Satinder KaurFaculty in Managementsatinder@ibusinessinstitute.org

Primary MarketPrimary market is a market for new issues or new financial claims. Hence, it is also called New Issue Market.

The primary market deals with those securities which are issued to the public for the first time. In the primary market, borrowers exchange new financial securities for long term funds. Thus, primary market facilitates capital formation.

Primary MarketThere are three ways by which a company may raise capital

in a primary market. They are:

(i) Public issue(ii) Rights issue(iii) Private placement

The most common method of raising capital by new companies is through sale of securities to the public. It is called public issue.

When an existing company wants to raise additional capital, securities are first offered to the existing shareholders on a pre-emptive basis. It is called rights issue.

Private placement is a way of selling securities privately to a small group of investors.

SEBI Guidelines pertaining to Capital Issue Activities

In order to remove inadequacies and systematic deficiencies, protect the interests of investors for the orderly growth and development of the securities market,

the SEBI has put in place guidelines as ground rules relating to new issue procedures/activities. These are in addition to the company law requirements in relation to issues of capital/securities.

They are applicable to :

(i) Public issues and offers for sale by listed/unlisted companies(ii) Rights issue by listed companies, except in cases where the aggregate value of securities, including premium, is less than Rs. 50 lac

ELIGIBILITY NORMS The companies issuing securities (capital) through offer document, that is

(i) Prospectus or offer for sale in the case of public issue

(ii) letter of offer in case of a rights issue

Filing of Offer Document In case of public issue of securities by any company as well as

any type of securities by a listed company through a rights issue in excess of Rs. 50 lac, a draft prospectus should be filed with the SEBI through an eligible registered merchant banker, at least 21 days prior to filing it with the Registrar of Companies (RoCs).

In case of rights issues of less than Rs. 50 lac, the company should prepare the letter of offer in accordance with the disclosure requirements and file the same with the SEBI for its information and for being put on the SEBI website.

OFFER DOCUMENTS Offer document mean prospectus in case of a

public issue or offer for sale and letter of offer in case of a right issue which filed with the Registrar of companies (ROC) and Stock Exchange.

An offer document covers all the relevant information to help investor to make investment decision.

ProspectusA company issuing shares to public must issue a 'prospectus'. The

prospectus is an 'invitation to offer'. It is an invitation to the public to take shares or debentures in the company or deposit money in the company.

Section 2(36) of the Companies Act, 1956 defines prospectus means "any document described or issued as a prospectus and includes any notice, circular advertisement or other document inviting deposits from the public or inviting offers from the public for the subscription or purchase of any shares in, or debentures of a body corporate. “

Prospectus includes information regarding the size of issue, the current statues of company, its equity capital, its current and past performance, the promoters, project, cost of project, product etc. it also contain lot of mandatory information regarding underwriting and statuary compliances. This help investor to evaluate short term and long term prospectus of company. It also provides a guide to future prospectus as per view of company management.

Abridged Prospectus Section 2 (1) of the Companies Act, 1956

defines abridged prospectus means 'a memorandum containing such salient features of a prospectus as may be prescribed. It contains all the salient features of a prospectus. A company cannot supply application forms for shares or debentures unless the form is accompanied by abridged prospectus.

Red-Herring Prospectus A prospectus is said to be a red-herring prospectus which contains all

information as per prospectus contents but does not have information on price of securities offered and number of securities (quantum) offered through such document. Thus, a red-herring prospectus lacks price and quantity of the securities offered. This is used in book building issues only.

In the case of book built issues, it is a process of price discovery and the price cannot be determined until bidding process is completed. Hence, such details are not shown in Red-herring prospectus filed with RoC in terms of the provisions of the Companies Act.

Only on completion of the bidding process, the details of the final prices are included in the offer document. The offer document filed thereafter with RoC is called a 'prospectus'.

PUBLIC ISSUESThe eligibility norms for issue of equity shares

and convertible securities relate to (1) unlisted companies (2) listed companies

Initial Public Offerings (IPO’s) by Unlisted Companies

An unlisted company can make an IPO only if it meets all the following conditions:

1. It has net tangible assets (i.e. total net assets, excluding intangible assets) of at least Rs. 3 crore in each of the preceding 3 full years (of 12 months each) of which not more than 50 per cent should be in monetary assets

2. It has a track record of distributable profits in terms of Section 205 of the Companies Act for at least 3 out of the immediately 5 years; extraordinary items should not be considered to compute the distributable profits.

3. It has a net worth i.e. the aggregate value of paid-up equity capital and free reserves (excluding revaluation reserve) minus the aggregate value of accumulated losses and deferred expenditure not written off (including miscellaneous expenses not written off) as per the audited balance sheet of at least Rs.1 crore in each of the preceding 3 full years (of 12 months each).

4. In case of change of its name within the last one year, at least 50 per cent of the revenue for the preceding one full year is earned by the company from the activity suggested by the new name

5. The aggregate of the proposed issue and all previous issues made in the same financial year in terms of size (i.e. offer through offer document plus firm allotment and promoters contribution through the offer document) does not exceed 5 times its pre-issue net worth as per the audited balance sheet of the last financial year.

(IPO’s) by Unlisted Companies………cont… If an unlisted company does not comply with any of the five conditions

specified above, it may make an IPO only if it satisfies both the following conditions :

(1) The issue is made through the book-building process with at least 60 per cent of the issue size being allotted to the Qualified Institutional Buyers (QIBs) failing which the full subscription would be refunded; or the project has at least 15 per cent participation by banks/financial institutions. In addition, at least 10 per cent of the issue size should be allotted to the QIBs failing which the full subscription should be refunded

(2) The minimum post-issue issue face value of capital of the company would be Rs. 10 crore or there would be a compulsory market-making for at least 2 years from the date of listing of the shares subject to the following

An unlisted company satisfying above conditions outlined can allot equity

shares only if the number of the prospective allottees is not less than 1,000.

Market MakerMarket maker is the person who undertake to Offer buy and sell quotes for a minimum

depth of 300 share And ensure that bid and ask spread for their

quotes not exceed 10 per cent at any time.

Public Issue By Listed Companies All listed companies are eligible to make public issue of equity

shares on the condition that the issue size in terms of the aggregate of the proposed issue and all previous issues made in the same financial year (i.e. offer through offer document plus firm allotment plus promoters' contribution through the offer document) does not exceed 5 times its pre-issue net worth as per the audited balance sheet of the last financial year.

In case of a change in the name of the issuer company within the last one year (reckoned from the date of filing of the offer document), the revenue accounted for by the activity suggested by the new name should not be less than 50 per cent of its total revenue in the preceding one full year.

A listed company which does not fulfill the above conditions, would be eligible to make a public issue through book-building process with the same conditions as are applicable to unlisted companies

Exemptions The eligibility norms specified above for IPO’s

are not applicable in the following cases Private/public sector banksInfrastructure companies, wholly engaged in

the business of developing, maintaining and operating infrastructure

Rights issue by a listed company.

Right Issue If an existing company intends to raise additional funds, it

can do so by borrowing or by issuing new shares. One of the most common methods for a public company to use is to offer existing shareholders the opportunity to subscribe further shares. This mode of rising finance is called rights issues'.

The existing shareholders have right to entitlement of further shares in proportion to their existing shareholding. A shareholder who does not want to buy the rights shares, his right of entitlement can be sold to someone else. The price of rights shares is generally fixed above the nominal value but below the market price of the shares. The issue of quoted shares at below the nominal value is not allowed, and it would be rare for this to happen for unquoted shares. Section 81 of the Companies Act provides for the further issue of shares to be first offered to the existing members of the company, such shares are known as 'Rights shares' and the right of the members to be so offered is called the right of pre-emption'.

Reasons for a Right Issue 'In times of inflation, the replacement costs of assets will be

high, unless the company can retain cash from substantial profits; the only alternative is to raise cash from a fresh issue of shares.

For funding expansion projects, a company may make rights issue.

If a company has a proportion of interest bearing loan capital, the company can suffer from a squeeze on profits. The company can improve the capital structure position by obtaining extra share capital.

At a time when the share prices were relatively high, companies found it easy to persuade their shareholders to subscribe cash for new issues with a view to expansion by takeover.

Advantages of Rights Issue To Companies : The company benefits from lower issue

costs, in that administration and underwriting costs are lower and the issue is made at the direction of the directors rather than via a general meeting of the company. This is because issue of equity through the stock exchange will alter the balance of ownership.

To the Shareholders: The main attraction of the rights issue for current shareholders is that they are able to maintain their original proportion of share ownership. Furthermore, any transfer of wealth away from them due to an equity issue being under priced, is avoided.

Pricing of Rights The rights issue has to be priced in a way to make it attractive

to existing shareholders and it must, therefore, be priced below the current market price for the shares. However, the price must not be set too low, due to the adverse effects on earnings per share. Thus in calculating the number of shares to issue to raise a given sum, account is taken of the resulting reduction of earnings per share at various issue prices. In practice, the most common pricing mechanism is to apply a discount of 15-20 per cent to the current market price.

When a rights issue is announced, all existing shareholders have the right to subscribe for new shares, and so there are rights attached to the existing shares. The shares are therefore described as being 'cum-rights’ (with rights attached) and are traded cum rights. On the first day of dealings in the newly issued shares, the rights no longer exist and the old shares are now 'ex-rights' (without rights attached).

After the issue has actually been made, the market price per share will normally fall, because there are more shares in issue and the new shares were issued at a discount price.

PRIVATE PLACEMENT In the primary capital market corporate can raise resources through public

issues and rights issues and 'private placement'. While public issues involve allotting securities to the general public, rights issues entail allotment of securities to the shareholders.

Private placement, in contrast, refers to direct sale of newly issued securities by the issuer to a small number of investors. Private placement of issues is arranged through merchant bankers, with the issuer entering into an arrangement regarding the various features of the issue being privately placed with the selected clients, which are financial institutions, corporates and high net-worth individuals.

The time taken as well as the cost of issue for the private placement route is much less for the issuer as compared with a public issue. Thus the private placement is a cost and time effective way of raising funds for the corporates. The privately placed issues offer greater flexibility to the issuers as the instruments can be structured according to the needs of the entrepreneurs. Moreover, private placement does not require detailed compliance of formalities as required in public or rights issues.

Private placement market in IndiaThe private placement market is subject to some regulations

rather than the other developed markets. In sharp contrast to this, the private placements in India are not bound by any regulatory system.

Information relating to various details of private placement is contained in "Memorandum of Information" and deals are struck through negotiations between the ultimate borrowers and lenders. In the case of equity issues, companies are free to fix the quantum of private placement and only follow the rule of pricing for preferential allotment as stipulated by SEBI.

Such private placements have no lock-in-period excepting those in favour of promoters. There is no compliance system for merchant bankers in private placement as in the case of public issues. In view of this, the private placement has become a favoured route for corporates and financial institutions in India for mobilising resources during the last few years

Qualified institutional placementSecurities issued by company by this way have to issue

securities only to QIB on a discretionary basis, with just 10% reservation for mutual fund.

This route is available only to listed company whose equity share of same class listed on any nationwide stock exchange, the issuer will have compliance with the prescribed minimum public shareholding requirement of the exchange.

Securities allotted under this regime shall not to any lock in period, however for a period of one year, they may only be traded on the floor of stock exchange in bulk or block transaction. So off-market deal are possible only after one year.

PRICING OF ISSUESA listed /unlisted company can freely price shares

through a public/rights issue. There is no price formula stipulated by SEBI.

However the company required to give full disclosure of the parameters which they considered while deciding the price.

There are two type of issue , one where company fix a fixed priced and other is where company stipulate a floor price and price band and leave to market force to determine the final price of issue. Called Book-Building process.

Book BuildingBook-building means a process by which a

demand for the securities proposed to be issued by a body corporate is elicited and built up and the price for such securities is assessed for the determination of the quantum of such securities to be issued by means of a Notice /circular / advertisement / document or information memoranda or offer document.

A company proposing to issue capital through book-building has to comply with the requirements issued by SEBI

100% BOOK BUILDING PROCESS Reservation or firm allotment to the extent of the percentage

specified in the relevant SEBI guidelines can be made only to promoters, permanent employees of the issuer company

The cap of the price band should not exceed 20 per cent of the floor.

The price band can be revised during the bidding period. The maximum revision on either side should not exceed 20 per cent. In other words, floor price of the band can move up or down to the extent of 20 per cent of floor of the price band disclosed and the cap of the revised price should be fixed

100% BOOK BUILDING PROCESS Any revision in the price band should be widely

disseminated by informing the stock exchanges, issuing press releases and indicating the change on the relevant website and the terminals of the syndicate members.

The bidding period should be extended by 3 days subject to a maximum of bidding period of 13 days.

The manner in which the short fall in the project financing resulting from lowering of price band to the extent of 20 per cent would be met should be disclosed. It should also be disclosed that allotment would not be made unless the financing is tied up.

Difference between book building and fixed price processIn fixed price the price is well known in

advance to investor and in book building process it is known only after closure of the issue.

In case of book building demand can be known everyday but in case of fix price it known at the close of the issue.

GREEN SHOE OPTION A company making an initial public offer of equity shares

though the book building mechanism can avail of the green shoe option (GSO) for Mobilising the post-listing price of its shares.

The GSO means an option of allocating shares in excess of the shares included in the public issue and operating a post-listing price stabilising mechanism through a stabilizing agent (SA).

The concerned issuing company should seek authorisation for the possibility of allotment of further issues to the SA at the end of the stabilisation period together with the authorisation for the public issue in the general meeting of its shareholders. It should appoint one of the lead book runners as the SA who would be responsible for the price stabilisation process.

Differential Pricing Listed/unlisted companies may issue securities to

applicants in the firm allotment category (i.e. allotment on a firm basis made to Indian and multilateral development finance institutions, Indian mutual funds, foreign institutional investors including non resident Indians/ overseas corporate bodies and permanent/regular employees of the issuing company) at a price different from the price at which the net offer to the public is made, provided the price at which the security is offered to the applicants in firm allotment category is higher than the price at which securities are offered to the public.

Promoter contributionPromoter should contribute at least 20% of post

issue capital.Promoter should bring in the full amount of their

contribution, including premium, at least one day before the public issue open date and should be kept in escrow account with a bank. However where promoter contribution already been deployed by company should disclosed in offer document where such fund used by cash flow statement.

Lock in RequirementThe minimum promoter contribution would

be locked in for a period of three years.The excess contribution by promoter from

minimum requirement would be locked for one year.

ISSUE ADVERTISEMENT The term advertisement is defined to include

notices, brochures, pamphlets, circulars, show cards, catalogues, hoardings, placards, posters, insertions in newspapers, pictures, films, cover pages of offer documents, or any other print medium, radio, television programmes through any electronic medium. The lead merchant banker should ensure compliance with the guidelines on issue advertisement by the issuing companies

Important Features of Issue Advertisement It should be truthful, fair and clear and should not contain

any statement that is untrue/misleading.

It should reproduce information contained in an offer document in full and disclose all relevant facts, and not be restricted to select extracts relating to that item.

It should be set forth in a clear, concise and understandable language

It should not contain statements that promise or guarantee rapid increase in profits

No models, celebrities, fictional characters, landmarks, or the like should be displayed on or form part of the offer documents or issue advertisements.

Important Features of Issue AdvertisementNo slogans, expletives or non-factual and unsubstantiated titles should

appear in the issue advertisements or offer documents.

If any advertisement carries any financial data, it should also contain data for the past three years and include particulars relating to sales, gross profit, net profit, share capital, reserves, earnings per share, dividends and the book values.

(a) All issue advertisements in newspapers, magazines, brochures, pamphlets containing highlights relating to any issue should also contain risk factors given equal importance in all respects, including the print size, (b) the print size of highlights and risk factors in issue advertisements should not be less than point seven size

No incentive, apart from the permissible underwriting commission and brokerage, should be offered through any advertisement to anyone associated with marketing the issue.

BOUGHT OUT DEAL (BOD) BOD is a process of investment by a sponsor or a syndicate of

investors/sponsors directly in a company.

Such direct investment is being made with an understanding between the company and the sponsor to go for public offering in a mutually agreed time. Bought out deal, as the very name suggests is a type of wholesale of equities by a company.

A company allots shares in full or in lots to a sponsors at a price negotiated between the company and the sponsor(s). After a particular period of agreed upon between the sponsor and the company the shares are issued to the public by the sponsor with a premium.

The holding cost of such shares by the sponsor may either be reimbursed by the company or the sponsor may absorb the profit in part or full as per the agreement, arising out of the public offering at a premium. After the public offering the shares are listed in one or more stock exchanges.

Advantages of BODThe company has the advantage of using the fund immediately without

waiting as in the case of direct public issue. In case of BOD the company instantly gets funds and is able to focus its attention on project implementation without worrying for source of investment. Bought out deals are ideally suited in circumstances when money needs to be arranged fast without which the project may suffer. Lowering or eliminating issue cost from the preliminary expenses is another advantage to the company.

The time taken to raise money in the capital market by a company takes as much as six months and this time is very high for a company in an infancy stage. The waste of time in the initial stage can be avoided by going for BOD.

In case of a new and untried product it is easier to convince an investment banker for an investment in the company rather than the general public. Hence BOD is an innovative method of financing for such companies.

Advantages of BODWhen the market sentiment is low and the secondary market is

undergoing a bear phase, a company may not like to come to the market with a public issue. In such case BOD is a superior process to get fund for the company.

The merchant bankers also gain handsomely from a BOD. The merchant bankers expect a return of around 30 per cent from a BOD whereas private financing institutions expect a return of 40 per cent to 60 per cent from a BOD. The gain can be tremendous provided the sponsors select proper issues and price it attractively to the investors.

The investors also gain from the BOD in a way that they get good issues where some merchant banker has already invested in it. The common investors do not have enough scope and information for proper evaluation of a company. The merchant bankers are professionals and can make proper appraisal of a company.

Drawbacks of BODThere is a fear of loss of management control because the sponsor is a

holder of a large chunk of equities at one time. The sponsor may also influence the policy decision which may affect the functioning of the company.

The investment banker who has to off-load the equities in the primary market at a later date is entitled to ask for a higher price for the risk taken by him. But this price may scare away the common investors.

If a company does not perform as per the expectations of sponsor or if the promoter does not cooperate with the sponsor later, the sponsor may have tough time and may find its entire investment has eroded.

If a merchant banker does not make proper analysis of the company it may face a lot of problems with the BOD. Unless it evaluates all the risks associated with the project, there is every chance that the sponsor may burn its fingers.

ISSUE OF DEBT INSTRUMENTS A company offering converting and non-convertible debt instruments

through an offer document should complies with the following provisions:

Requirement of Credit Rating

Creation of Debenture Redemption Reserves

Redemption

Disclosure and Creation of Charge

Requirement of Letter of Option

Rollover of Non-Convertible Portions of Partly Convertible Debentures (PCD/ Non-Convertible Debentures (NCDs) by Company not Being in Default

Rollover of NCDs/PCDs By a Listed Company Being In Default

Requirement of Credit Rating

Public or rights issue of all debt instruments (i.e. convertible as well as non-convertible) can be made only if credit rating of a minimum investment grade is obtained from at least two registered credit rating agencies and disclosed in the offer document.

Creation of Debenture Redemption Reserves (DRR) If debentures are issued for project finance, the DRR can be

created up to the date of commercial production, either in equal installments or higher amounts if profits so permit.

In the case of partly convertible debentures, the DRR should be created with respect to the non-convertible portion on the same lines as applicable for fully non-convertible debenture issue.

The drawal from DRR is permissible only after 10 per cent of the debenture liability has actually been reduced by the company. The requirement of creation of DRR is not, however, applicable in the case of issue of debt instruments by infrastructure companies.

Creation of Debenture Redemption Reserves (DRR) In case of convertible issues by new companies, the

creation of DRR should commence from the year the company earns profits for the remaining life of debentures.

The DRR should be treated as a part of the general reserves for consideration of bonus issue proposals and for price fixation related to post-tax return.

The company should create the DRR equivalent to 50 per cent of the amount of debenture issue before the commencement of debenture redemption.

Disclosure and Creation of Charge The offer document should specifically state the

assets on which the security would be created as also the ranking of the charge(s). In case of second/residual charge or subordinated obligation, the associated risks should also be clearly stated. The relevant consent for creation of security such as pari passu letter, consent of the lesser of the land in case of leasehold land, and so on, should be obtained and submitted to the debenture trustee before opening of the debenture issue.

Other Requirements No company should Issue fully convertible debentures (FCDs)

have a conversion period of more than 36 months unless conversion is made optional with "put" and "call" option.

If the conversion takes place at or after 18 months from the date of allotment, but before 36 months, any conversion, in part or whole, of the debenture should be optional and in the hands of the debenture-holders. However, the issue of debenture cannot be made for acquisition of shares or providing loan to any group company.

This requirement would not apply to the issue of fully convertible debentures providing conversion within a period of 18 months. The premium amount and time of conversion should be determined and disclosed by the issuer company. The interest rate for debentures can be freely determined by the issuer company.