Methods Of Raising Equity Capital

Methods Of Raising Equity Capital

The primary market serves the purpose of raising funds in the form of new securities. The Primary Markets brings investors and users together resulting in transfer of funds from one to the other. Transfer of investible funds into industrial enterprises serves the three functions: namely, Originations, Underwriting and Distribution. A company planning to source funds has several options. IPO is just one of them. Other forms of equity financing include secondary offerings, rights issue, private placement, offer for sale and warrants.

All these forms are discussed in the following sections.

 

Initial Public Offering

The first sale of stock by a private company to the public, i.e., if the company has never issued equity to the public, is known as an IPO. This is the most common method of raising funds from public by issuing shares. The actual IPO process itself starts with the company proposing to raise capital from the markets. Two options are available for the issuing company: [1] the fixed price route where the issue price is fixed [2] the book-building route where the price band is fixed and the issue price is finalized after the issue closes. But before we proceed ahead, we need to understand which companies are eligible to undertake an IPO.

 

Eligibility Criteria

1: As per SEBI regulations provided in the “Issue of Capital and Disclosure” Requirements (Regulations), 2009, an issuer may take an initial public offer, if the following conditions are satisfied:

• It has net tangible assets of at least three crore rupees in each of the preceding three full years (of twelve months each), of which not more than fifty percent, are held in monetary assets: Provided that if more than fifty percent of the net tangible assets are held in monetary assets, the issuer has made firm commitments to utilize such excess monetary assets in its business or project.
• It has a track record of distributable profits in terms of section 205 of the Companies Act, 1956, for at least three out of the immediately preceding five years: Provided that extraordinary items shall not be considered for calculating distributable profits.
• It has a net worth of at least one crore rupees in each of the preceding three full years (of twelve months each)
• The aggregate of the proposal issue and all previous issues made in the same financial year in terms of issue size does not exceed five times its pre-issue net worth as per the audited balance sheet of the preceding financial year.
• If it has changed its name within the last one year, at least fifty percent of the revenue for the preceding one full year has been earned by it from the activity indicated by the new name.

2: An issuer not satisfying any of the conditions stipulated above may make an initial public offer if:

• The issue is made through the book building process and the issuer undertakes to allot at least fifty percent of the net offer to public to qualified institutional buyers and to refund full subscription monies if it fails to make allotment to the qualified institutional buyers. Or At least fifty percent of the cost of the project is contributed by scheduled commercial banks or public financial institutions, of which not less than ten percent shall come from the appraisers and the issuer undertakes to allot at least ten percent of the net offer to public to qualified institutional buyers and refund full subscription monies if it fails to make the allotment to the qualified institutional buyers.
• The minimum post-issue face value capital of the issuer is ten crore rupees. Or The issuer undertakes to provide market-making for at least two years from the date of listing of the specified securities, subject to the following:
  1. The market makers offer buy and sell quotes for a minimum depth of three hundred specified securities and ensure that the bid-ask spread for their quotes does not, at any time, exceed ten percent.
  2. The inventory of the market makers, as on the date of allotment of the specified securities, shall be at least five percent of the proposed issue.

3: An issuer may make an initial public offer of convertible debt instruments without making a prior public issue of its equity shares and listing thereof.

4: An issuer shall not make an allotment pursuant to a public issue if the number of prospective allottees is less than one thousand.

5: No issuer shall make an initial public offer if there are any outstanding convertible securities or any other right which would entitle any person any option to receive equity shares after the initial public offer: Provided that the provisions of this sub-regulation shall not apply to:

• A public issue made during the currency of convertible debt instruments which were issued through an earlier initial public offer, if the conversion price of such convertible debt instruments was determined and disclosed in the prospectus of the earlier issue of convertible debt instruments.
• Outstanding options granted to employees pursuant to an employee stock option scheme framed in accordance with the relevant Guidance Note or Accounting Standards, if any, issued by the Institute of Charted Accountants of India in this regard.

6: Subject to provisions of the Companies Act, 1956 and these regulations, equity shares may be offered for sale to public if such equity shares have been held by the sellers for a period of at least one year prior to the filing of draft offer document with the Board in accordance with sub-regulations (1) of regulation 6 of the ICDR (2009); Provided that in case equity shares received on conversion or exchange of fully paid-up compulsorily convertible securities including depository receipts are being offered for sale, the holding period of such convertible securities as well as that of resultant equity shares together shall be considered for the purpose of calculation of one year period referred in this sub-regulation; Provided further that the requirement of holding equity shares for a period of one year shall not apply:

• In case of an offer for sale of specified securities of a government company or statutory authority or corporation or any special purpose vehicle set up and controlled by any one or more of them, which is engaged in infrastructure sector.
• If the specified securities offered for sale were acquired pursuant to any scheme approved by a High Court under sections 391-394 of the Companies Act, 1956, in lieu of business and invested capital which had been in existence for a period of more than one year prior to such approval.

7: No issuer shall make an initial public offer, unless as on the date of registering prospectus or red herring prospectus with the Registrar of Companies, the issuer has obtained grading for the initial public offer from at least one credit rating agency registered with the Board.

The Following May Be Noted:

1: “Net Tangible Assets” mean the sum of all net assets of the issuer, excluding intangible assets as defined in Accounting Standard 26 (AS 26) issued by the Institute of Charted Accountants of India.

2: “Project” means the object for which monies are proposed to be raised to cover the objects of the issue.

3: In case of an issuer which had been a partnership firm, the track record of distributable profits of the partnership firm shall be considered only if the financial statements of the partnership business for the period during which the issuer was a partnership firm, conform to and are revised in the format prescribed for companies under the Companies Act, 1956 and also comply with the following:

• Adequate disclosures are made in the financial statements as required to be made by the issuer as per Schedule VI of the Companies Act, 1956.
• The financial statements are duly certified by a Charted Accountant stating that:
  1. The accounts and the disclosures made are in accordance with provisions of Schedule VI of the Companies Act, 1956.
  2. The accounting standards of the Institute of Charted Accountants of India have been followed.
  3. The financial statements present a true and fair view of the firm’s accounts.

4: In case of an issuer formed out of a division of an existing company, the track record of distributable profits of the division spun-off shall be considered only if the requirements regarding financial statements as provided for partnership firms in Explanation III are compiled with.

5: “Bid-Ask Spread” means the difference between quotations for sale and purchase.

6: The term “infrastructure sector” includes the facilities or services as specified in Schedule X of the SEBI ICDR (Regulations), 2009.

 

Secondary Public Offering Or Follow-On Public Offering

A secondary public offering or Follow-on Public Offering (FPO) is the issue of additional shares, subsequent to the company’s initial public offering. A Secondary offering can be dilutive in nature. The Company sells new shares, thereby, increasing the number of outstanding shares, which may dilute the existing shareholder stake. But the FPO can be used to generate additional long term capital for the company.

The eligibility norms for a company to make a FPO are that the company needs to satisfy the following:

• The aggregate of the proposed issue and all previous issues made in the same financial year in terms of issue size does not exceed five times its pre-issue net worth as per the audited balance sheet of the preceding financial year.
• If it has changed its name within the last one year, at least fifty percent of the revenue for the preceding one full year has been earned by it from the activity indicated by the new name.

An issuer not satisfying any of the conditions stipulated above may make a FPO if the following is satisfied:

• The issue is made through the book building process and the issuer undertakes a allot at least fifty percent of the net offer to public to qualified institutional buyers and to refund full subscription monies if it fails to make allotment to the qualified institutional buyers. Or At least fifteen percent of the cost of the project is contributed by scheduled commercial banks or public financial institutions, of which not less than ten percent shall come from the appraisers and the issuer undertakes to allot at least ten percent of the net offer to public to qualified institutional buyers and to refund full subscription monies if it fails to make the allotment to the qualified institutional buyers.
• The minimum post-issue face value capital of the issuer is ten crore rupees. Or The undertakes to provide market-making for at least two years from the date of listing of the specified securities, subject to the following:
  1. The market makers offer buy and sell quotes for a minimum depth of three hundred specified and ensure that the bid-ask spread for their quotes does not, at any time, exceed ten percent.
  2. The inventory of the market makers, as on the date of allotment of the specified securities, shall be at least five percent of the proposed issue.

 

Rights Issue

It is the issue of new shares in which the existing shareholders are given preemptive rights to subscribe to the new issue on a pro-rata basis within a specified time. Rights are often transferable, allowing the holder to sell them on the open market.

 

Private Placement

It is a process of placing shares / debentures directly with a group of market participants and assumes market participants have sufficient knowledge and expertise of evaluating the merits and risks of the investment (as no formal prospectus is issued). The investment banker plays a vital role in preparing an offer memorandum, and negotiating with potential investors.

 

Private Placement By Unlisted Company

A private placement is an issue of shares or of convertible securities by a company to a select group of persons under Section 81 of the Companies Act, 1956 which is neither a rights issue nor a public issue. This is a faster way for a company to raise equity capital. Companies opt for private placement due the speed of raising capital (normally it takes 2-3 months), confidentiality (as information related to company’s business operations to be accessed by few investors), and is less expensive.

 

Offer For Sale

An Offer for Sale is also known as Disinvestment. It is the process of issuing existing shares of promoters to investors. This is a non-dilutive type of offering where shares are offered for sale by company directors or other privately held shares (by venture capitalist) who may be looking to diversify their holdings. The offering is not dilutive to existing shareholders as no new shares are created.

 

Raising Equity Capital In International Markets

Following are the different avenues for resource mobilization from international markets:

• Global Depository Receipts (GDR)
• American Depository Receipts (ADR)

In this post, we shall discuss about the GDR, ADR and IDR. There is also one other method of raising capital. This is external commercial borrowing. But we would not be discussing this method under this post, since it pertains to Debt Capital. Also, foreign currency convertible bonds are also an important method of raising capital, whereby, on a later date, the debt issued may be converted into equity capital.

Let us understand the mechanics of raising capital through GDR, ADR, and IDR.

 

Global Depository Receipts (GDR)

Global Depository Receipts (GDR) are equity instruments issued by authorized Overseas Corporate Bodies (OCB) against shares / bonds of Indian Companies that are deposited with designated domestic custodian banks. The issue of GDR is in lieu of the shares deposited. The GDR can be listed in international stock exchanges and are tradeable. A GDR may represent one or more shares of the company, based on fixed ratio. A holder of the GDR can convert the receipt into equity shares it represents, at any time. A GDR by itself does not carry voting rights. But after conversion, the shares allotted have all characteristics of common / ordinary equity shares issued by the company and tradeable on the domestic (Indian) exchange. Most of the listings of the GDR issued by Indian companies are in Luxembourg Stock Exchange and London Stock Exchange. Indian GDR are primarily sold to institutional investors. GDR are tradeable on the over-the-counter markets also, where market makers provide liquidity for the instrument.

In May 1992, Reliance became the first Indian company to raise equity in international capital markets through the mechanism of Global Depository Receipts (GDR).

 

American Depository Receipts (ADR)

American Depository Receipts (ADR) is a negotiable instrument that is denominated in US Dollars (USD). When a non-US based company – that seeks to list in USA – deposits its shares with a designated bank, the company receives a receipts, which enables it to issue American Depository Shares (ADS). These ADS are share certificate and are used interchangeably with ADR, which represent ownership of the deposited shares.

ADR represents a fraction of a share, a single share, or multiple shares of company’s deposited stock. These receipts pay dividends in USD (through a trustee) and is traded on a US-based stock exchange – such as New York Stock Exchange (NYSE) or the NASDAQ. The price of an ADR is based on the price of the issuing company’s stock in its home market.

Thus, investors attempting to enter the emerging markets or other foreign stock exchanges have to go through expensive commissions and currency exchange before successfully investing in a foreign market. With ADR, investors can take advantage of foreign markets while trading in US stock markets.

Following Are Some Of The Types Of ADR Issues:

• Level-1: These are issued in the over-the-counter (OTC) markets and have the lowest regulatory requirements from Securities and Exchange Commission. The company is not required to issue quarterly or annual reports in compliance with US Generally Accepted Accounting Principles (GAAP).
• Level-2: These are listed on New York Stock Exchange (NYSE), NASDAQ, and the American Stock Exchange (AMEX). They have slightly more requirements from the SEC, but they have greater visibility and trading volume.
• Level-3: The issuer floats a public offering of ADR on a U.S. exchange and raises capital. Setting up a level 3 program means that the foreign company is not only taking some of its shares from its home market and depositing them to be traded in the U.S.; it is actually issuing shares to raise capital.

 

Difference Between ADR And GDR

Following are the major differences between ADR and GDR:

• ADR issues offer access to not only the institutional investors, but also retail investors based in USA. On the other hand, GDR offers, access only to the US-based institutional investors.
• If the depository receipt is traded in a country other than USA, it is called a Global Depository Receipt. GDR can be converted into ADR. This is based on Securities Exchange Commission (SEC) guidelines. SEC is the regulator in US.
• The investors in Europe are not actively participating in the GDR issuance process. This is due to the lack of confidence among investors, in the Indian company’s performance. Thus, more companies are converting their existing GDR into ADR, as well as issue ADS to enable greater market reach, liquidity and participation by US-based investors.

 

Indian Depository Receipts (IDR)

Similar to the mechanism by which Indian companies can issue GDR and ADR in the international markets, the foreign companies can source capital by issuing Indian Depository Receipts (IDR) in the Indian markets. IDR enables Indian investors to diversify their portfolio risk. It also serves to integrate the Indian capital markets with international markets.

A foreign company can access Indian securities market for raising funds through issue of Indian Depository Receipts (IDRs). An IDR is an instrument denominated in Indian Rupees in the form of a depository receipt created by a Domestic Depository (custodian of securities registered with the Securities and Exchange Board of India) against the underlying equity of issuing company to enable foreign companies to raise funds from the Indian Securities Markets. Central Government notified the Companies (Issue of Indian Depository Receipts) Rules, 2004 (IDR Rules) pursuant to the section 605 A of the companies Act. SEBI issued guidelines for disclosure with respect to IDRs and notified the model listing agreement to be entered between exchange and the foreign issuer specifying continuous listing requirements. The eligibility criteria given under IDR Rules and Guidelines are as under:

The eligibility guidelines for issue of IDR are based on the Companies (Issue of Indian Depository Receipts) Rules, 2004 and are as follows:

• Company should be registered overseas and should have pre-issue paid up capital and free reserves of at least USD 100 million, and average turnover of USD 500 million during the 3 financial years immediately preceding the public issue.
• Issuing company should have made profits for at least 5 years prior to the issue and dividends record of not less than 10% in those years. Also, the issuing company should ensure that it has a pre-issue debt equity ratio of not more than 2:1.
• Application should be made at least 90 days before opening of the issue, with a refundable fee of USD 10,000. Upon receiving the approval, an issue fee of 0.50% subject to a minimum of Rs. 1,000,000 (Rs. 10 Lakhs) needs to be made for issues up to Rs. 1,000,000,000 (Rs. 100 Crores). If the issue size is greater than Rs. 100 Crores, then an incremental fee of 0.25% is charged of the extent to which the issue size of greater than Rs. 100 Crores.
• Repatriation of proceeds would be depending on the laws in force for export of foreign exchange.
• IDR shall not be redeemable into equity shares for a period of 1 year from the date of issue.
• IDR issued in a financial year cannot exceed 15% of the issuing company’s paid up capital and free reserves.
• IDR will be denominated in Indian Rupees and listed on an Indian stock exchange(s).
• The company’s equity shares should be deposited with a designated overseas custodian bank. One of the Indian depositories would authorize the company to issue IDR.
• Then the company needs to appoint a merchant banker for overseeing the issue process.
• Indian investors are subject to FEMA, 1999 guidelines at the time of investing in IDR.
• The issuing company should be listed in its home country.
• The company should not be prohibited to issue securities by any Regulatory Body.
• It has good track record with respect to compliance with securities market regulations.
• The size of an IDR issue shall not be less than Rs. 50 Crores.
• Foreigners resident or employed in India, subsidiaries of global corporations, and foreign funds registered in India – Foreign Institutional Investors based in India are also eligible to invest in IDR.

As with public issues, there are a set of intermediaries which are involved in issue of IDR.

• Overseas Custodian Bank is a banking company which is established in a country outside India and has a place of business in India and acts as custodian for the equity shares of issuing company against which IDRs are proposed to be issued in the underlying equity shares of the issuer is deposited.
• Domestic Depository which is a custodian of securities registered with SEBI and authorized by the issuing company to issue Indian Depository Receipts.
• Merchant Banker registered with SEBI is responsible for due diligence and through whom the draft prospectus for issuance of the IDR is filed with SEBI by the issuer company.

The Foreign issuer is required to file the draft prospectus with SEBI. Any changes specified by SEBI shall be incorporated in the final prospectus to be filed with Registrar of Companies.

IDRs can be converted into the underlying equity shares only after the expiry of one year from the date of the issue of the IDR, subject to the compliance of the related provisions of Foreign Exchange Management Act and Regulations issued thereunder by RBI in this regard. On of the receipt of dividend or other corporate action on the IDRs, the Domestic Depository shall distribute them to the IDR holders in proportion to their holdings of IDRs.

IDRs can be purchased by any person who is resident in India as defined under FEMA. Minimum application amount in an IDR issue shall be Rs. 20,000. Investment by Indian companies in IDRs shall not exceed the investment limits, if any, prescribed for them under applicable laws. In every issue of IDR, at least 50% of the IDRs issued shall be subscribed to by QIBs and and the balance 50% shall be available for subscription by non-institutional investors.

 

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