.

A merchant bank can be defined as an institution or an organization that provides a number of financial services like share issue management, portfolio services, underwriting activities, insurance, credit syndication, financial advising, project counseling, etc. A normal commercial bank cannot be treated as a merchant bank. A merchant bank mainly offers financial services for a fee whereas, commercial banks accept deposits and grant loans.

In India, merchant banking services came into existence in 1967 by National Grindlays Bank followed by Citi Bank in 1970. The State Bank of India was the first Indian Commercial Bank to set up a separate Merchant Banking Unit in 1972. In India, merchant banks have been primarily operating as issue managers and underwriters than full- fledged merchant banks as in other countries. Sicom Ltd, Tamilnad Mercantile Bank Ltd, Bajaj Capital Ltd, SBI Capital Markets Ltd, Motilal Oswal are some the widely known merchant bankers in India.

Functions of a Merchant Bank

A merchant bank mainly works for enterprises and not individuals. Its main duty is to manage the security issue process of its client company. Some of its major activities towards share offering are discussed herewith.

1. Promotional Activities:

A merchant bank works as a promoter of enterprises. It generally helps the entrepreneur in generating thoughts, identifying projects, preparing feasibility reports, manage regulations, etc. Some merchant banks also provide assistance for technical and financial collaborations and joint ventures.

2. Share Issue Management:

On of the main functions of a merchant bank is to manage new public issues of corporate securities of new companies, existing companies (further issues) and even foreign companies in dilution of equity as per Foreign Exchange Regulation Act (FERA). The merchant banks usually acts as sponsor of issues. They act as experts of the type, timing and terms of issues of corporate securities and make them acceptable for the investors and also provide flexibility and freedom to the issuing companies.

3. Syndication:

These merchant banks pool up with other institutions and provide specialized syndicated services in project preparation, loan applications for obtaining short-term and long- term loans from banks and financial institutions, etc. They also manage foreign-issues and provide fund raising from abroad.

4. Share Pricing:

A merchant banker, at the time of IPO plays a vital role in determining the share price that needs to be fixed up by the company. This is done in consultation with the issuing company. The merchant bank track minute records of the bidding process during the offering and find out that price which has got maximum bidding. This price becomes applicable at the time of issuing shares to the investors.

5. Servicing of Issues:

Merchant banks also act as paying agents for the debt- security services and also as registrars or transfer agents. They also maintain the registers of shareholders and debenture holders and arrange to pay dividend or interest due to them.

6. Underwriting of Public Issue:

A merchant banker also provides underwriting facilities. It is a guarantee given by the underwriter (merchant banker) during the share issue process that in case of under-subscription, the amount underwritten or the deficit would be subscribed by the underwriter itself. Merchant banking subsidiaries cannot underwrite more than 15% of any issue.

Other general functions of a merchant bank are as:

1. Portfolio Management:

A merchant bank offer services not only to the companies issuing securities but also to the key investors. They advise their clients, mostly institutional investors, regarding investment decisions. Merchant bankers even undertake the function of purchase and sale of securities for their clients so as to provide them portfolio management services. Some merchant bankers are operating mutual funds and even off shore funds.

2. Leasing and Financing:

Many merchant bankers provide lease and financial services to the clients. They also engage in venture capital funds to help entrepreneurs. They also help to raise finance by way of public deposit.

3. Broker in stock exchange:

Merchant bankers also act as brokers in stock exchanges. They help their investors in buying and selling shares on their behalf. They conduct equity research analysis and advise clients regarding precise share purchase options.

4. Regulations:

For every business step, there are certain legal formalities that has to be followed. Merchant bankers help their clients to adhere such government regulations by doing documentation and other work on their behalf.

5. Revival of Sick Units:

A merchant bank plays a leading role when it comes to reviving sick units. They basically negotiate with banks, institutions and government to plan and execute for revival of such sick companies.

6. Management of Returns:

Merchant banks help their client companies to manage returns like interest and dividends to its investors. They also guide and advise about the rate of dividend and the period of payment.

7. Money Market Operations:

Merchant bankers also deal in short term money market instruments such as commercial papers, treasury bills, certificate of deposits, etc.

Thus, it can be proved that an IPO cannot take place without the help of a merchant banker due to its varying inevitable services. 

Red Herring Prospectus

A Red Herring Prospectus is the first prospectus submitted by a company while going public. Its a document that does not contain details of price nor number of shares that are being offered by the issuing company. It discloses everything clear and concise about the events that has happened or about to happen. It covers all information from the date of incorporation like nature of the business, promoters, projects, business activities, financial details, objects of raising finance, benefits and risks involved, etc.

The Red Herring Prospectus is drafted by a team of legal counsels who are appointed by the merchant bankers or the underwriters. They focus not only into making true disclosures about the company, but also present the draft in a creative and appealing manner. Any kind of mis-statements or false information provided in the prospectus may lead to heavy penalties to be imposed by SEBI. 

Stages of Prospectus

There are three various stages involved while preparing and finalizing a prospectus. All those three stages are discussed below:

1. Draft Red Herring Prospectus:

This prospectus contains all the details of the issuing company except specific details such as price band, issue size and number of shares being offered. This prospectus is given to SEBI and the merchant bankers for 21 days in order to obtain comments and complaints about the company and the prospectus. These comments and complaints are properly dealt with and are updated by the merchant bankers. On a satisfactory note, clearance order is issued by SEBI.

2. Red Herring Prospectus:

It is the next level after Draft Red Herring Prospectus, not containing the exact share price but involving a price band/range for the shares. It is placed with the SEBI after clearing all the comments and complaints. Based on this document, the merchant bankers start promoting the company through advertising and other means.

3. Final Prospectus:

Once the Red Herring Prospectus is made public, it starts getting bids as per the price band and thus, further updating is done. The final prospectus gets updated with share price, number of shares and issue size, thereby making it complete.

Contents featuring a Red Herring Prospectus

A Red Herring Prospectus should contain the following information evidencing to be true and fair:

i.          Company’s purpose and object of issue.

ii.        Disclosure of any agreement.

iii.      Commission payable to Underwriters.

iv.      Preliminary and promotional expenses.

v.        Net Proceeds of the company.

vi.      Statement of Balance Sheet.

vii.    Financial track records of the last 3 years.

viii.  Details like name and address of the company, promoters, officers involved, directors, underwriters, etc.

ix.      Copy of Underwriting Agreement.

x.        Auditor’s Report

xi.      Legal information pertaining to litigations, government approvals and other regulatory and statutory disclosures.

xii.    Main provisions of the Articles of Association.

xiii.  List of documents for inspection.

xiv.  Declaration

Note: All the above information are organized in a standard format