MERCHANT BANKING

CHAPTER 1

Concept of Merchant Banking

The dictionary meaning of merchant bank refers to an organization that underwrites

corporate securities and advises such clients on issues like corporate mergers, etc.
involved in the ownership of commercial ventures. This organization may be a bank,
corporate body, firm or proprietary concern.

The Securities and Exchange Board of India has defined merchant banks as “ any
person who is engaged in the business of issue management either by making
arrangements regarding selling, buying or subscribing to securities as manager,
consultant, advisor or rendering corporate advisory service in relation to such issue
management”.

In Indian context this definition suits well. Merchant banking in India started with the
management of public issues and loan syndication and has been slowly and gradually
covering activities like project counselling, portfolio management, investment
counselling and mergers and amalgamation of the corporate firms. Although,
merchant banking organizations present a long list of services they contemplate to
render to their clients but the main services so far being rendered by them are those as
authorized by the SEBI.

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MERCHANT BANKING

CHAPTER 2

History of Merchant Banking

Origin of merchant banking

The origin of merchant banking can be traced back to the 13 th century when the
development of international trade and finance took place. The early merchant
bankers were traders of commodities. These bankers also acted as bankers to the kings
of European States and financed continental wars and coastal trades. The earlier
merchant bankers used to lend their name to the lesser known traders by accepting
bills through which they guaranteed that the holder of the bill would receive full value
on the date of payment. Hence the name merchant was used because of its roots in
merchant trade.

The growth of merchant banking in India

Formal merchant activity in India was originated in 1969 with the merchant banking
division setup by the Grindlays Bank, the largest foreign bank in the country. The
main service offered at that time to the corporate enterprises by the merchant banks
included the management of public issues and some aspects of financial consultancy.
Following Grindlays Bank, Citibank set up its merchant banking division in 1970.The
division took up the task of assisting new entrepreneurs and existing units in the
evaluation of new projects and raising funds through borrowing and equity issues.
Management consultancy services were also offered. Merchant bankers are permitted
to carry on activities of primary dealers in government securities. Consequent to the
recommendations of Banking Commission in 1972, that Indian banks should offer
merchant banking services as part of the multiple services they could provide their
clients, State Bank of India started the Merchant Banking Division in 1972. In the
initial years the SBI’s objective was to render corporate advice and assistance to small
and medium entrepreneurs.

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MERCHANT BANKING

CHAPTER 3

Importance & Need and of Merchant Bankers

Important reason for the growth of merchant banking has been developmental activity
throughout the country, exerting excess demand on the sources of funds for ever
expanding industry and trade, thus, leaving a widening gap unbridged between the
supply and demand of inventible funds. All Indian financial institutions and
experienced resources constraint to meet the ever increasing demands for funds from
the corporate sector enterprises. In the circumstances corporate sector had the only
alternative to avail of the capital market services for meeting their long-term financial
requirements through capital issues of equity and debentures. With the growing
demand for funds there was pressure on capital market that enthused the commercial
banks, share brokers and financial consultant firms to enter into the field of merchant
banking and share the growing capital markets. With the result, all the commercial
banks in nationalized and public sector as well as in private sector including the
foreign banks in India have opened their merchant banking windows and are
competing in this field. There has been a mushroom growth of financial consultancy
firms and broker firms doing advisory functions as well as managing public issues in
syndication with other merchant bankers.

Notwithstanding the above facts, the need of merchant banking institutions is felt in
the wake of huge public savings lying still untapped. Merchant banks can play highly
significant role in mobilizing funds of savers to investible channels assuring
promising return on investments and thus can help in meeting the widening demand
for investible funds for economic activity. With the growth of merchant banking
profession corporate enterprises in both public and private sectors would be able to
raise required amount of funds annually from the capital market to meet the growing
requirements for funds for establishing new enterprises, undertaking
expansion/modernization/diversification of the existing enterprises. This reinforces
the need for a vigorous role to be played by merchant banks.

Merchant banks have been procuring impressive support from capital market for the
corporate sector for financing their projects. This is evidenced from the increasing
amount raised form the capital market by the corporate enterprises year after year.

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MERCHANT BANKING

In view of multitude of enactments, rules and regulations, guidelines and offshoot

press release instructions brought out by the government from time to time imposing
statutory obligations upon the corporate sector to comply with all those requirements
prescribed therein, the need of skilled agency existed which could provide counseling
in these matters in a package form. Merchant bankers, with their skills, updated
information and knowledge, provide this service to the corporate units and advise
them on such requirements to be complied with for raising funds from the capital
market under different enactments viz. Companies Act, Income-tax Act, Foreign
Exchange Regulation Act, Securities Contracts (Regulation) Act and various other
corporate laws and regulations.

Merchant bankers advise the investors of the incentives available in the form of tax
reliefs, other statutory relaxations, good return on investment and capital appreciation
in such investment to motivate them to invest their savings in securities of the
corporate sector. Thus, the merchant bankers help the industry and trade to raise funds
and the investors to invest their saved money in sound and healthy concerns with
confidence, safety and expectation for higher yields.

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MERCHANT BANKING

CHAPTER 4

Organizational Setup of Merchant Bankers in India

(A) Institutional Base

Where merchant banks function as an independent wing or as subsidiary of

various private/Central Governments/State Governments financial institutions.
Most of the financial institutions in India are in public sector and therefore such
setup plays a role on the lines of government priorities and policies.

(B) Banker Base

These merchant bankers function as division/subsidiary of banking organization.

The parent banks are either nationalized commercial bank or the foreign banks
operating in India. These organizations have brought professionalism in merchant
banking sector and they help their parent organization to make a presence in
capital market.

(C) Broker Base

In the recent past there has been an inflow of qualified and professionally skilled
brokers in various stock exchanges of India. These brokers undertake merchant
banking related operations also like providing investment and portfolio
management services.

(D) Private Base

These merchant banking firms are originated in private sector. These

organizations are the outcome of opportunities and scope in merchant banking
business and they are providing skill-oriented specialized services to their clients.
Some foreign merchant bankers are also entering either independently or through
some collaboration with their Indian counterparts.

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MERCHANT BANKING

CHAPTER 5

Qualities of Good Merchant Bankers

Merchant bankers are individual experts who organize and manage the merchant
banks. The operations of merchant banks are, therefore, influenced by the
personality trait of these individuals. For the success of merchant banks’
operations, the qualities which merchant bankers should have are discussed
below:-

1. Leadership – Merchant banker should posses all relevant skills, updated

knowledge to interact with the clients and effectively communicate.
Leadership is synonymous with followers who follow the one who leads.

2. Aggressive action – Aggressiveness is a personality trait of a good leader

but in merchant banking it has a wider connotation. Aggressive merchant
bankers are always looking for new business. Once a business opportunity
has been located, the merchant banker has got to obtain the mandate for
the merchant banking assignment from the clients at once which will
depend upon his own communication skills, persuasiveness and the
background of the organization to which he belongs. A good merchant
banker is one who does not allow his client to think anything outside
except what has been advised.

3. Co-operation and friendliness – No doubt, these two characteristics are

the symbols of good leadership but it hardly needs to be stressed that
cooperation and friendliness coupled with persuasiveness are the main
instruments with which a merchant banker mixes with the people, gathers
information, obtains business mandate and renders satisfactory services to
the clients. Business of an honest merchant banker spreads with
geometrical propagation when he shares the thoughts of his clients with
sympathetic gestures and offers pragmatic suggestions without greed or

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MERCHANT BANKING

favours. Very often, rude, intemperate and indifferent disposition or blunt

out burst withdraw fortunate business opportunities forever. These are the
vices unbecoming of a merchant banker and should be eschewed.
Friendliness and cooperation must flow as natural traits in the merchant
banker to win over the trust of the clients like a doctor or lawyer who
retain their clients permanently.

4. Contacts – Success of a merchant banker depends upon his sociable

nature and the richness of wider contacts. A merchant banker is supposed
to be acquainted deeply with all the constituents of merchant banking. The
scope of contact encompasses intimate contiguity and acquaintances
within his own organization, Central and State Government Offices where
compliances under various relevant enactments are to be reported, Indian
and foreign banks, financial institutions at Central and State levels,
promoters/directors/owners and chief executives of the private and public
enterprises which would be prospective beneficiaries of merchant banking
services, printers, advertising agencies, brokers and stock exchange
dealers, advocates and solicitors and members of the press whose services
are availed of in executing merchant banking assignments.

5. Attitude towards problem solving – The most important personality trait

of a merchant banker is his attitude towards problem solving. Every client
coming to him has got to return fully satisfied having consulted a
merchant banker. Positive approach to understand the view point of others,
their difficulties and their adverse circumstances is possible only when a
person is skilled in human relations particularly the inter-personal and
intra-personal behaviour. Effective communication and proper feedback
are the pre-requisites for creating a positive attitude towards problem
solving which could be gains partly through learning process and partly as
an in-born quality.

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MERCHANT BANKING

CHAPTER 6

Requirements for Setting up a Merchant Banking Outfit

1. Formation of the Business Organisation

SEBI act, 1992 does not prescribe any specific form of business organization
to carry on the activities as merchant banker. However, the types of
organizations are listed below:

a) Sole proprietorship
b) Partnership firm
c) Hindu Undivided Family (HUF)
d) Corporate Enterprises
e) Co-operative Society

Generally it is preferred that the Merchant Banking outfit be a registered

company. Merchant Banks are generally setup as subsidiary companies of banks
(Public or Private). For example, SBI caps, ICICI Securities etc.

2. Adoption of a viable business plan

All the basic tests required to find out whether the business to be undertaken is
viable or not are also applicable to a Merchant Banking setup. Capital
adequacy, profitability, growth opportunities and current market size are some
of the factors which need to be looked into.

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MERCHANT BANKING

3. Registration of Merchant Bankers

a) Application for grant of certificate

An application for grant of a certificate needs to be made to SEBI .

The application can be made for any one of the following categories of the
merchant banker namely:-

 Category I, that is –

(i) to carry on any activity of the issue management, which will inter-alia
consist of preparation of prospectus and other information relating to the
issue, determining financial structure, tie-up of financiers and final allotment
and refund of the subscription; and

(ii) to act as adviser, consultant, manager, underwriter, portfolio manager.

 Category II, that is, to act as adviser, consultant, co- manager, underwriter,
portfolio manager;

 Category III, that is to act as underwriter, adviser, consultant to an issue;

 Category IV, that is to act only as adviser or consultant to an issue.

To carry on the activity as underwriter or portfolio manager a separate certificate

of registration needs to be obtained from SEBI.

b) Application to conform to the requirements

The application should conform to all the requirements under the SEBI
guidelines, otherwise it may be rejected.

c) Furnishing of information, clarification and personal representation

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MERCHANT BANKING

The Board may require the applicant to furnish further information or clarification
regarding matters relevant to the activity of a merchant banker for the purpose of
disposal of the application. The applicant or its principal officer may appear
before the Board for personal representation.

d) Consideration of application

The Board shall take into account for considering the grant of a certificate, all
matters, which are relevant to the activities relating to merchant banker and in
particular the applicant complies with the following requirements, namely: -

 the applicant shall be a body corporate other than a non- banking financial
company

 the merchant banker who has been granted registration by the Reserve
Bank of India to act as a Primary or Satellite dealer may carry on such
activity subject to the condition that it shall not accept or hold public
deposit

 the applicant has the necessary infrastructure like adequate office space,
equipments, and manpower to effectively discharge his activities

 the applicant has in his employment minimum of two persons who have
the experience to conduct the business of the merchant banker

 a person directly or indirectly connected with the applicant has not been
granted registration by the Board;

 the applicant fulfils the capital adequacy requirement is as follows:

The capital adequacy requirement should not be less than the net worth of the
person making the application for grant of registration. The networth shall be
as follows,

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MERCHANT BANKING

Category Minimum Amount

Category I Rs. 5, 00, 00, 000

Category II Rs. 50, 00, 000

Category III Rs. 20, 00, 000

Category IV Nil

 the applicant, his partner, director or principal officer is not involved in

any litigation connected with the securities market which has an adverse
bearing on the business of the applicant and have not at any time been
convicted for any offence involving moral turpitude or has been found
guilty of any economic offence
 the applicant has the professional qualification from an institution
recognised by the Government in finance, law or business management
 grant of certificate to the applicant is in the interest of investors.

e) Procedure for Registration

The Board on being satisfied that the applicant is eligible shall grant a certificate.
On the grant of a certificate the applicant shall be liable to pay the fees as
prescribed.

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MERCHANT BANKING

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.

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.

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MERCHANT BANKING

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

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MERCHANT BANKING

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.

a) 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.

b) 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.

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MERCHANT BANKING

Advantages

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

a) 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;

b) 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;

c) Broad-based company attracts income tax exemptions under the

Income-tax Act.

d) 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.

e) 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:-

a) Creation of public market for the securities provides liquidity,

transferability and opportunities and diversification of investment.

b) Thus, investors can plan to avoid risk faced in a close held company

c) Opportunity to share in the growth of the company by getting bonus

shares, rights shares, making capital gains in shares, etc.

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MERCHANT BANKING

Disadvantages

The main disadvantages of going public are as under:-

a) 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.

b) Pressure dividend distribution involve a drain on working capital funds

of the company

c) Non-payment of dividend tarnish the public image of the company

d) 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.

e) 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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MERCHANT BANKING

(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:

I. Steps to be taken by the issuing company.

II. 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.

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MERCHANT BANKING

(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.

(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:

Size of the public issue Number of Lead Merchant Bankers

(Rs. in crores)

Less than Rs.50 crores Two

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MERCHANT BANKING

Rs.50 crores but less than Rs100 Three

crores

Rs.100 crores but less than Rs.200 Four

crores

Rs.200 crores but less than Rs.400 Five

crores

Rs.400 crores and above Five or more as may be agreed by the

SEBI

(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:

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MERCHANT BANKING

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:

a) Fresh issue of capital to public: equity shares and preference

shares.

b) Rights issue/public issue by existing listed companies.

c) Bonus issue.

d) Debenture issue.

e) Public sector bonds.

f) 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:

a) Appointment of underwriters to the issue.

b) Appointing brokers for selling the issue.

c) Appointment of bankers to the issue.

d) Appointment of registrars to the issue.

e) Appointment of printers.

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MERCHANT BANKING

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:

a) Auditors of the company.

b) Solicitors/Advocate as legal advisors to the public issue/issue

of prospectus.

c) 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:

a) Legal advisor.

b) Auditors.

c) Co-managers to the issue.

d) Institutional underwriters.

e) SEBI clearance to prospectus.

f) Approval of stock exchanges to the draft prospectus.

8. Action to be taken by the company

a) Board of directors meetings.

b) Making application to stock exchanges for permission.

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MERCHANT BANKING

c) Filing prospectus with Registrar of Companies.

d) Forwarding copy of the prospectus to SEBI.

e) 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.

a) Advertisements.

b) Wirte-ups/reportings about the company/its promoters in

economic journals.

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MERCHANT BANKING

c) 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

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MERCHANT BANKING

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: -

Communication Module

Managers to the The Issuing

issue Company

Registrars to the
Issue

Controlling Controlling Controlling

Branch Bank A Branch Bank B Branch Bank C

Bank A Bank B Bank C

Collection Centres Collection Centres Collection Centres

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MERCHANT BANKING

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

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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

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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.

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: -

i. 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.

ii. 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.

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iii. Report on the basis of allotment.

iv. 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

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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.

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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.

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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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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.

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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MERCHANT BANKING

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.

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MERCHANT BANKING

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.

1. All India Financial Institutions:

i. Industrial Finance Corporation of India (IFCI)

ii. Industrial Development Bank of India (IDBI)

iii. Industrial Credit and Investment Corporation of India Ltd. (ICICI)

iv. Industrial Reconstruction Bank of India (IRBI)

v. Shipping Credit and Investment Company of India Ltd. (SCICI Ltd.)

2. State Level Financial Bodies:

i. State Financial Corporations (SFCs)

ii. State Industrial Development Corporations (SIDCs)

iii. State Industrial and Investment Corporations (SIICs)

iv. 3. All India Level Investment Institutions:

i. Life Insurance Corporation of India (LIC)

ii. Unit Trust of India (UTI)

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MERCHANT BANKING

iii. 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

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

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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.

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.

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MERCHANT BANKING

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:

i. Collect qualitative and quantitative data available in each area of

objectives.

ii. Analyse the data using statistical tools and predict reliable results and
values.

iii. Compare the results and values in contemporary set up.

iv. Choose the best alternative.

v. 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:

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MERCHANT BANKING

i. Technical know-how and other requirements.

ii. Plant and equipment.

iii. Manpower requirements for both skilled and non-skilled.

iv. Financial requirements.

v. 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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MERCHANT BANKING

i. Plant size and location.

ii. Project engineering aspect.

iii. The market.

iv. Organization and management.

v. 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:

i. Product

ii. Capacity

iii. Technical process

iv. Schedule of implementation

v. Cost of the project

vi. 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

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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:

Means of financing the project cost:

(1) Share capital (owners funds)

 Equity/Preferences shares

 Indian promoters

 Foreign collaboration

 State agency

 Non-resident Indians

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MERCHANT BANKING

(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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MERCHANT BANKING

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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MERCHANT BANKING

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

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MERCHANT BANKING

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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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..

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MERCHANT BANKING

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:

i. Fiscal, financial and monetary policies of the Central Government or

Reserve Bank of India.

ii. 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:-

i. 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;

ii. Analysis of securities market trend be done on a continuous basis.

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MERCHANT BANKING

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

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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:

a) Agreement with the persons holding major interest in the company

management like members of the board or major shareholders
commanding majority of voting power.

b) Purchase of shares in open market.

c) Takeover offer to the general body of shareholders.

d) Purchase of new shares by private treaty.

e) 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.

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MERCHANT BANKING

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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MERCHANT BANKING

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,

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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:

a) 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.

b) 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:

a) For cash transactions, the format of contents of the certificate or letters to

be signed by the acquiring company and the target company.

b) 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.

c) Settlement documents for retrenchment or unemployment compensation.

d) Documents for transfer of deposits from target company’s account to

buyer’s account.

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e) 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:

a) Acquisition (for cash) of the shares or assets of one company by the other.

b) Acquisition (in exchange for shares or other securities in the acquiring

company) of shares or assets of one company by another.

c) Acquisition of undertaking or shares of both companies by a new

company in exchange for shares or other securities.

d) 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.

a) Audited accounts for 5 years and current year.

b) Cash flow and ratio analysis for 5 years with projections for 5
years.

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c) Recent valuation report on land, building, plant and machinery,

leases, stocks, etc.

d) 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.

e) Budgeted accounts and management accounts for past 5 years

covering current year with comments of management.

f) Departmental analysis for past 5 years commenting on staff,

workload, output, suggested changes.

g) Production costs for current year and projection for 5 years.

6. Production

a) Different products and techniques of production.

b) Plant location, deficiency of labour on plant.

c) Total number of companies in industry and the position of the

target company in the industry – production-wise.

d) Product research or technological obsolescence.

7. Sales

a) Product performance in the market vis-à-vis competition or market share.

b) Image of the company.

c) 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.

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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.

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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

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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.

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MERCHANT BANKING

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.

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 .

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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:

a) Buyer negotiates terms of purchasing plant and machinery or other

material with the seller.

b) Buyer receives delivery of goods with invoice and instructions by the

seller to make payment to the factor on due dates.

c) 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:

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a) Memorandum of understanding with the buyer in the form of letter

exchanged between them or agreement entered into between them.

b) Sells goods to the buyer as per memorandum of understanding.

c) Delivers copies of invoice, delivery challan, memorandum of

understanding, instructions to make payment to factor given to buyer.

d) Seller receives 80% or more payment in advance from factor on selling the
receivables from the buyer to him.

e) Seller receives balance payment from factor after deduction of factor’s

service charges, etc.

f) (3) The factor:

a) The factor enters into agreement with seller for rendering factor services
to it.

b) 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.

c) The factor receives payment from the buyer on due dates and remits the
money to seller after usual deductions.

d) The factor also ensures that the following conditions should be met to give
full effect to the factoring arrangements:

i. 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.

ii. The seller should confirm in writing to factor that all the payments
arising out of these bills are free from any encumberances, charge, lien,

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pledge, hypothecation or mortgage or right of set-off or counter-claim

from another etc.

iii. 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.

iv. 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.

v. 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.

Mechanics of Factoring

Places order
Seller
Buyer
Delivery of
Goods &
Invoice with
Prepayment Notice to pay
Factor Payment

Balance
amount Follow-up if
unpaid by
Fixation of Copy of due date
Customer Invoice
Limit
Monthly
Statements
Factor

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MERCHANT BANKING

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.

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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.

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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.

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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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Conclusion

Merchant bank is difficult to define. The function of merchant bankers varies

from country to country. Merchant bankers are also known as “Accepting and
Issuing houses” in UK and as “Investing Banks” in USA.

In India merchant banker are allowed to undertake only those activities which
related to securities market including issue management activities and are
prohibited from carrying on fund based activities other than those related
exclusively to the capital market. This reduces the scope of merchant banks in
India.

Inspite of problems popping up, merchant banking in India has vast scope to
develop because of lot of domestic as well as foreign businesses booming here.
Indian economy provides an amicable environment for these firms to set up,
flourish and expand here.

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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:

 www.sbicaps.com

 www.google.com

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