Session 2 Mergers & Acquisitions: An Introduction as Globalization Forces

8/14/2019 Session 2 Mergers & Acquisitions: An Introduction as Globalization Forces

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Session 2Mergers & Acquisitions: An Introduction

As globalization forces corporations to concentrate on core areas andenhance inherent strengths, Indian companies are looking at M&A

activity with renewed interest.The volume of M&A deals in India as steadily increased over the lastdecade, largely due to:

An improved regulatory environment in the liberalized Indianeconomy.

A shift of Indian entrepreneurial thinking away from diversifiedconglomerates towards more focused companies.

An influx of MNCs using the M&A route to enter the Indianmarket.

Objectives:A merger/ acquisition would be attractive to the shareholders of therespective companies, if it increases the value of their shares.

Value creation may result from a number of factors such as:

Economies of scale in production and distribution.

Technology transfer.

Acquisition of new channels of distribution.

Cross-selling of products.

Merger vs. Acquisition:

In a merger, the surviving company assumes all the assets andliabilities of the merged company, which ceases to exist as a separateentity.

In an acquisition, the buyer purchases some or all the assets or thestock of the selling firmLegal requirements, tax considerations, and the ability to attainshareholder approval determine the type of transaction chosen.

Difference between buying and selling:


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Both are dependent upon each other for a successful transactionoutcome.

Even though both may have opposing viewpoints with respect to thespecific final process and outcome objectives, both also have a vested

interest in making the process proceed to a productive and profitableconclusion.

The basic difference between buying and selling can be summed upas:

The buyer is looking for future value to be derived from thepurchase. Toward this end, the buyer is looking to purchase themaximum amount of company for lowest possible price.

The seller wants to sell for the highest possible price combinedwith the fewest number of future entanglements.

Buyers and sellers in a strategic merger are looking for a lastingpartnership relationship that benefits buyer, seller, and their respectiveshareholders. They act in good faith.

Preparing to buy and sell:

A common misconception is that a business manager can decideto buy or sell a company today, and simply close the deal withina few weeks.

That might be the case on rare occasions, but an M&A

transaction is usually complicated and may take months, or evenyears in some rare cases, to finalize.

If you are selling, you must prepare your company to look asappealing as possible to a potential buyer.

If you are buying, you must do some homework to determine theproper selection criteria for determining the optimal acquisitiontarget company.

Consideration items for seller:

Your legal structure should be in order so that there are nounexpected legal, tax, or litigation issues that will catch you or aprospective buyer by surprise.

Your financial reports should be auditable with a minimal numberof red flags (problems) coming to the surface.


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Your operational plans should be standardized so that anotheruninitiated party can understand the value intrinsic to what youdo.

Your personnel and management should be stable andexperienced, because a prospective buyer will often want the

management team to transfer with the company whenpurchased.

Sellers might find that their company runs better with all of thesevalue-enhancing factors in place which makes their implementation agood idea for all parties involved.

Buyers are well served by giving advance consideration to:

What is strategic fit between your company and the proposedacquisition target? the desired

What are the financial parameters within which the acquisitionmust conform? These parameters may include annual sales,expected purchase price, financial structure, ownership, andothers.

What are the desired personnel requirements between theacquired management and that of your company?

Are there intrinsic economies of scale parameters that qualify ordisqualify a potential acquisition target?

What levels of technology and engineering are required toenable the acquired company to meet the buyers technologygoals?

The more that a buyer understands his or her motivations for acquiringanother company, the more effective the buyer will be at separatingthe unlikely candidates from those that present the highest likelihoodof a successful transaction.

Both Buyer and Seller should form an M&A team ofprofessionals and managers who will work togetherthroughout the process:

An accountant for assistance on the financial side of thetransaction.

An M&A attorney who is experienced with transactions of yourtype, whether a privately held, publicly held, or nonprofitorganization.

A tax attorney (who might be the same person as the M&Aattorney, but does not necessarily have to be).


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Key members of your management team who understand thebusiness aspects of the transaction. Select these personnelbased on previously determined strategic business goals for theM&A transaction.

You might want to investigate investment bankers who can

assist you with finding either a buyer or a seller, depending onyour side of the transaction.

Finally, you must ensure secrecy on the part of all peopleinvolved.

In summary, buyers should not expect to find the right deal unlessthey have done the homework needed to recognize that deal. Sellersmust make themselves as attractive as possible and must understandtheir most likely buyer, if they plan to get the highest possible price fortheir company.

Step I: Finding the Right CandidateFew items to consider as initial filtering criteria:

The maximum and minimum revenue range.

Geographic location.

Years in business.

Market share.

Reputation (either good or poor).

Distribution channels.

Technology provided.

Corporate culture.

Specific business strengths, such as R&D, sales/marketing, orproduction.

Low-cost as opposed to high-price provider.

Services or products provider.

Industry.

Publicly traded or privately held.

Reputation of the management team.

Services of an investment banker at this initial qualificationstage:

These companies take a percentage of the transaction total(usually five to fifteen percent) for assisting with the initialsearch and with the consummation of the final deal.

Using a broker usually speeds up the filtering stage of theacquisition process, but it is not cost-free.

Remember that their fees must be paid at some point and areembedded into the purchase price.


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Session 3

Additional considerations to be noted:The M&A process can become quite complicated unless the transactionvalue is small and the number of parties involved are few:

The Buyer has a team of experts, as does the seller.

Should either party be involved publicly traded company, thecomplexity increases again?

Should either party be involved in litigation of any kind, thecomplexity increases yet again?

Step II: Initiate Discussions

The seller and buyer will have a number of internal meetingsearly in their respective processes that help define thevarious objectives of the purchase/sale.

Notice that none of these meetings involve anyone outsideof the immediate company since this is the planning stagefor both buyer and seller respectively.

The next meetings often involve a business broker who will assistin either marketing the firm if you are the seller or finding viableacquisition targets for the buyer.

Once the target companies are determined, initial meetings willbe set up to investigate the willingness of the parties to eitherbuy or sell.

After these initial meetings, a letter of intent (or letter of

understanding or expression of interest) is oftenprepared stating both parties desires to proceed to thenext step

o This letter is critically important because it represents a

written understanding between the parties involved.o A letter of intent can be effectively used as a

communication tool that ensures that both partiesare working in the same direction and with the sameoverall intentions.

The seller and buyer both have a vested interest in finding deal-stoppers at an early stage.

Step III: The Due Diligence Stage

Due diligence is usually the most time-consuming, nerve-wracking, and expensive stage of the M&A process.

The intent of this stage is to help the buyer understandthe inner workings of the sellers company.


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o The better the understanding, the more realistic the

expectations and price.

It requires that the buyer be given a high degree ofaccess to the selling companys customers, financialrecords, legal records, and operations, sales, and

marketing functions. The due diligence teams are typically looking for items that

either validate the offered price or items that diminish thecompanys value and its purchase price.

What happens when both parties are direct competitors in thesame industry space and there is a possibility of the deal

falling through?

What happens when both parties operate in the same industryspace?

The seller does not want to reveal unnecessary information tothe buyer, should the deal not consummate in a final purchase.

This fear of disclosure is particularly acute when the buyer is thesellers direct competitor, and for very good reason.

Every company would love to know the detailed financial,marketing, and sales aspects of its competition, and duediligence requires that this information be disclosed.

Should the transaction fall apart, the seller is placed at a decideddisadvantage compared to the buyer, who disclosed little or noconfidential information about its own internal processes duringdue diligence.

Once again, the letter of intent comes into play

Sellers should make their secrecy boundaries clearlyknown in the letter of intent.

The buyer can either accept or reject those boundaries at thisearlier stage instead of being caught by surprise later.

Non disclosure agreements (NDAs) are also executedearly in the process specifically with the intent of protectingthe secrecy needs of the parties involved.

Alternate approach

As an alternative approach to immediate full disclosure to thebuyer by the seller, an interim stage can be defined.

Here, the buyer gains access to certain information with theintention of deciding on a purchase price and set ofacceptance conditions.


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This approach provides both the seller and buyer with some levelof protection

Duediligence, by its very nature, pushes the threshold ofconfidential information disclosure and should be treatedwith the respect it deserves.

Step III A: A sample due diligence checklist

A legal structure review, including tax liabilities, employeedisagreements, any other pending litigation.

A review of ownership and capitalization structure.

A general breakdown of the customer base, with a more detailedanalysis required to make an effective assessment.

A review of intellectual property rights, including trademarks,patents, and other areas of unique and intrinsic value. This isparticularly true for technology companies.

Outstanding loans that are guaranteed by the company and/orits owners.

Technology evaluation that includes development tools, cycles,processes, and personnel. Key value areas should be highlightedand evaluated in light of acquisition goals.

Financial statement review for the prior three to five years,including the minutes of board meetings and so on.

Annual reports and required stock exchange filings for anypublicly traded company. This action can also be taken duringthe prequalification screening stages.

Due diligence process in conclusion

Due diligence is a complicated process which should be givenmajor emphasis.

It is that stage where the buyer determines whether the targetcompany is worth pursuing.

Sellers also get a chance to learn more about the internalworkings at the buyers company, which also enables them todetermine for themselves if a cultural fit between the two exists.

A willing seller is critical during due diligence. The integrity of all

parties must be intact or the seller could fight the buyersinformation requests at every step, making it a tough andstressful process for all concerned.

Further, due diligence works both ways, especially if the buyerexpects the seller to take stock.

Due diligence is an integral and critical part of the M&A process.The way it is handled tells a lot about the buyer and seller while


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providing the foundation upon which a final purchase price isbased.

The more the buyer and seller know about each other, themore accurately they can assess the likelihood of a successful

future business relationship. Plan for this process to take time.Spend the required time in the due diligence stage andthoroughly understand what you are committing to with the

sale or purchase.

Session 4

Arranging finance:

Financing depends on the financial condition of the acquiredcompany as well as the acquiring company.

The buying and/or selling company must be creditworthy or thedeal will simply not go through.

Buyers have usually lined up financing when the letter ofintent is signed sellers can ask about the buyers ability

to fund the purchase before signing the LOI. Sellers may seriously consider stalling the M&A stage until the

buyer has shown itself to be creditworthy.

Negotiating & signing agreements:

The lawyers begin negotiating the specific terms and condition ofthe deal.

The role of the business manager is to make sure the overallbusiness intentions are met.

The end result should be a legally binding agreement that also

makes business sense.

Valuation methodologies for an M&A transaction:

Valuation is not an exact science; more an art.

Valuation is essentially bringing together the economic conceptof value.


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Decision to accept the valuation lies with the management ofboth the acquirer and the target.

Courts do not disturb the Exchange Ratio unless it isobjected and found grossly unfair.

Structure of value:

Valuation methodologies for an M&A transaction

Selection of Method:

History and nature of business.

Economic outlook for the company and the industry in which itoperates.

Prior sale of the firms equity, if any.

Market value of other firms which are traded actively in the freeand open market.

Combination of 2/3 methods e.g. asset value, forecasted value,EBITDA multiple.

Decision of the Indian courts in the past.

Discounted Cash Flow Approach:

This methodology is used to determine present value of abusiness on a going concern assumption.

A DCF technique primarily depends on the projection of futurecash flows and selection of an appropriate discounting factor.


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Enterprise Value is derived based on summation of:o projected cash flows over a specified projected period

(Primary period); ando cash flows to perpetuity that a company will generate after

the Primary period.

Equity value is equal to Enterprise value less Net Debt. Computation of Cost of Capital.

Cost of Capital:

Cost of capital iso A function of the investment and the investor

o Forward looking and represents investors expectations

The principal factors which influence the risk-free rate, equityrisk premium and level of the beta are as follows:

Forecasting performance:

Forecast period has the following characteristics:o Forecast should be the most likely figures.

o The forecasting process should be able to give insightful

information about the overall business risk.o The length of the forecast period is very critical and should

include the period of accelerated growth or risk.

The steady state period has the following characteristics:o Constant or steady rate of growth in line with mature

industry.o Capital expenditure and in depreciation are substantially

balance.o Rate of return remains substantially constant.

Terminal value growth rate:


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o Assumed perpetuity growth rate for the Company being

valued i.e. the growth rate at which the Company wouldcontinue to grow to perpetuity.

o The perpetuity/terminal growth rate is assumed based on

the status of industry and evolution of business.

DCF valuation A sample:

Market Multiples:

Comparable companies:

In arriving at the selected range of multiples applied to thecompanys earnings we consider the overall dynamics of thesector. We also include an analysis of the level of sales multiplesagainst absolute sales and also EBITDA multiples againstEBIT margins.

In arriving at the level of multiple to apply, we have to considercompanies that are broadly in the same size.

Based on the specific characteristics of the company we considermultiples in the range that are appropriate in the circumstances.

Sample spreadsheet:


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In assessing the level of multiple applied to the company, wealso consider takeover premia paid in the market and the level oftransactions in the sector.

Based on the specific characteristics of the company wecalculate multiples in the range to be appropriated in thecircumstances.

Sample spreadsheet:

Other Methods:

Net Assets Method:

Assets at historical cost or replacement cost on valuation dateconsidered:

o Intangible assets

o Revaluation of fixed assets

o Deferred tax asset/ liabilities

Outstanding liabilities deducted.

Some adjustments that may be called for:o Contingent liabilities

o Investments and Surplus assets

o Inventory and Debtors

Valuation methodologies for an M&A transactionSources of information:

Historical data such as audited results of the companies beingvalued.

Discussions with the management of the companies involved.


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Future projections.

Market surveys, newspaper reports.

Representation by the management.

Stock market quotations.

Data on comparable companies.

Some issues associated with undertaking valuation:

Value of surplus assets.

Replacement value - reliance on valuers report.

Investments/marketable securities.

Contingent liabilities.

Unusual fluctuation in market prices.

Review of projections - Underlying assumptions.

Findings of due diligence reviews.

Tax benefits e.g. Sales Tax exemption. Dilution of equity ESOP, Convertible instruments.

Selecting methods to be employed.

Assigning weightage to the values arrived as per differentmethods.

Consensus for exchange ratio.

Exchange Ratio how it works?


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Conclusion:

Understanding of business is key to valuations.

Valuation is an art, however objectivity and consistency shouldprevail.

Session 5

Steps towards closure of a transaction:

Financial model of the merger

A detailed analysis of the effect of the merger on shareholdervalue requires building financial models of the acquirer, thetarget, and the merged firm.

The financial models should produce income statements,balance sheets, and cash flow statements for the forecastperiod for a given set of operating and financingassumptions.

The financial model permits performing the following analyses:

Free cash flow valuation:


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Valuation of the stand-alone acquirer, the target and the mergedfirm.

The Target is valued under the operating assumptions assumedby the acquirer decision.

Break-even synergies:A first calculation of the value of the synergies net of transactionexpenses necessary to maintain the share price of the acquirer at itspre-merger level

Accretion dilution analysis:

Calculation of EPS for the Acquirer with and without theacquisition.

An estimate of the synergies required to breakeven.

Stress testing and scenario analysis:

Accretion-dilution and valuation computations should be tested forrobustness, via sensitivity and scenario analysis.

Finalizing the terms of the merger:

Form of payment whether in cash, stock of or acombination both.

The type of transaction adopted for the tax purposes (whether amerger, a purchase of assets or a purchase of stock):

o The tax consequences of the transaction for buyerand seller, and whether there are transferable netoperating losses.

The fees and expenses to be paid by the parties.

Financing the merger

How the cash component of the price and the transactionexpenses will be financed, whether from available cash inthe target and/ or the acquirer or with additionalborrowing?

What pre-merger debt and other claims such as preferred stockand warrants are assumed or exchanged and what claims are tobe retired, at what cast and how will retirements be financed.

This is summarized in a statement of sources and uses offunds.

Conclusion:

The financial analysis of the merger is an iterative processthat assists the buyer in carrying out due diligence, testingthe consistency of the merger assumptions, formulating theterms of the offer, and reaching a decision.


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Negotiating an acquisition is a process of give and take as theparties get comfortable with each other and learn about theirintentions.

A flexible financial model will assist the acquirer during thenegotiation process by showing the financial and value

implications of alternative deal terms. Reaching a final agreement may require the addition of earnouts,

collars, escrows, and other contingencies to the terms of the mergerin order to close the valuation gap separating buyer and seller.

Types of M&A:

Vertical Mergers:

Mergers of firms that produce goods or services that representthe output of successive stages of the same vertical chain.

A vertical chain represents the various stages from rawmaterial inputs to the final product sold to the customer,e.g. from iron ore to steel products sold to automobilemanufacturers.

The different stages of the vertical chain are also referred to asdownstream or upstream activities in the flow of the productionprocess.

At any stage in the vertical chain the activities thatprecede that stage are up stream to that stage and allactivities that follow are downstream.

Vertical integration as a make or buy decision:

The decision to internalize production of an input ratherthan source it from an external supplier is akin to amake or buy decision.

The decision has to be made on the balance of costs andbenefits of either alternative.

The buy decision may be implemented in a variety of ways:o In a spot market transaction, the product is sold in a spot

market characterized by a large number of sellers from

whom it could be bought for immediate delivery and at aknown price in an arm length transaction.

Why does a firm seek to replace market-based transactions orsupplier contracts with internal production?

The choice between external arrangements and internalizationthrough vertical merger is based on the relative costs and


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benefits of external versus internal coordination of the activitiesin a vertical chain.

o Current and future availability of spot markets for arm-

length transactions.o Cost of sourcing from the spot market.

o Direct and indirect costs of contracts and informalarrangements.

o Uncertainty and information asymmetry between buyer

and seller.o Direct and indirect costs of internalizing production.

Benefits and Cost of buying in markets:

Benefits of buying

Cheapest supplier if market is competitive.

Supplier able to maximize scale and learning economies.

Allows efficiency, increasing division of labour and specialization.

Motivated to enhance production efficiency.

Supplier has high incentive to keep up with newtechnology.

Avoids internal coordination costs.

Costs of Buying

Quality and delivery.

Uncertainties.

Supplier products if branded maybe too constly.

Suppliers of specialized products too few and hence costly. Problems in coordinating production flows through vertical

chains.

Leakage of private information to supplier and possiblerivals.

Transaction costs high relative to.

Internal production.

Horizontal Mergers:

Where firms selling products that are not identical interms of end-use but nevertheless share certaincommonalities, such as technology, markets, marketingor channels, branding knowledge base, merge, we referto such mergers as related mergers.

The term related is thus more widely and looselydefined than horizontal.


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Horizontal mergers often characterize industries andmarkets whose products are generally in the mature ordeclining stages of the product life cycle.

The overall growth rate of these markets is low and firms havebuilt up production capacity that far exceeds in demand.

Combination of low market growth and excess capacity placespressure on firms to achieve cost efficiencies throughconsolidating mergers. Such efficiencies may result from scale,scope and learning economies.

Characteristics of mature industries:

Low overall growth in demand for the industry products.

Excess capacity.

A small number of large competitors.

Considerable price pressure and pressure to reduce costs.

Sources of value creation in horizontal mergers:

Revenue enhancing while maintaining the existing cost base.

Cost reducing while maintaining the existing revenuelevel.

Generating new sources and capabilities that lead to revenuegrowth or cost reduction.

Sources of value in horizontal mergers:

Session 6

Leveraged Buyouts


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When a group of investors finance the acquisition of acorporation or division mainly by borrowing against thetargets future cash flows, it is referred to as an LBOtransaction.

The buyout is organized and effected by the promoters,

which include a financial sponsor/ investor and, often,existing management as well.

When the latter is an important part of the transaction, iteffectively controls the acquisition.

LBOs are financed mainly with secured bank debt andunsecured subordinated debt.

By changing the relative participation of debt and equity in thecapital structure, an LBO redistributes returns and risks amongthe providers of capital.

In addition, the total expected return could be greater than thatof the original company because of larger tax shields and therealization of additional operating gains.

Why do LBOs take place?

It is the ability to act quickly in appraising and structuring atransaction that gives buyout specialists a competitiveadvantage over other buyers, including large corporations withseveral levels of decision making.

For a buyout to take place, its promoters must believe thatthey can increase free cash flows above the levelexpected by the seller.

In the case of MBOs, management teams typically want togain independence and autonomy, apart from having thepower to influence strategic decisions and give thecompany future direction.

Why do MBOs take place?

MBOs involve the management wanting to purchase acontrolling interest in the company and working alongwith financial advisors to fund the change of control.

Management teams typically want to gain independence and

autonomy, apart from having the power to influence strategicdecisions and give the company future direction.

o MBO through PE-funding enables not only this, but

also provides the much-needed capital gain.

If the management decided to sell the company to a new firm itwould most likely not only bring with it a new managementteam, but would also leave existing management without a sayin strategy matters.


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It saves the PE house the trouble of finding a new set of skilledmanagement to run the new business.

Who is an ideal LBO candidate?The desirable characteristics are:

A firm with predictable revenues and cash- generatingcapacity.

Competent management that understands the demandsimposed by the financial structure of the LBO as the focusshifts to cash generation and debt retirement.

The nature of the companys assets is also important,particularly the possibility of reducing working capital and theresale market for the company as a whole or for some of itsassets, which can provide future financing and an exit to thepromoters investment.

Where do the candidates come from?

A large firm that wants to sell a unit for lack of fit butcannot find a corporate buyer. At that point, themanagement team may come up with a buyout offer orthe corporation itself may suggest it to the managers.

o The seller may hire an investment banker to run an auction

and private equity potential may be invited to participate.

The management of the LBO candidate approaches a fund orbank, or the latter approaches management with the idea oforganizing an LBO for the firm because either party believes thecompany would become more valuable under the LBOorganization.

Exit Options:

LBO are typically transitory forms of ownership:o During the buyout period, management attempts to

improve operations, and the financial sponsor looks for atransfer of ownership to a more permanent owner.

Exit can be made via

o an IPO to recapitalize the firm once debt has been reduced

to a manageable level.o sale to strategic buyers of all or part of the original

company; oro another LBO to provide some liquidity to the financial

sponsor and higher ownership to management.


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Financing LBOs:LBO financing is provided by:

o secured debt financing from banks, and other institutional

investors;

o the high-yield public market for corporate debto sellers willing to accept debt for the price (vendor

financing)

Debt capacity and affordable price:

Debt capacity is an estimate of how much the company canborrow against its expected cash flow and still be able toamortize senior debt and pay interest to both senior andsubordinated debt.

The use of debt capacity determines how much is left to equity-

holders to exit time.

Risks associated:

If the new company does not achieve the desired results, the PEhouse can sell the company soon after buying it.

If there is conflict between existing management and the PEinvestor over company perspectives/aims/goals, in such casesthe MBO won't be very successful.

PE firms aim to maximize their returns and exit after three to fiveyears and the management is more concerned with the wellbeing of the company and the jobs and therefore may not be tooforthcoming when taking risks.

Further, the management is trying to protect short-term earningsand stock prices since their own compensation is also linked tothe company's performance.

This difference in perspective and aim can cause investor andmanagement conflict

Additionally, an important factor to consider before entering intoa buyout agreement with the existing management is thecommercial viability of the business as an independent or

standalone entity.

Case Study: Blackstone Concludes Management Buyout OfIntelenet BPO (2007):

Structuring of the deal:


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A Special Purpose Vehicle (SPV) was floated into which bothHDFC and Barclays (Original Promoters) transferred their stake inIntelenet Global Services, a major BPO operator.

Post the transaction, Intelenets management and employeeswere to hold 20 per cent and Blackstone to own 80 per cent of

the SPV, which now owns the Target Company. Management team

o Intelenets existing management team, led by Mr. Susir

Kumar, CEOo Two representatives of Blackstone India and two others

from Blackstones New York office joined the companyboard of management.

Largely, BSs role would be limited largely to openingaccess to customers through its portfolio companiesand helping the company with its inorganic growthplans.

o It maybe noted that around 300-400 employees in thesenior management of Intelenet became the shareholdersin the firm.

Expected exit strategy for Blackstone: IPO

Actis buyout of Phoenix Lamps for USD 700 MN in 2006.o Actis introduced the management of Phoenix Lamps to newer

suppliers, reducing production costs and provided numerouscustomer introductions enhancing revenues.

o Further, they provided access to technology enabling Phoenix

Lamps to develop into a complete lighting solutions company.

ICICI Venture has done four management buyouts - Tata Infomedia,ACE Refractories (from ACC), Ranbaxys Fine Chemicals and VATech..

Session 7Corporate Restructuring: divided into

Business Restructuring.

Distress Restructuring.

Key Aspects:


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Business Restructuring:

It is a change in the nature of the company businessaccomplished by total or partial disposition of some of theassets and liabilities held by the company and the possibleacquisition of others.

Identification of distinct business undertakings is a pre-requisite forrealizing the true worth of the Business.

Pre-requisite from an Investors perspective (explained by wayof an illustration below):

Issue of shares may be undertaken in favor of theinvestor- Indian/ foreign.

Investment of funds by foreign investor is regulated by ForeignDirect Investment (FDI) policy. Implications under FDI policyneeds to be examined in case of investment by a foreigninvestor.

Restructuring of businesses may be carried out under thefollowing illustrative modes:


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De merger/ slump sale.

Amalgamation/ merger.

Hiving off of business entities may be carried out by way of aDe merger / Slump sale:

De-merger / Slump sale contemplate transfer of an undertaking asper the provisions of the Indian tax laws. Undertaking may bedefined as a combination of assets and liabilities constituting abusiness activity as a whole.

Advantages of hiving off businesses:

Creation of business focused entities.

Creation of focused managements which enable each companyto build upon its core competencies and pursue its own strategicobjectives.

Unlocking shareholders wealth.

Amalgamation/ Merger:

Amalgamation refers to consolidation of two or moreEntities

Amalgamation under the Indian tax laws contemplates transfer of anundertaking. Undertaking may be defined as a combination of assetand liabilities constituting a business activity.

Advantages:

Achieving economies of scale.

Increase competitiveness of the resulting entity.

Synergies in operations.


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Some of the issues to be considered for BusinessRestructuring:

IPO:

The first sale of stock by a private company to the public. IPOsare often issued by smaller, younger companies seeking thecapital to expand, but can also be done by large privately ownedcompanies looking to become publicly traded.

Usually, a company will offer stock to the public in anattempt to raise capital to invest in expansion or growth.

o There are instances of companies offering stock because of

liquidity issues (i.e. not enough cash to pay the bills), butinvestors should be wary of any offering of this type.

An IPO would maximize the proceeds to the seller only if themarket impounds its stand-alone value in to its share price.


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If the owner is simply trying to attain corporate clarity, a spin-off,which involves distributing shares to existing shareholders givingownership in the separate entity, is a direct way of transferringownership.

An initial public offering in which a parent company spins off one

of its subsidiaries or divisions, but retains a majority stake in thecompany after issuance is called Minority/ Carve Out IPO.

o This means that after the public offering, the parent

company will still have a controlling stake of the new publiccompany.

A crave-out can reduce the possible drag on value due to theinformation gap between management and investors.

Once investors have had time to evaluate the newly tradedcompany and the carve-out has proved itself in the market place,the rest of the retained stock be offered to the public.

Empirical evidence shows that the announcement of voluntary

spin-offs has a positive effect on the stock of the company doingthe spin-off.

Additional Items

Back Door/ Reverse Listing

Green-shoe Option

Underwriting

Follow-on offering

Sum-of-parts Valuation

Prospectus:

o Red Herringo Final

o Rights Issue

Session 8

Capital Structure and Leverage

Leverage, refers to the amount of fixed costs a firm haso Fixed costs may be fixed operating expenses, such as

building or equipment leases, or fixed financing costs, such

as interest payments on debt. Greater leverage leads to greater variability of the firms after-tax

operating earnings and net income.

Business risk refers to the risk associated with a firm operatingincome and is the result of uncertainty about firm revenues andthe expenditures necessary to produce those revenues. Businessrisk is the combination of sales risk and operating risk:.


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o Sales risk is the uncertainty about the firm sales. Operating

risk refers to the additional uncertainty about operatingearnings caused by fixed operating costs. The greater theproportion of fixed costs to variable costs, the greater a firmoperating risk.

Financial risk refers to the additional risk that the firm commonstockholders must bear when a firm uses fixed cost (debt)financing.. The greater the proportion of debt in a firms capitalstructure, the greater the firm financial risk

Key Ratios:

Degree of Operating Leverage (DOL)

Operating leverage involves using a large proportion of fixedcosts to variable costs in the operations of the firm. The higherthe degree of operating leverage, the more volatile the EBITfigure will be relative to a given change in sales, all other thingsremaining the same

Degree of Financial Leverage (DFL)

Financial leverage involves using fixed costs to finance the firm,and will include higher expenses before interest and taxes(EBIT). The higher the degree of financial leverage, the more

volatile EPS will be, all other things remaining the same.Debt Instruments

Commercial paperCPs are promissory notes issued by the corporate sector for raisingshort term funds. they are sold at a discount to face value.

Salient features

Under RBI guidelines, maturity of the CP can range between aminimum of 7 days and a maximum of 1 year from the date ofissue.

CPs are required to be rated. Every issue has an Issuing and Paying agent(IPA), which has to

be a scheduled bank.

While CPs can be issued by way of promissory notes, banks,financial institutions and PDs can invest in and hold CPs only indematerialized form. Stamp duty maybe payable.

CPs are also actively traded in the secondary market.


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DebenturesX% Secured Redeemable Non-convertible Bonus Debentures of Rs.X/-each of the Company were allotted on 2nd July 200X to allshareholders of ABC Ltd in the ratio of 1 Bonus Debenture on every

Equity Share of Re.1/- each, held on the record date of 23rd June,200X.

Salient features

Convertible or non-convertible.

Listed on one or more recognized stock exchange.

Credit rating.

Arrangement with a depository for dematerialization.

Appoint of merchant bankers.

Appointment of a debenture trustee/ drawing a trust deed/create debenture redemption reserve/ create charge on asecurity.

Offer document.

Underwriting.

Corporate Bond Market

Significant portion of corporate bond issues is subscribed bybanks and other institutional investors, the maturity in thecorporate bond market remains limited to around 5 or, in a fewcases, 7/8 years.

Corporate issues typically have to pay a higher return than thecentral government and this depends on the credit rating; thelower the rating, higher will be the return demanded by theinvestor.

The actual extra return ,or premium over G-Sec yields, is also afunction of the liquidity, the premium tends to narrow: it widenswhen money is tight

Merchant banks play an important role in structuring, pricing andmarketing corporate bonds.

Trustees or a trustee company is set-up to look after the interestof the bondholders, to monitor the observance of any covenants

agreed to by the issuer as part of the bond, creation of security,listing and other relevant factors.

The cost of the trustee(s) or Trustee Company is borne bythe issuer although the trustee primary responsibility istowards the investor.

From the issuer perspective, the total cost of a bond issue wouldcomprise not only the return to investors but also front endcosts like the fees of the merchant/investment banks,


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brokerage in the case of public issues, legal,documentation and other issue expenses, securitycreation cost, the fee of the trustee company, etc.

While the principal amount of most bonds is repayable onmaturity, there are also issues of amortizing bonds: a

predetermined proportion of the principal is repaid in, say,annual installments. The installments may be payable the everyyear through life of the bond, or only during the concluding 2 or3 years.

Creating a sinking fund or debenture redemption reserve forhonoring the bond. The issuer makes contributions to the fundperiodically. The fund can be used to buy back bonds from themarket- or invested in safe avenues to be available for meetingthe bond liability.

Debt Restructuring

Changes in economic conditions, overoptimistic projections,excessive debt, and managerial errors can precipitate default.

How to deal with a company in financial distress dependson if it is worth more as a going concern than inliquidation.

Salvaging the going concerns requires a recapitalization of thecompany and the implementation of a turnaround plan directedto conserve cash, reduce expenses, stabilize cash flow, andassure economic viability.

Liquidation involves an orderly selling of assets tomaximize proceeds If the company is worth more as agoing concern than under liquidation, a recapitalizationplan that recognizes the reduced debt capacity ofcompany may be feasible.

The main goal is to determine the debt capacity of the companygiven its new condition, or how much cash flow can becommitted for distribution among the several security-holdersand still have a viable entity.

The specific distribution of the new securities among the severalclaimants is a matter of negotiation and of the relative

bargaining power of the parties.

Corporate Debt Restructuring (CDR)

The objective of the Corporate Debt Restructuring (CDR)framework is to ensure timely and transparentmechanism for restructuring the corporate debts ofviable entities facing problems, outside the purview of


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BIFR, DRT and other legal proceedings, for the benefit of allconcerned.

Two categories of debt restructuring are applicable under theCDR system.

o Accounts, which are classified as standard and

sub-standard in the books of the lenders, will berestructured under the first category (Category 1).

o Accounts which are classified as doubtful in the

books of the lenders would be restructured underthe second category (Category 2).

CDR system has a three tier structure:o CDR Standing Forum and its Core Group

o CDR Empowered Group

o CDR Cell

The CDR Standing Forum would be the representative general bodyof all financial institutions and banks participating in CDR system.

The CDR Standing Forum shall meet at least once every 6months and would review and monitor the progress of corporatedebt restructuring system.

The Forum would also lay down the policies andguidelines to be followed by the CDR Empowered Groupand CDR Cell for debt restructuring and would ensuretheir smooth functioning and adherence to the prescribedtime schedules for debt restructuring.

A CDR Core Group will be carved out of the CDR Standing Forumto assist the Standing Forum in convening the meetings and

taking decisions relating to policy, on behalf of the StandingForum.o The Core Group will consist ofChief Executives of IDBI,

SBI, ICICI Bank Limited, Bank of Baroda, Bank ofIndia, Punjab National Bank, Indian Banks'Association, Deputy Chairman of Indian Banks'Association representing foreign banks in India anda representative of RBI.

The individual cases of corporate debt restructuring shall bedecided by the CDR Empowered Group, consisting of ED levelrepresentatives of IDBI, ICICI Bank Ltd. and SBI as standing

members, in addition to ED level representatives of financialinstitutions and banks who have an exposure to the concernedcompany.

There should be a general authorisation by the respective Boardsof the participating institutions / banks in favour of theirrepresentatives on the CDR Empowered Group, authorising themto take decisions on behalf of their organization, regardingrestructuring of debts of individual corporates.


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The CDR Empowered Group will consider the preliminary reportof all cases of requests of restructuring, submitted to it by theCDR Cell. After the Empowered Group decides that restructuringof the company is prima-facie feasible and the enterprise ispotentially viable in terms of the policies and guidelines evolved

by Standing Forum, the detailed restructuring package will beworked out by the CDR Cell in conjunction .with the LeadInstitution.

The decisions of the CDR Empowered Group shall be final.If restructuring is not found viable, the creditors wouldthen be free to take necessary steps for immediaterecovery of dues and / or liquidation or winding up of thecompany, collectively or individually.

The CDR Cell will make the initial scrutiny of the proposalsreceived from borrowers / lenders, by calling for proposedrehabilitation plan and other information and put up the matter

before the CDR Empowered Group, within one month to decidewhether rehabilitation is prima facie feasible.

o If found feasible, the CDR Cell will proceed to prepare

detailed Rehabilitation Plan with the help of lenders and, ifnecessary, experts to be engaged from outside. If notfound prima facie feasible, the lenders may start action forrecovery of their dues.

The Empowered Group can approve or suggest modificationsbut ensure that a final decision is taken within a totalperiod of 90 to 180 days from the date of reference to theCDR Cell.

The administrative and other costs shall be shared by allfinancial institutions and banks.

CDR Scheme

The CDR mechanism will cover only multiple bankingaccounts / syndication / consortium accounts withoutstanding exposure of Rs. 10 crore and above by banksand institutions.

The company may be eligible for consideration under the CDR

system provided, the initiative to resolve the case under the CDRsystem is taken by at least 75% of the lenders (by value) and60% of creditors by number.

CDR will be a non-statutory mechanism which will be a voluntarysystem based on Debtor- Creditor Agreement (DCA) and Inter-Creditor Agreement (ICA).


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The Debtor-Creditor Agreement (DCA) and the Inter-Creditor Agreement (ICA) shall provide the legal basis tothe CDR mechanism.

The lenders in foreign currency outside the country arenot a part of CDR system.

The lenders who wish to exit from the package would have theoption to sell their existing share to either the existing lenders orfresh lenders, at an appropriate price, which would be decidedmutually between the exiting lender and the taking over lender.

The new lenders will rank on par with the existing lenders forrepayment and servicing of the dues since they have taken overthe existing dues to the exiting lender.

The CDR Empowered Group, while deciding the restructuringpackage, should decide on the issue regarding convertibility (intoequity) option as a part of restructuring exercise whereby thebanks / financial institutions shall have the right to convert a

portion of the restructured amount into equity, keeping in viewthe statutory requirement under the Banking Regulation Act,1949, (in the case of banks) and relevant SEBI regulations.

Exemptions from the capital market exposure ceilings prescribedby RBI in respect of such equity acquisitions should be obtainedfrom RBI on a case-tocase basis by the concerned lenders.

Session 9NCLT: National Company Law Tribunal constituted underCompanies Act, 1956

With the failure of SICA, the National Company Law Tribunal(NCLT) was constituted under the Companies Act Chapter VI A.

o Many provisions of SICA have been incorporated in Chapter

VI A, in a more diluted form.

Some major provisions of Chapter VI A are:

Definition: Sick industrial company means an industrial company,which has at the end of any financial year:

o accumulated losses exceeding 50% of average net

worth during 4 years; or

o has failed to repay debts to its creditor(s) in 3consecutive quarters on demand made in writing.

Company is required to submit a scheme of revival &rehabilitation at the time of making reference to theNCLT. Further, it is also required to furnish a certificatefrom auditor on the panel approved by NCLT givingreasons for such reference.


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NCLT is empowered to examine, as preliminary issue, whetherthe company is a sick industrial company even beforeconsidering the viability of the scheme of revival & rehabilitation.

NCLT has to consider and decide whether it is practicable for thecompany to revive on its own within a reasonable time.

Alternatively, it may direct any operating agency to prepare suchscheme in accordance with the guidelines prescribed by it in thisbehalf.

Operating agency to prepare the scheme for revival &rehabilitation

o NCLT may review and modify the scheme, if necessary.

o The draft scheme as vetted by Tribunal to be circulated.

o Draft scheme may be sanctioned within 60 days,extendable upto 90 days.

o Copy of the sanctioned scheme to be filed with the

Registrar.o Scheme may also be prepared by the creditors, if

agreed to by 75% of creditors.o Scheme shall be binding on creditors and all concerned.

Tribunal can itself order the winding up of the company, if it is ofthe opinion that the sick company is not likely to revive.

o Tribunal can appoint an officer to act as theliquidator.

o Further, Tribunal can also sell off assets of the sick

company and distribute the proceeds.

Securitisation Act : The Securitization and Reconstruction ofFinancial Assets And Enforcement of Security Interest(SARFAESI)

The purpose of this Act is to promote the setting up ofasset reconstruction/securitisation companies to takeover the Non Performing Assets (NPA) accumulated withthe banks and financial institutions.

o The Act provides special powers to lenders andsecuritisation/ asset reconstruction companies, toenable them to take over of assets of borrowers

without first resorting to courts. The Act also provides secured creditors with greater rights

against defaulters allowing for seizure and sale ofmortgaged assets in case of NPAs.

Select guidelines pertaining to Securitisation/ Reconstruction(ARC) companies:

o A Securitisation (or Reconstruction) Company should

obtained a certificate of registration issued by the


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RBI under the Act can undertake both Securitisationand Reconstruction activities.

o Guidelines prohibit a Securitisation (orReconstruction) Company from raising monies byway of deposit.

An ARC can issue security receipts to financial institutionsthrough one or more trusts set-up exclusively for the purpose:

o The trusteeship of such trusts is required to vest with the

ARC.o The ARC is required to transfer the financial assets to the

said trust.

The Guidelines require that an ARC shall formulate policies forasset acquisition, including valuation procedure, rescheduling ofdebts of borrowers (to be supported by an acceptable businessplans, projected earnings and cash flows of the borrower),settlement of debts due from borrower, and plans for realization

of assets. As per the Sale Guidelines, the following classes of assets

can be sold by banks/FIs to Securitisation (orReconstruction) Companies:

o An NPA

o A standard asset (i.e., an asset that is not an NPA)where:

the asset is under consortium /multiplebanking arrangements,

at least 75% by value of the asset is classified

as NPA in the books of other bank/FIs, and at lease 75% by value of the banks/FIs who are

under the consortium/multiple bankingarrangement agree to the sale of the asset tothe ARC

The sale of financial assets from a bank/FI may be on a withoutrecourse or with recourse basis.

ARCs Indian Scenario

Presently, approximately 10 ARCs have been approved by RBI

o ARCs already registered with RBI include Arcil,International Asset Reconstruction Company, Pegasus, Dhir& Dhir, Kotak Mahindra ARC, UTI-promoted Asrec, IFCI-promoted ACE, ADA Group-promoted Reliance ARC andPridhvi Asset Reconstruction and Securitisation Company.

o ARCIL is the oldest, set up in 2003, is estimated to have

bought more than Rs32,000 worth of assets at aroundRs8,000 crore.


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The net non-performing assets in the domestic banking industryare estimated at Rs 24,742 crore in 2007-08, risen from Rs20,280 crore in 2006-07.

The current economic situation has presented a two-prongedstrategy:

o The current slowdown in the economy may increase thechance of slippages, which means that some good loansmay become bad loans, which in turn, will provide goodbusiness opportunity to ARCs.

o Once the economy recovers, rising stock market and

surging real estate prices would offer returns frombad assets It is estimated, in some cases, therecovery is more than 50% of the price at which thefirms have been buying the stressed assets.

The law allows the sellers of bad assets to double up asinvestors.

o When an ARC buys bad assets from banks, it issuessecurity receipts (SRs) to such banks and instead ofbeing a lender to bad assets, the banks becomeinvestors in such assets.

o Banks keep on getting money as and when ARCs

recover them and if the recovery is beyond thepromised returns, the difference is shared by theinvestor and the ARC involved.

An example:o International Asset Reconstruction Co. Pvt. Ltd (Iarc), in Jan

2008, bought 99 stressed accounts worth Rs 410 crorefrom Bank of Baroda at around Rs67 crore. For every dollarworth of bad loan, Iarc has paid 16.5 cents.

Recent deal in this sector (October 2008):

Tata Capital picked up 20% in IARC.o HDFC is the largest shareholder in IARC and got its stake

through its acquisition of Centurion Bank of Punjab.

IARC currently has assets worth Rs 500 crore undermanagement.

Session 10

SEBI (Substantial acquisition of shares and takeovers)Regulations, 1997 Updated 2006

Control in a listed company:

Acquisition of 5% and more shares of a company


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Any acquirer, who acquires shares or voting rights which would entitlehim to more than five percent or ten per cent or fourteen percent orfifty four per cent or seventy four per cent shares or voting rights in acompany, in any manner whatsoever, shall disclose at every stagethe aggregate of his shareholding or voting rights in that

company to the company and to the stock exchanges whereshares of the target company are listed.

Open Offer:

An acquirer who acquires 15% or more of the shares of acompany is required to make an open offer for shares

Appointment of a Merchant Banker.

The merchant banker shall make the publicannouncement not later than four working days ofentering into an agreement for acquisition of shares.

The public announcement shall be made in all editions of oneEnglish national daily with wide circulation, one Hindi nationaldaily with wide circulation and a regional language daily withwide circulation at the place where the registered office of thetarget company is situated and at the place of the stockexchange where the shares of the target company are mostfrequently traded.

Simultaneously a copy of the public announcement shallbe:

o submitted to SEBI through the merchant banker.

o sent to all the stock exchanges on which the shares

of the company are listed for being notified on thenotice board.

sent to the target company at its registered office for beingplaced before the Board of Directors of the company.

Contents of the Public Announcement of Offer

The total number and percentage of shares proposed to beacquired from the public.

The minimum offer price for each fully paid up or partly paid upshare.

The identity of the acquirer(s) and in case the acquirer is acompany or companies, the identity of the promoters and/or thepersons having control over such company(ies).

The existing holding, if any, of the acquirer in the shares ofthe target company, including holdings of persons acting inconcert with him.

Salient features of the agreement, if any, such as the date, thename of the seller, the price at which the shares are being


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acquired, the manner of payment of the consideration and thenumber and percentage of shares.

The highest and the average price paid by the acquirer orpersons acting in concert With him for acquisition, if any, ofshares of the target company made by him during the twelve

month period prior to the date of public announcement. Object and purpose of the acquisition of the shares and

future plans, if any, of the acquirer for the targetcompany.

Submission of Letter of Offer to SEBI

Within fourteen days from the date of publicannouncement, the acquirer shall, through its merchantbanker, file with SEBI, the draft of the letter of offer,containing disclosures as specified by SEBI.

The letter of offer shall be dispatched to the shareholdersnot earlier than 21 days from its submission to SEBI.

o If SEBI specifies changes to the offer letter, the merchant

banker and the acquirer shall carry out such changesbefore the letter of offer is despatched to the shareholders.

The acquirer shall, while filing the draft letter of offer with SEBIpay the requisite fee.

Offer Price

The offer price shall be the highest of:o The negotiated price under the agreement

o Price paid by the acquirer or persons acting inconcert with him for acquisition, during the twentysix week period prior to the date of publicannouncement

o The average of the weekly high and low of the

closing prices of the shares of the target companyas quoted on the stock exchange where the sharesof the company are most frequently traded during the26 weeks or the average of the daily high and low of theprices of the shares during the two weeks preceding the

date of public announcement, whichever is higher If the shares of the Target are infrequently traded,

o Other parameters including return on networth,book value of the shares of the target company,earning per share, price earning multiple vis-a-visthe industry average


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SEBI may require valuation of such infrequently tradedshares by an independent merchant banker or charteredaccountant with minimum 10 years of experience

Minimum number of shares to be acquired

The public offer made by the acquirer to theshareholders of the target company shall be for aminimum twenty per cent of the voting capital of thecompany.

Where the number of shares offered for sale by theshareholders are more than the shares agreed to be acquired bythe person making the offer, such person shall, accept the offersreceived from the shareholders on a proportional basis, inconsultation with the merchant banker, taking care to ensurethat the basis of acceptance is decided in a fair and equitablemanner.

The acquirer shall, within a period of fifteen days from thedate of the closure of the offer, complete all procedures relatingto the offer including payment of consideration to theshareholders who have accepted the offer.

General obligations of the merchant banker (Extract)

The public announcement of offer is made in terms of theRegulations.

The provision relating to escrow account is made.

The merchant banker shall furnish to SEBI a due diligencecertificate which shall accompany the draft letter of offer.

The merchant banker shall ensure that the contents ofthe public announcement of offer as well as the letter ofoffer are true, fair and adequate and based on reliablesources, quoting the source wherever necessary.

The merchant banker shall not deal in the shares of the targetcompany during the period commencing from the date of hisappointment till the expiry of the fifteen days from the date ofclosure of the offer.

Upon fulfillment of all obligations by the acquirers under theRegulations, the merchant banker shall cause the bank with

whom the escrow amount has been deposited to release thebalance amount.

The merchant banker shall send a final report to SEBIwithin 45 days from the date of closure of the offer.

Provision of Escrow (Extract)

The escrow amount shall be calculated in the following manner.


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o For consideration payable under the public offer,

upto and including Rs.100 crores - 25%; exceedingRs.100 crores - 25% upto Rs.100 crores and 10%thereafter.

The escrow account shall consist of:

o cash deposited with a scheduled commercial bank.o bank guarantee in favour of the merchant banker.

In case there is any upward revision of offer, the value of theescrow account shall be increased to equal at least 10% of theconsideration payable upon such revision.

SEBI can in case of non-fulfillment of obligations under theRegulations by the acquirer forfeit the escrow account either infull or in part.

SEBI (Disclosure and Investor Protection) Guidelines UpdatedAug 2008

Eligibility norms for companies issuing securities:

Filing of Offer Document

Draft Prospectus has been filed with SEBI through a MerchantBanker, at least 30 days prior to the filing of theProspectus with the Registrar of Companies (ROC).

o If SEBI suggests changes, Company or Lead Manager to

carry out such changes before filing it with ROC.o SEBI would issue observations within 30 days from

the date of receipt draft prospectus.o Company should also make an application for listing of the

stock exchange.

Exception to the above: Public issue of securities or rights issueby a listed company, where:

o Stocks have been listed for at least 3 years.

o Avg. market capitalisation is atleast Rs 10,000 crore in the

recent previous year.o Company has redressed atleast 95% of shareholder/

investor complaints received till the end of the recentprevious quarter.

o Company has complied with listing agreement foratleast previous 3 years.

o No pending prosecution proceedings or show cause notice

by SEBI.

IPOs by Unlisted Companies should meet the following criteriaCompany has net tangible assets of atleast Rs 3 crore in each of the

preceding 3 full years


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Company has a track record of distributable profits in theimmediately preceding 3 out of 5 years

Company has a net worth of at least Rs 1 crore in each of thepreceding 3 years

An unlisted company not complying with any of the above canmake an IPO if:

The issue is made through book-building process, with at least50% of net offer to public being allotted to the QualifiedInstitutional Buyers (QIBs), failing which the full subscriptionmonies shall be refunded OR

The project has at least 15% participation by FinancialInstitutions/ Scheduled Commercial Banks, and at least 10% ofthe issue size shall be allotted to QIBs, failing which the fullsubscription monies shall be refunded AND

The minimum post-issue face value capital of the

company shall be Rs. 10 crores. An unlisted public company shall not make an allotment

pursuant to a public issue if the prospective allottees are lessthan one thousand (1000) in number.

Public Issue by listed companies to comply with thefollowing:

Aggregate of the proposed issue and all previous issues made inthe same financial year in terms of size (i.e., offer through offerdocument + firm allotment + promoters contribution throughthe offer document), issue size does not exceed 5 times its pre-issue networth as per the audited balance sheet of the lastfinancial year.

In case there is a change in the name of the issuer companywithin the last 1 year (reckoned from the date of filing of theoffer document), the revenue accounted for by the activitysuggested by the new name is not less than 50% of its totalrevenue in the preceding 1 full-year period.

Exceptions to the above:

A banking company.

An infrastructure company, whose project has been appraised bya Infrastructure Development Finance Corporation (IDFC) orInfrastructure Leasing and Financing Services Ltd (IL&FS) not lessthan 5% of the project cost is financed by any of the institutionsreferred.

Credit Rating of Debt instruments


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No issuer company shall make a public issue or rightsissue of convertible debt instruments, unless:

o Credit rating is obtained from at least one credit rating

agency registered with the Board and disclosed in the offerdocument.

o The company is not in the list of willful defaulters of RBI.o The company is not in default of payment of interest or

repayment of principal in respect of debentures issued tothe public, if any, for a period of more than 6 months.

o Where credit ratings are obtained from more than one

credit rating agencies, all the ratings, including theunaccepted ratings, shall be disclosed in the offerdocument.

o All the credit ratings obtained during the three (3) years

preceding the pubic or rights issue of debt instrument(including convertible instruments) for any listed security

of the issuer company shall be disclosed in the offerdocument.

IPO Grading

No unlisted company shall make an IPO unless the followingconditions are satisfied as on the date of filing of Prospectus:

o the unlisted company has obtained grading for the IPO

from at least one credit rating agency.o Disclosures of all the grades obtained, along with the

rationale/ description furnished by the credit ratingagency(ies) for each of the grades obtained, have beenmade in the Prospectus.

o the expenses incurred for grading IPO have been borne by

the unlisted company obtaining grading for IPO.

Pricing by companies issuing securitiesSummary of provisions:

Companies (including banks) can freely price theirsecurities.

If a company wants to adopt differential pricing, price at whichthe security is being offered to the institutions category is higher

than the price at which securities are offered to public.o Difference should not be more than 10% Issuer company

can have a price band of 20%.

Issuer company can have a price band of 20%.

Promoters contribution and lock in period

Promoters contribution


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In a public issue by an unlisted or listed company, thepromoters shall contribute not less than 20% of the postissue capital.

Promoters shall bring in the full amount of the promoterscontribution at least one day prior to the issue opening date,

which shall be kept in an escrow account, and the saidcontribution/ amount shall be released to the company alongwith the public issue proceeds.

If the promoters contribution has been brought prior to thepublic issue, the company shall give the cash flow statement inthe offer document disclosing the use of such funds.

Where the promoters minimum contribution exceeds Rs.100crores, the promoters shall bring in Rs.100 crores before theopening of the issue and the remaining contribution shall bebrought in by the promoters on pro-rata basis before calls aremade to the public.

Lock in requirementso In case of any issue of capital to the public theminimum promoters contribution shall be locked in for aperiod of 3 years.o The lock-in shall start from the date of allotment in the

proposed public issue and the last date of the lock-in shall bereckoned as 3 years from the date of commencement ofcommercial production or the date of allotment in the publicissue whichever is later.o In case of a public issue by unlisted or listed company, if

the promoters contribution in the proposed issueexceeds the required minimum contribution, such excesscontribution shall also be locked in for a period of oneyear.o The entire pre-issue capital, other than that locked-in as

minimum promoters contribution, shall be locked-in for a periodof one year from the date of allotment.o Exception: Shares held by the Venture Capital Fundor the Foreign Venture Capital Investor, as the case maybe, for a period of at least one year as on the date of

filing draft prospectus.o Securities issued to institutional investors shall be

locked-in for 1 year from the date of commencement ofcommercial production or the date of allotment, whicheveris later Locked-in Securities held by promoters may be pledgedonly with banks or financial institutions as collateral security forloans granted by such banks or financial institutions.


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o The securities may be pledged if the loan has been

granted by such banks or financial institutions for thepurpose of financing one or more of the objects of theissue.o Shares held by the person other than the promoters, prior

to Initial Public Offering (IPO), which are locked in, may betransferred to any other person holding shares which are lockedunder the same guidelines.o Shares held by promoter(s) which are locked in as per the

relevant provisions of this chapter, may be transferred to andamongst promoter/ promoter group or to a new promoterpersons in control of the company, subject to continuation oflock-in.

Documents

Session 2 Mergers & Acquisitions: An Introduction as Globalization Forces