Financing New Ventures And Businesses

process of floating of ipo and role of merchant banker

• What is the process when a company goes for raising of funds through an ipo and what steps are to be taken by the merchant bankers so that funds are raised?

What is IPO?

• Initial public offering (IPO), also referred to simply as a "public offering" or "flotation", is when a company issues common stock or shares to the public for the first time. They are often issued by smaller, younger companies seeking capital to expand, but can also be done by large privately-owned companies looking to become publicly traded.

• In an IPO the issuer may obtain the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), best offering price and time to bring it to market.

• An IPO can be a risky investment. For the individual investor, it is tough to predict what the stock or shares will do on its initial day of trading and in the near future since there is often little historical data with which to analyze the company.

• Also, most IPOs are of companies going through a transitory growth period, and they are therefore subject to additional uncertainty regarding their future value. However, in order to make money, calculated risks need to be taken.

• The Initial Public Offering (IPO) for a new public company is the first opportunity for the investing public to be able to purchase shares in the company.

• An IPO is a very exciting time for the company, and IPOs are often eagerly anticipated by the investing public as well.

Reasons for company going in IPO

There are several reasons for which a private company may wish to become a public company. 1. raise capital2. to allow the original investors or entrepreneurs who started

the company to realize profits on their investment and time. • Undertaking an IPO is a large and exciting event for a new

company. • A well received IPO means that the company will have cash to

further its development and growth. • It also usually means that the people who started the company

realize some significant profits for their efforts.

Risk associated with IPO

• The investing public is usually excited about an IPO. It is hard to understand why, since most stocks that are sold during an IPO tend to perform badly at first.

• Some companies also do not survive, so investing in an IPO is more risky and usually less rewarding then investing in more established stocks.

• Perhaps investors believe the sales hype that usually accompanies an IPO.

• Perhaps they are excited about being among the first to own the next potential IBM or Microsoft.

Preparations to be done before issue of IPO

• An IPO requires a great deal of work, from filing the necessary paperwork with the regulatory bodies and writing a prospectus for potential investors to devising and implementing a sales campaign for the sale of the initial shares.

• Since the company also needs to continue to function and complete its normal activities, a financial firm is usually hired to do this work. This firm is referred to as the underwriting firm for the IPO.

• For a really large IPO, the work may even be split between several underwriting firms.

Procedure

• IPOs generally involve one or more investment banks as "underwriters." The company offering its shares, called the "issuer," enters a contract with a lead underwriter to sell its shares to the public. The underwriter then approaches investors with offers to sell these shares.

• The sale (that is, the allocation and pricing) of shares in an IPO may take several forms. Common methods include:

Best efforts contract Firm commitment contract All-or-none contract Bought deal Dutch auction Self distribution of stock

Pricing of IPO

• A company that is planning an IPO appoints lead managers to help it decide on an appropriate price at which the shares should be issued. There are two ways in which the price of an IPO can be determined:

the company with the help of its lead managers fixes a price.

the price is arrived at through the process of book building.

Principal steps in floating a public issue

• Pre-issue task1. Drafting and finalization of the prospectus2. Selecting the intermediaries and entering into

agreements with them3. Attending to other formalities-printing of

prospectus and application forms, dispatching to intermediaries, filing of initial listing application with stock exchange

• Opening and closing of the issue

• Post-issue task-1. Scrutiny, processing and tabulation of application

forms.2. Determination of liabilities of underwriters3. In case of over subscription, basis of allotment to

be decided in consultation with stock exchange.4. Allotment letters and share certificates to be

dispatched to the allottees. Refund orders to be dispatched to the applicants whose applications are rejected.

What is Merchant Bank?

• A Merchant Bank deals with the commercial banking needs of international finance, long term company loans, and stock underwriting.

• A merchant bank does not have retail offices where one can go and open a savings or checking account.

• A merchant bank is sometimes said to be a wholesale bank, or in the business of wholesale banking. This is because merchant banks tend to deal primarily with other merchant banks and other large financial institutions.

Role of merchant banker

• The most familiar role of the merchant bank is stock underwriting. • A large company that wishes to raise money from investors through

the stock market can hire a merchant bank to implement and underwrite the process.

• The merchant bank determines the number of stocks to be issued, the price at which the stock will be issued, and the timing of the release of this new stock.

• The merchant bank files all the paperwork required with the various market authorities, and is also frequently responsible for marketing the new stock, though this may be a joint effort with the company and managed by the merchant bank.

• For really large stock offerings, several merchant banks may work together, with one being the lead underwriter.

Role of Merchant Bank in IPO

• When a company wants to raise funds through initial public offering (IPO) it appoints an merchant bank for underwriting the issue. Since in an IPO a company participates for the first time, it doesn’t have complete understanding of the rules and documentation, required to be submitted, to get a clearance from the regulator.

• Famous merchant bankers world over are Goldman Sachs, Credit Suisse and Morgan Stanley. Banks like Deutsche, Citi, UBS etc. have investment banking wings. Underwriters assess and analyse firm’s current performance, firm’s future earnings potential, industry scenario, competition in the same sector, current local and global market situations etc. to decide the issue price/price band. They also work on the activities like completion of the mandatory documentation as required by the regulatory body. Underwriters charge a fee for this activity, which is generally a percentage of the issue size.

• If the issue size is very large a syndicate of merchant banks takes up the task of underwriting the issue. However one merchant bank leads the other.

Functions of a Merchant Banker:

1) Management of debt and equity offerings- This forms the main function of the merchant banker. He assists the companies in raising funds from the market. The main areas of work in this regard include:• instrument designing• pricing the issue• registration of the offer document• underwriting support• marketing of the issue• allotment and refund• listing on stock exchanges.

2) Placement and distribution- The merchant banker helps in distributing various securities like • equity shares• debt instruments• mutual fund products• fixed deposits• insurance products• commercial paper to name a few. The distribution network of the merchant banker can be classified as institutional and retail in nature. The institutional network consists of mutual funds, foreign institutional investors, private equity funds, pension funds, financial institutions etc. The size of such a network represents the wholesale reach of the merchant banker. The retail network depends on networking with investors.

3) Corporate advisory services- Merchant bankers offer customised solutions to their clients financial problems. The following are the main areas in which their advice is sought: • Financial structuring includes determining the right debt-equity ratio and gearing ratio

for the client, the appropriate capital structure theory is also framed.• Merchant bankers also explore the refinancing alternatives of the client, and evaluate

cheaper sources of funds. • Another area of advice is rehabilitation and turn around management. • In case of sick units, merchant bankers may design a revival package in coordination

with banks and financial institutions. • Risk management is another area where advice from a merchant banker is sought. He

advises the client on different hedging strategies and suggests the appropriate strategy. 4) Project advisory services- Merchant bankers help their clients in various stages of the project undertaken by the clients. They assist them in conceptualising the project idea in the initial stage. Once the idea is formed, they conduct feasibility studies to examine the viability of the proposed project. They also assist the client in preparing different documents like the detailed project report.

5) Loan syndication- Merchant bankers arrange to tie up loans for their clients. This takes place in a series of steps. Firstly they analyse the pattern of the client’s cash flows, based on which the terms of borrowings can be defined. Then the merchant banker prepares a detailed loan memorandum, which is circulated to various banks and financial institutions and they are invited to participate in the syndicate. The banks then negotiate the terms of lending on the basis of which the final allocation is done.6) Providing venture capital and mezzanine financing- Merchant bankers help companies in obtaining venture capital financing for financing their new and innovative strategies.

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