Sources of Long Term Finance

1
• Term Loans, Debentures/Bonds and
Securitisation

2
• Term Loans
Term (long-term) loan is a loan made by a
bank/financial institution to a business having an
initial maturity of more than 1 year.

3
 Features of Term Loans

• Maturity
• The maturity period of term loans is typically longer in case of sanctions by financial institutions in
the range of 6-10 years in comparison to 3-5 years of bank advances. However, they are
rescheduled to enable corporates/borrowers tide over temporary financial exigencies.
• Negotiated
• The term loans are negotiated loans between the borrowers and the lenders. They are akin to
private placement of debentures in contrast to their public offering to investors
• Security
• All term loans are secured. While the assets financed by term loans serve as primary security, all
the other present and future assets of the company provide collateral/secondary security for the
term loan.
• Covenants
• To protect their interest, the financial institutions reinforce the asset security stipulation with a
number of restrictive terms and conditions. These are known as covenants. They are both
positive/affirmative and negative in the sense of what the borrower should and should not do in
the conduct of its operations and fall broadly into four sets as respectively related to assets,
liabilities, cashflows and control.

4
Repayment Schedule/Loan Amortisation

• The term loans have to be amortised according to predetermined schedule. The

payment/repayment has two components:
- Interest and
- Repayment of principal.
• The interest component of loan amortisation is a legally enforceable contractual
obligation. The borrowers have to pay a commitment charge on the unutilised
amount.
• Typically, the principal is repayable over 6-10 years period after an initial grace
period of 1-2 years. Whereas the mode of repayment of term loans is equal
semi-annual instalments in case of institutional borrowings, the term loans from
banks are repayable in equal quarterly instalments.

5
 Debentures/Bonds/Notes
Debenture/bond is a debt instrument indicating that a company has borrowed
certain sum of money and promises to repay it in future under clearly defined
terms.

Attributes
As a long-term source of borrowing, debentures have some contrasting features
compared to equities.
Trust Indenture When a debenture is sold to investing public, a trustee is
appointed through an indenture/trust deed.
Trust (bond) indenture is a complex and lengthy legal document stating the
conditions under which a bond has been issued.
Trustee is a bank/financial institution/insurance company/ firm of attorneys that
acts as the third party to a bond/debenture indenture to ensure that the issue
does not default on its contractual responsibility to the bond/ debenture holders.
Interest The debentures carry a fixed (coupon) rate of interest, the payment of
which is legally binding/enforceable. The debenture interest is tax-deductible and
is payable annually/semi-annually/quarterly.
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• Maturity
• It indicates the length of time for redemption of par value. A company can choose the maturity period,
though the redemption period for non-convertible debentures is typically 7-10 years. The redemption of
debentures can be accomplished in either of two ways:
• (1) Debentures redemption reserve (sinking fund)
• A DRR has to be created for the redemption of all debentures with a maturity period exceeding 18 months
equivalent to at least 50 per cent of the amount of issue/redemption before commencement of
redemption.
• (2) Call and put (buy-back) provision.
• The call/buy-back provision provides an option to the issuing company to redeem the debentures at a
specified price before maturity. The call price may be more than the par/face value by usually 5 per cent,
the difference being call premium. The put option is a right to the debenture-holder to seek redemption at
specified time at predetermined prices.
• Security
• Debentures are generally secured by a charge on the present and future immovable assets of the
company by way of an equitable mortgage
• Convertibility
• Apart from pure non-convertible debentures (NCDs), debentures can also be converted into equity shares
at the option of the debenture-holders. The conversion ratio and the period during which conversion can
be affected are specified at the time of the issue of the debenture itself. The convertible debentures may
be fully convertible (FCDs) or partly convertible (PCDs). The FCDs carry interest rates lower than the
normal rate on NCDs; they may even have a zero rate of interest. The PCDs have two parts:
1) Convertible part,
2) Non-convertible part.

7
Credit Rating
• To ensure timely payment of interest and redemption of
principal by a borrower, all debentures must be
compulsorily rated by one or more of the four credit
rating agencies, namely, Crisil, Icra, Care and FITCH
India.
• Claim on Income and Assets
• The payment of interest and repayment of principal is a
contractual obligation enforceable by law. Failure/default
would lead to bankruptcy of the company. The claim of
debenture-holders on income and assets ranks pari
passu with other secured debt and higher than that of
shareholders–preference as well as equity.

8
• Advantages
• The advantages for company are (i) lower cost due to lower
risk and tax-deductibility of interest payments, (ii) no dilution
of control as debentures do not carry voting rights. For the
investors, debentures offer stable return, have a fixed
maturity, are protected by the debenture trust deed and enjoy
preferential claim on the assets in relation to shareholders
• Disadvantages
• The disadvantages for the company are the restrictive
covenants in the trust deed, legally enforceable contractual
obligations in respect of interest payments and repayments,
increased financial risk and the associated high cost of
equity. The debenture-holders have no voting rights and
debenture prices are vulnerable to change in interest rates.

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 Innovative Debt Instruments

• In order to improve the attractiveness of bonds/debentures, some new features are

added. As a result, a wide range of innovative debt instruments have emerged in
India in recent years. Some of the important ones among these are discussed below.

• Zero Interest Bonds/Debentures (ZIB/D)

Also known as zero coupon bonds/debentures, ZIBs do not carry any

explicit/coupon rate of interest. They are sold at a discount from their maturity value. The
difference between the face value of the bond and the acquisition cost is the gain/return
to the investors.

10
 Deep Discount Bond (DDB)

A deep discount bond is a form of ZIB. It is issued at a

deep/steep discount over its face value. It implies that
the interest (coupon) rate is far less than the yield to
maturity. The DDB appreciates to its face value over
the maturity period.
The DDBs are being issued by the public financial
institutions in India, namely, IDBI, SIDBI and so on.
• Secured Premium Notes (SPNs)
• The SPN is a secured debenture redeemable at a
premium over the face value/purchase price. The
SPN is a tradeable instrument. A typical example is
the SPN issued by TISCO in 1992.
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 Floating Rate Bonds (FRBs)
• The interest on such bonds is not fixed. It is floating and is
linked to a benchmark rate such as interest on treasury bills,
bank rate, maximum rate on term deposits.

• Callable/Puttable Bonds/Debentures/Bond Refunding

• Beginning from 1992 when the Industrial Development Bank

of India issued bonds with call features, several
callable/puttable bonds have emerged in the country in recent
years. The call provisions provide flexibility to the company to
redeem them prematurely. Generally, firms issue bonds
presumably at lower rate of interest when market conditions
are favourable to redeem such bonds.
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 EQUITY/ORDINARY SHARES

• Fundamentals of Equity Shares

• Types
Authorised Share Capital Authorised share capital is the number of
ordinary shares capital that a firm can raise without further
shareholder approval.
Issued Capital The portion of the authorised capital offered by the
company to the investors is the issued capital.
Subscribed Share Capital Subscribed share capital is the number of
share (capital) outstanding.
Paid-up Capital The actual amount paid by the shareholders is the
paid-up capital.
Par (face) Value Par (face) value is a value arbitrarily placed on the
shares.
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Book Value

• The book value of ordinary shares refers to the

paid-up capital plus reserves and surplus (net
worth) divided by the number of outstanding
shares.
• Market Value
• The price at which equity shares are traded in
the stock market is their market value. However,
the market value of unlisted/thinly traded shares
is not available.

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• Equity/ordinary share capital represents ownership capital and
its owners—equity-holders/ordinary shareholders—share the
reward and risk associated with the ownership of corporate
enterprises.
• Features
• The ordinary shares have some special features in terms of the
rights and claims of their holders:
1) Residual claim to income,
2) Residual claim on assets,
3) Right to control,
4) Pre-emptive rights and
5) Limited liability.

• A shareholder can (1) exercise (2) sell in the market and (3)
renounce/forfeit his pre-emptive right partially/completely. He
does not gain/lose from rights issues. However, he would suffer
dilution of financial interest if he does not exercise his pre-
emptive right.
15
• Ordinary share capital is a high-risk-high-reward source
of finance for corporates. The shareholders share the
risk, return and control associated with ownership of
companies.

16
 Hybrid Financing/Instruments

• Preference Share Capital

• Convertible Debentures/Bonds
• Warrants
• Options

17
• A hybrid source of financing partakes some features of
equity shares and some features of debt instruments.
The important hybrid instruments are: preference shares,
convertible debentures/bonds, warrants and options.
• The issue procedure for these instruments is similar to
the raising of equity shares.

18
 Preference Share Capital
• Preference capital is a unique type of long-term financing in that it combines
some of the features of equity as well as debentures. As a hybrid security/form of
financing, it is similar to debenture insofar as:

1) it carries a fixed/stated rate of dividend,

2) it ranks higher than equity as a claimant to the income/assets,
3) it normally does not have voting rights and
4) it does not have a share in residual earnings/assets.
5) It is redeemable after certain period of time subject to maximum period of 20
years . ( No company can issue perpectual preference shares)

• It also partakes some of the attributes of equity capital, namely

1) dividend on preference capital is paid out of divisible/after tax profit, that is, it is
not tax-deductible,
2) payment of preference dividend depends on the discretion of management, that
is, it is not an obligatory payment and non-payment does not force
insolvency/liquidation.

19
 Features
Prior Claim on Income/Assets Preference capital has a prior claim/preference
over equity capital both on the income and assets of the company. In other
words, preference dividend must be paid in full before payment of any
dividend on the equity capital and in the event of liquidation, the whole of
preference capital must be paid before anything is paid to the equity capital.
Cumulative Dividends Cumulative (dividend) Preference shares are
preference shares for which all unpaid dividends in arrears must be paid
along with the current dividend prior to the payment of dividends to ordinary
shareholders.
Redeemability Preference capital has a limited life/specified/fixed maturity
after which it must be retired. However, there are no serious penalties for
breach of redemption stipulation.
Straight Preference Shares Straight preference shares value/price is the
price at which a preference share would sell without the redemption/call
feature.

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Fixed Dividend Preference dividend is fixed and is expressed as a
percentage of par value. Yet, it is not a legal obligation and failure to pay
will not force bankruptcy. Preference capital is also called a fixed income
security.
Convertibility Conversion feature convertibility is a feature that allows
preference shareholders to change each share in a stated number of
ordinary shares.
Voting Rights Preference capital ordinarily does not carry voting rights. It
is, however, entitled to vote on every resolution if (i) the preference
dividend is in arrears for two years in respect of cumulative preference
shares or (ii) the preference dividend has not been paid for a period of
two/more consecutive preceding years or for an aggregate period of
three/more years in the preceding six years ending with the expiry of the
immediately preceding financial year.
Participation Features Participation is a feature that provides for dividend
payments based on certain formula allowing preference shareholders to
participate with ordinary shareholders in the receipt of dividends beyond a
specified amount.
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• Merits
• The advantages for the investors are: (i) stable dividend, (ii) the
exemption to corporate investors on preference income to the
extent of dividend paid out. The issuing companies enjoy several
advantages, namely, (i) no legal obligation to pay preference
dividend and skipping of dividend without facing legal
action/bankruptcy, (ii) redemption can be delayed without
significant penalties, (iii) as a part of net worth, it improves the
credit-worthiness/ borrowing capacity and, (iv) no dilution of
control.
• Demerits
• The shareholders suffer serious disadvantages such as (a)
vulnerability to arbitrary managerial action as they cannot enforce
their right to dividend/right to payment in case of rede-mption, and
(b) modest dividend in the context of the associated risk. For the
company, the preference capital is an expensive source of finance
due to non-tax deductibility of preference dividend.
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 Convertible Debentures/Bonds
Convertible Debentures Convertible debentures give the
holders the right (option) to change them into a stated
number of shares.
Conversion Ratio Conversion ratio is the ratio at which a
convertible debenture can be exchange for shares.
Conversion Price Conversion price is the per share price that
is effectively paid for the shares as the result of exchange of
a convertible debenture.
Conversion Time The conversion time refers to the period
from the date of allotment of convertible debentures after
which the option to convert can be exercised.
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 Warrants
• Warrant is an instrument that gives its holder the right to
purchase a certain number of shares at a specified price
over a certain period time.
• Difference with Convertible Debentures
• Warrants are akin to convertible debentures to the extent
that both give the holder the option/right to buy ordinary
shares but there are differences between the two. While
the debenture and conversion option are inseparable, a
warrant can be detached. Similarly, conversion option is
tied to the debenture but warrants can be offered
independently also. Warrant are typically exercisable for
cash.
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• Features
Exercise Price It is the price at which the holder of a warrant
is entitled to acquire the ordinary shares of the firm.
Generally, it is set higher than the market price of the shares
at the time of the issue.
Exercise Ratio It reflects the number of shares that can be
acquired per warrant. Typically, the ratio is 1:1 which implies
that one equity share can be purchased for each warrant.
Expiry Date It means the date after which the option to buy
shares expires, that is, the life of the warrant. Usually, the life
of warrants is 5-10 years although theoretically perpetual
warrants can also be issued.
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 Lease Financing

Lease is a contractual arrangement under which the

owner of an asset (lessor) allows the use of the asset
to the user (lessee) for an agreed period of time (lease
period) in consideration for the periodic payment (lease
rent). At the end of the lease period, the asset reverts
back to the owner, unless there is a provision for the
renewal of the lease contract.
Essential Elements
Parties to the Contract
There are essentially two parties to a contract of lease
financing, namely, the owner and the user, called the
lessor and the lessee, respectively.
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• Lessor is the owner of the assets that are being leased.
• Lessee is the receiver of the services of the assets under a
lease contract.
• Assets
• The assets, property or equipment to be leased is the subject
matter of a lease financing contract. The asset may be an
automobile, plant and machinery, equipment, land and building,
factory, a running business, an aircraft and so on. The asset
must, however, be of the lessee’s choice, suitable for his
business needs.
• Ownership Separated from User
• The essence of a lease financing contract is that during the
lease tenure, ownership of the asset vests with the lessor and
its use is allowed to the lessee. On the expiry of the lease
tenure, the asset reverts to the lessor.
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• Term of Lease
• The term of lease is the period for which the agreement of
lease remains in operation. Every lease should have a definite
period, otherwise it will be legally inoperative. The lease period
may sometimes stretch over the entire economic life of the
asset (i.e. financial lease) or a period shorter than the useful
life of the asset (i.e. operating lease). The lease may be
perpetual, that is, with an option at the end of lease period to
renew the lease for the further specific period.
• Lease Rentals
• The consideration that the lessee pays to the lessor for the
lease transaction is the lease rental. Lease rentals are
structured so as to compensate (in the form of depreciation)
the lessor for the investment made in the asset, and for
expenses like interest on the investment, repairs and servicing
charges borne by the lessor over the lease period.
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Modes of Terminating the Lease :
At the end of the lease period, the lease is terminated and
various courses are possible, namely,.
- The lease is renewed on a prepetual basis or for a definite
period, or
- The asset reverts to the lessor, or
- The asset reverts to the lessor and the lessor sells it to a
third party or
- The lessor sells the asset to the lessee.
The parties may mutually agree to and choose any of the
aforesaid alternatives at the beginning of a lease term.

29
 Finance Lease and Operating Lease
• Finance Lease
• According to the International Accounting Standards
(IAS-17), in a finance lease the lessor transfers,
substantially all the risks and rewards incidental to
the ownership of the asset to the lessee, whether or
not the title is eventually transferred. It involves
payment of rentals over an obligatory non-
cancellable lease period, sufficient in total to
amortise the capital outlay of the lessor and leave
some profit.

30
 Operating Lease
• According to the IAS-17 and AS-19, an operating
lease is one that is not a finance lease. In a
operating lease, the lessor does not transfer all the
risks and rewards incidental to the ownership of the
asset and the cost of the asset is not fully amortised
during the primary lease period. The lessor provides
services (other than the financing of the purchase
price) attached to the leased asset, such as
maintenance, repair and technical advice. For this
reason, an operating lease is also called a ‘service
lease’.

31
 An operating lease is structured with the following features:

 An operating lease is generally for a period significantly shorter

than the economic life of the leased asset. In some cases, it
may be even on an hourly, daily, weekly or monthly basis. The
lease is cancellable by either party during the lease period.
 Since the lease periods are shorter than the expected life of
the asset, the lease rentals are not sufficient to totally amortise
the cost of assets.
 The lessor does not rely on the single lessee for recovery of
his investment. His ultimate interest is in the residual value of
the asset. The lessor bears the risk of obsolescence, since the
lessee is free to cancel the lease at any time;
 Operating leases normally include a maintenance clause
requiring the lessor to maintain the leased asset and provide
services such as insurance, support staff, fuel and so on.

32
Examples of operating leases are:
a) Providing mobile cranes with operators;
b) Chartering of aircrafts and ships, including the provision of crew, fuel and
support services;
c) Hiring of computers with operators;
d) Hiring a taxi for a particular travel, which includes service of the driver, provision
for main-tenance, fuel, immediate repairs and so on.
Limitations of Leasing
Restrictions on Use of Equipment A lease arrangement may impose certain
restrictions on use of the equipment, acquiring compulsory insurance and so on.
Limitations of Financial Lease A financial lease may entail a higher payout obligation
if the equipment is not found to be useful and the lessee opts for premature
termination of the lease agreement.
Loss of Residual Value The lessee never becomes the owner of the leased asset.
Thus, he is deprived of the residual value of the asset and is not even entitled to any
improvements done by the lessee or caused by inflation or otherwise, such as
appreciation in value of leasehold land.

33
Consequence of Default If the lessee defaults in complying with any
terms and conditions of the lease contract, the lessor may terminate
the lease and take over the possession of the leased asset.
Understatement of Lessee’s Asset Since the leased asset does not
form part of the lessee’s assets, there is an effective
understatement of his assets, which may sometimes lead to gross
underestimation of the lessee.
Double Sales Tax With the amendment of the sales tax law of
various States, a lease financing transaction may be charged sales
tax twice—once when the lessor purchases the equipment and
again when it is leased to the lessee.

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 Hire-purchase
• Hire purchase is an arrangement for buying
expensive consumer goods, where the buyer
makes an initial down payment and pays the
balance plus interest in installments. The term
hire purchase is commonly used in the United
Kingdom and it's more commonly known as an
installment plan in the United States.
• With hire purchase agreements, the ownership of
the merchandise is not officially transferred to the
buyer until all the payments have been made.

35
 Advantages of Hire Purchase Agreements

• Like leasing, hire purchase agreements allow companies with

inefficient working capital to deploy assets. It can also be
more tax efficient than standard loans because the payments
are booked as expenses—though any savings will be offset by
any tax benefits from depreciation.
• Businesses that require expensive machinery—such as
construction, manufacturing, plant hire, printing, road freight,
transport and engineering—may use hire purchase
agreements, as could startups that have little collateral to
establish lines of credit.
• A hire purchase agreement can flatter a company's return on
capital employed (ROCE) and return on assets (ROA). This is
because the company doesn't need to use as much debt to
pay for assets.
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 Disadvantages of Hire Purchase Agreements

• Hire purchase agreements usually prove to be more expensive in the long

run than making a full payment on an asset purchase. That's because
they can have much higher interest costs. For businesses, they can also
mean more administrative complexity.
• In addition, hire purchase and installment systems may tempt individuals
and companies to buy goods that are beyond their means. They may also
end up paying a very high interest rate, which does not have to be
explicitly stated.
• Rent-to-own arrangements are also exempt from the Truth in Lending
Act because they are seen as rental agreements instead of an extension
of credit.
• Hire purchase buyers can return the goods, rendering the original
agreement void as long as they have made the required minimum
payments. However, purchasers suffer a huge loss on returned or
repossessed goods, because they lose the amount they have paid
towards the purchase up to that point.
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 Venture Capital

• Venture capital (VC) is a form of private equity and a

type of financing that investors provide
to startup companies and small businesses that are
believed to have long-term growth potential. Venture
capital generally comes from well-off investors,
investment banks, and any other financial institutions.
• Venture capital is typically allocated to small companies
with exceptional growth potential, or to companies that
have grown quickly and appear poised to continue to
expand.

38
 Private Equity

• Private equity is an alternative investment class and consists of

capital that is not listed on a public exchange. Private equity is
composed of funds and investors that directly invest in private
companies, or that engage in buyouts of public companies,
resulting in the delisting of public equity. Institutional and retail
investors provide the capital for private equity, and the capital can
be utilized to fund new technology, make acquisitions, expand
working capital, and to bolster and solidify a balance sheet.
• Private equity investment comes primarily from institutional
investors and accredited investors, who can dedicate substantial
sums of money for extended time periods. In most cases,
considerably long holding periods are often required for private
equity investments in order to ensure a turnaround for distressed
companies or to enable liquidity events such as an initial public
offering (IPO) or a sale to a public company.

39
40
 Bought out Deal

• A bought deal is a securities offering in which an investment bank commits

to buy the entire offering from the client company. A bought deal
eliminates the issuing company’s financing risk, ensuring that it will
raise the intended amount. On the flip side, taking this approach, rather
than pricing the offering via the public markets with a preliminary
prospectus filing, usually results in the client firm getting a lower price.
• A bought deal is relatively risky for the investment bank. This is because
the investment bank must turn around and try to sell the acquired block
of securities to other investors for a profit. The investment bank assumes
the risk of a potential net loss in this scenario, as the securities might lose
value and sell at a lower price, or not sell at all.
• To offset this risk, the investment bank often negotiates a significant
discount when buying the offering from the issuing client. If the deal is
large, an investment bank may team up with other banks and form
a syndicate, so that each firm bears only a portion of the risk.

41
 Private placement

• A private placement is a sale of stock shares or bonds to pre-

selected investors and institutions rather than on the open
market. It is an alternative to an initial public offering (IPO) for a
company seeking to raise capital for expansion.
• Investors invited to participate in private placement programs
include wealthy individual investors, banks and other financial
institutions, mutual funds, insurance companies, and pension
funds.
• One advantage of a private placement is its relatively few regulatory
requirements.

42
 IPO

• IPO Process in India

• Understanding The Need For IPO Process

• A company can change itself from a privately-held body to a publicly-traded entity through
the process of Initial Public Offering (IPO). Typically, companies offer IPO to raise money
and get access to liquidity by offering their stocks/shares to the public. Companies have to
abide by the IPO process in India - as stipulated by stock exchanges - before its shares are
eligible to be publicly traded. This process is often complicated and long-drawn.
• Hiring Of An Underwriter Or Investment Bank
• To start the initial public offering process, the company will take the help of financial
experts, like investment banks. The underwriters assure the company about the capital
being raised and act as intermediaries between the company and its investors. The experts
will also study the crucial financial parameters of the company and sign an underwriting
agreement. The underwriting agreement will usually have the following components:
• Details of the deal
• Amount to be raised
• Details of securities being issued

43
• Registration For IPO
• This IPO step involves the preparation of a registration statement along with the draft
prospectus, also known as Red Herring Prospectus (RHP). Submission of RHP is mandatory, as
per the Companies Act. This document comprises all the compulsory disclosures as per the
SEBI and Companies Act. Here’s a look at the key components of RHP:
• Definitions: It contains the definitions of the industry-specific terms.
• Risk Factors: This section discloses the possibilities that could impact a company’s finances.
• Use of Proceeds: This section discloses how the money raised from investors will be used.
• Industry Description: This section details the working of the company in the overall industry
segment. For instance, if the company belongs to the IT segment, the section will provide
forecasts and predictions about the segment.
• Business Description: This section will detail the core business activities of the company.
• Management: This section provides information about key management personnel.
• Financial Description: This section comprises financial statements along with the auditor's
report.
• Legal and Other Information: This section details the litigation against the company along with
miscellaneous information.
• This document has to be submitted to the registrar of companies, three days before the offer
opens to the public for bidding. Alongside, the submitted registration statement has to be
compliant with the SEC rules. Post-submission, the company can make an application for an
IPO to SEBI.

44
• Verification by SEBI:
• Market regulator, SEBI then verifies the disclosure of facts by the
company. If the application is approved, the company can announce a
date for its IPO.
• Making An Application To The Stock Exchange
• The company now has to make an application to the stock exchange for
floating its initial issue.
• Creating a Buzz By Roadshows
• Before an IPO opens to the public, the company endeavors to create a
buzz in the market by roadshows. Over a period of two weeks, the
executives and staff of the company will advertise the impending IPO
across the country. This is basically a marketing and advertising tactic to
attract potential investors. The key highlights of the company are shared
with various people, including business analysts and fund managers. The
executives adopt various user-friendly measures, like Question and
Answer sessions, multimedia presentations, group meetings, online
virtual roadshows, and so on.
45
• Pricing of IPO
• The company can now initiate pricing of IPO either through Fixed
Price IPO or by Book Binding Offering. In the case of Fixed Price
Offering, the price of the company’s stocks is announced in
advance. In the event of Book Binding Offering, a price range of
20% is announced, following which investors can place their bids
within the price bracket. For the bidding process, the investors
have to place their bids as per the company’s quoted Lot price,
which is the minimum number of shares to be purchased.
Alongside, the company also provides for IPO Floor Price, which is
the minimum bid price and IPO Cap Price, which is the highest
bidding price. The booking is typically open from three to five
working days and investors can avail the opportunity of revising
their bids within the stipulated time. After completion of the
bidding process, the company will determine the Cut-Off price,
which is the final price at which the issue will be sold.
46
• Allotment of Shares
• Once the IPO price is finalised, the company
along with the underwriters will determine
the number of shares to be allotted to each
investor. In the case of over-subscription,
partial allotments will be made. The IPO stocks
are usually allotted to the bidders within 10
working days of the last bidding date.

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 Consequences of a Right Issue

• Illustrative data of XYZ ltd

• Paid-up equity capital (1,000,000 shares of Rs.10
each) 10,000,000
• Retained earnings 20,000,000
• Earnings before interest & tax 12,000,000
• Interest 2,000,000
• Profit before tax 10,000,000
• Taxes (50%) 5,000,000
• Profit after tax 5,000,000
• Earnings per share 5
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• Market price per share (price earnings ratio of
8 is assumed)
40
• Number of additional equity shares proposed
to be issued as rights shares
200,000
• Proposed subscription price
20
• Number of existing shares required for a rights
share (1,000,000 / 200,000) 5

• Calculate value of a share, value of a right and

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• Value of a Share, after the rights issue, is
expected to be

• Where N is the number of existing shares

required for a rights share
• Po is the cum-rights market price per share
• S is the subscription price at which the rights
share are issued

• Rs. 36.67
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• Value of a Right

• = Rs. 16.67

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 Wealth of Shareholders (who owns 100 equity shares)

• When he exercises his rights

• Market value of original shareholding at the rate of Rs.40 per share

4,000
• Additional subscription price paid for 20 rights shares at the rate of
Rs.20 per share 400
• Total investment
4,400
• Market value of 120 shares at the rate of Rs.36.67 per share after
the rights subscription
4,400
• Change in wealth (4,400-4,400=0)
Nil
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 When he sells his rights
• Market value of original shareholding at the rate of
Rs.40 per share 4,000
• Value realized from the sale of 20 rights at Rs.16.67
per share 333
• Market value of 100 shares held after the rights issue
at the rate of Rs.36.67 per share 3667

• Change in wealth (3667+333-4000=0) 0

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 He allows his rights to expire
• Market value of original shareholding at the
rate of Rs.40 per share 4000
• Market value of 100 shares held after the
rights issue at the rate of Rs.36.67 per share
3667
• Change in wealth (3667-4000) (333)

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