Long-Term Financing:

An Introduction

Ajay Kumar Chauhan

.
 Sources of long term financing

Equity Stock – Primary market

Equity Shares- Secondary Market
Private Equity
Preference shares

Corporate Long-Term Debt

Company Deposits
Recent Trends in Capital Structure
 Raising of funds

Debt Sources Equity Sources

Secured and unsecured loans Equity shares
Debentures/Bonds Preference Shares
Company Deposits Retained earnings

Low Cost of Capital High cost of capital

High Financial Leverage No Leverage
Solvency risk is high No Solvency risk
Low time required High Formalities and time
 Initial Public Offerings
Going Public

When an unlisted Co. makes either a

fresh issue of securities or an offer for
sale of its existing securities or both for
the first time to the public.
 Types of Markets
1. Primary Market

2. Secondary market

Both the markets are governed by the SEBI

 Issues

Public Right Private Placement

Private Preferential Qualified

placement Issues Institutional
Placement

IPO FPO

Fresh Offer Fresh Offer

issue for sale issue for sale
 Initial Public Offerings

Fixed Price Issue Book Building Process

(issue size > Rs 100 crore)

Fixed Price Price Band

Face Value + Premium Floor price ---- Cap
500 - 600
cut-off price = 565
 Subscription

Oversubscription undersubscription

Subscription ratio
Proportionate basis Refund of application money
lottery method

Underwriting
(is a form of guarantee that the new issue would be sold by eliminating the risk arising from
uncertainty of public response)
 Types of investors

Retail Non-institutional Qualified

Investors Investors institutional Buyers

HNIs
Limit =Rs 2,00,000 above Rs 2,00,000 50 % reservations
25% reservations
Have the option of bidding at cut-off.
 Intermediaries in an issue

Lead Managers or Merchant Bankers

Registrars to the issue
Bankers to the Issue
Auditors of the Company
Underwriters to the Issue
 Basic information about IPOs
• Bullish and Bearish Market.

• Information about the coming IPO is available in the market at least

two-three weeks before.

• Upper Cap in the price band should not be more than 20 % of the
flour price.

• All the public issues of size in excess of Rs 10 crore, are to made

compulsorily in the demat mode.

• Subscription list for public issues shall be kept open for at least 3
working days and not more than 10 working days. In case of book
built issues, the min and max period for which bidding will be open is
3-7 working days extendable by 3 days in case of a revision in the
price band.
 IPO Grading
• Assessment by an independent agency
• Represents a relative assessment of the fundamentals of
the issue on a 5 point scale
• Is not an investment recommendation.

• IPO grade 1: Poor fundamentals

• IPO grade 2: Below-average fundamentals
• IPO grade 3: Average fundamentals
• IPO grade 4: Above-average fundamentals
• IPO grade 5: Strong fundamentals

• A company which has filed the draft offer document for its IPO with SEBI, on or after 1st
May, 2007, is required to obtain a grade for the IPO from at least one CRA.
• The public issue made by an infrastructure company may be kept open for a max
period of 21 working days. Right issues shall be kept open for at least 30 days
and not more than 60 days.

• The investor is entitled to receive a Confirmatory Allotment Note in case he has

been allotted shares within 15 days from the date of closure of a book built issue.

• Green shoe option is an arrangement wherein the issue would be

over allotted to the extent of a max of 15% of the issue size. From
the investor’s perspective, an issue with green shoe option provides
more prob. of getting shares and also that post listing price may
show more stability as compared to market.
• Time lag problem: sentiments could change from the time the application is
made and shares are ultimately listed. E.g. DLF issue. In case of this issue the
response is very poor but due to the changes in the sentiments the stock did well
on the listing day.
• Locking of the money for 3 weeks. Opportunity cost mean while the investor
can trade in the secondary market.
• A red herring prospectus, as a first or preliminary
prospectus, is a document submitted by a company (issuer)
as part of a public offering of securities. Most frequently
associated with an IPO, this document, must be filed with
the SEBI.

• is issued to potential investors, but does not have complete

particulars on the price of the securities offered and
quantum of securities to be issued.

• front page of the prospectus displays a bold red disclaimer

stating that information in the prospectus is not complete
and may be changed, and that the securities may not be
sold until the registration statement, filed with the market
regulator, is effective.
• Potential investors may not place buy orders for
the security, based solely on the information
contained within the preliminary prospectus. Those
investors may, however, express an "indication of
interest" in the offering, provided that they have
received a copy of the red herring at least 48 hours
prior to the public sale.

• After the registration statement becomes effective,

and the stock is offered to the public, indications of
interest may be converted to purchase orders, at the
buyer's discretion. The final prospectus must then
be promptly delivered to the buyer.
India is ranked 7th among the worlds biggest IPO
markets in the first eight months of 2007 and its
share in the global IPO proceeds is now 3.5 per
cent, as compared to 1.7 per cent in 2006.
 For Retail Investors

Attractive investment avenue to earn good returns

Investing in IPO is an easy, low-risk way to make an average

of 15-100 % in 20 days.

An opportunities for picking up shares at relatively low prices.

Comparatively lower risk as compared to secondary

market.
 For Companies

Preferred route for raising funds

Helps in Mergers and acquisitions

Companies can provides ESOPS to attract the best of the talents

To acquire and enhance the Public image

To make the promoters rich.

To get Exposed to the global market as global presence, global brands

and global markets is the success mantra for the success of the company.
Economy as a whole will grow in true
sense if the business and industry
matures and when the wealth created by
entrepreneurs is shared with the
investors.
 Conclusions of the earlier research
• IPO provides abnormal initial returns, i.e. they are
underpriced.

Under pricing

15 + 7 days

Issue Price List Price

Very small as well as very large issues had higher initial
returns than the issues of medium size.

Smaller sized issues tend to have higher initial returns as

compared to large issues

Under pricing or the Initial returns were higher on fixed offer

pricing.

Average under pricing of group companies was higher than

that of stand alone companies.
Under pricing is higher for companies affiliated to
private foreign (multi national) and private Indian
groups.

Under pricing was less during the high volume

(hot) period as compared to the slump period in the
Indian stock market.

Opening price returns does not differ significantly

from the closing price returns.
 Theories of Underpricing of IPOs
• Winner’s Curse Hypothesis : informed investors are rewarded for
purchasing the securities and revealing the information.

• Certification Hypothesis : Investment bankers and Auditors

possess a certification role which reduces the uncertainty in the IPO
process
• Signalling hypothesis : underpricing of IPOs is used as a tool by
the firms to signal their quality. This will spread a kind of assurance to
the public that the subsequent issues by them will also provide good
returns to the shareholders.
• Market feed back hypothesis : feedback of the market is
responsible in the decisions of subsequent Issues.

• Fads hypothesis: based on the evidence that IPOs

underperforms the market over the long run, this hypothesis
assumes that the abnormal initial returns for IPOs is not due to
systematic underpricing but overvaluation of IPOs by investors or
the presence of fad in the early aftermarket trading.
 Eight guidelines

for retail investors to select the IPO’s to invest in

and make sure the risk involved is min and at the
same time ensuring chances of allotment are very
high.

These are applicable only to those investing in

IPO’s for listing gains
1 : Blindly invest in a particular IPO, if the
institutional category is oversubscribed by over
5 times.

Institutional investors have access to information

that retail investor will never have access to. This
sometimes involves even insider information. So,
just leverage on their analysis.
2 : Always invest at cut-off price. The “cut off
” feature is an excellent facility that is offered
only to retail investors. Make sure you make use
of this facility.

3 : Apply for the max shares possible that a

retail investor is eligible to apply for (Rs.
2 lakh limit). If you apply for the minimum shares,
most probably you will not get allotment and you would
just end up locking your money for 20 days.
4 : If you find 3 or 4 IPO’s which are good but have
only 1 lakh of capital to invest, select the best IPO
among the 3 and invest in it. Don’t split your
money. You might end up not getting allotment in
any of the IPO. Diversifying doesn’t work
in IPO’s
5 : Always apply for an IPO through ASBA. Once
the final subscription figures are released and if you find
that either the

QIB category has been subscribed less than 5 times or

if the retail investor category has received much higher

response than the QIB category (increases the chances of
a bad listing, since most retail investors would sell on
listing and there would be a huge selling pressure on the
day of listing) or

if the IPO has been oversubscribed by more than 50

times or so,

then go ahead and give a stop payment

6 : If you want to invest more than 2 lakh in a
particular IPO, invest in more than 1
application.

7 : Update your ECS details and make sure you write the
following in bold and very clearly in the IPO application
form.
1) Your name
2) Your DP details

If your name or DP number is incorrect or unclear, then you

will face unnecessary delays in getting the shares alloted
and you wouldn’t be able to sell on listing. Also make sure
you opt for ECS refund. Cheques can be lost or
delayed. ECS is hassle free and safe.
8 : Sell of the shares allotted to you on the day of
listing. Sell 50% between 9.15 and 9.30
AM and the rest in the afternoon. The
shares of that particular IPO might do well in day 2
and day 3 and in subsequent weeks too, but an
equivalent number of IPO’s have witnessed a huge
fall in the second and third day after listing.
 Conclusion
In the 2nd highest growing economy of the world, if investors
are well informed about the primary market, they can earn
handsome returns from their investments. The industry also
requires considering the IPO route as a method of sharing the
growth with the country than as a simple method of raising
funds. The result would be in the enhancement of the wealth
of investors and entrepreneurs, which ultimately is necessary
for the good health of the economy as a whole. If the investors
and industry of India grows, who can stop us in reaching the
heights?
 Thanks

v_akc@rediffmail.com

09811216905