Concept of mode of placement of shares:
In private limited companies, public limited companies (listed or not), anyone who wants raise the money in a company cannot take it without a proper corporate process. The choice of corporate process is called mode of placement of new equity. The mode of placement is decided by whether the share placement is done with the existing shareholders for new shareholders, whether the issue is being made to select private individuals or the public at large. (In case of private limited company, please note that an individual unrelated to company cannot even lend a small amount to the company without RBI approval which typically would be rejected.). All these processes are evolved to take care of specific interest of the the company raising fund, to protect the interest of the shareholders and to protect the interests of the various types of investors.
Types of modes of issue or placement of equity
Following are the various modes of issue of new securities to raise equity capital:
Rights issue:
A company can raise capital from its existing shareholders by issuing them the rights to buy new equity shares in proportion of their existing shareholding percentage. It can be also provided that the existing shareholders can transfer right to the other individuals who are outsiders.
When is rights issue carried out? When the existing shareholders of the company believe in the growth story of the company and also when they have additional personal funds with them for investment in the company. Right issue results equity funding with the ownership of the same set of people as before and no involvement of new entities. Rights issue is undertaken if if the existing group of owners of a company do not want to include third party new investor and also have sufficient capital who raise required money.
Preferential allotment:
Preferential allotment of shares (convertible instruments or common shares) refers to the procedure of bulk allotment of fresh shares to a specific group of individuals, investors, companies, or any other outsider person. It is for to a pre-identified people, who may or may not be the existing shareholders of a firm.
What is the process? The company needs to pass a special resolution for preferential allotment. For the listed companies, preferential allotment is subject to to all the regulations such as the Takeover Code. Valuation from certified valuers has to be carried out. (Please note that you did not get confused between preferential allotment of shares and allotment of preference shares.)
When is preferential allotment done? Preferential allotment is done to the individuals who are interested in getting a material stake in the company. Preferential allotment is also a means of awarding specific individuals for their contribution in the progress of the company. The word preferential connotes a certain kind of preference when it comes to eligibility, selection, concession, discount and favourable terms. Among all the prescribed methods, the preferential allotment is considered to be the best fundraising option for unlisted companies.
Private placement:
Private placement is raising equity or any other form of security capital through placement of additional equity to the existing shareholders or new individuals. These individuals are identified by the management and their selection is based on a criteria. The word private converts that the company cannot raise money from the general public as it does in the the initial public offer.
What is the process? The maximum number of individuals in a single issue can be around 50 and the maximum number of investors in a year can be maximum 200. The consideration is only cash. The security can be of any type. The terms of investment have to be elaborated and communicated to the investors. The compliance of this process is very less as compared to the public issue.
When is private placement used? When are small and medium enterprises takes equity funding from private equity investors, this is the most preferred mode of placement of shares. The word private in private placement refers to no involvement of public investors.
Employee stock option plan (ESOP):
It means the option given to the directors, officers or employees of a company or of its holding company or a subsidiary company to purchase the shares of the company at a future date at a predetermined price. It helps the company to save liquid cash by making part payments in the form of these options. Issuing equity options to the employees themselves mitigate all the risks of involvement of outsider equity investors. Discount given to the Employees on the market price is typically 5-20%.
When are ESOP issued? They are issued when the company is in the formative stage. They provide liquidity as a certain fraction of employee compensation or incentives is postponed. They save tax. They make the employees work hard for growth of the company.
Bonus Issue:
A company issues bonus shares to its existing shareholders instead of paying a dividend. These shares are given to the current shareholders on the basis of their existing holding in the company. Bonus shares are given out of the profits or reserves of the company. The reserves in the form of accumulated profits are typically expected to be distributed as dividend. The issue of bonus shares results in increase in the total shares of the company keeping the market capitalisation for value of anyone’s portfolio same. Corporate process has to be followed. No Tax is payable by the recipients of the bonus shares.
When are bonus shares issued? Bonus shares are issued by a company when it is not able to pay a dividend to its shareholders due to shortage of funds in spite of earning good profits for that period. When the company converts them into equity capital, it indicates the the confidence of the management in the growth of the company. Bonus issue has a psychological value for the shareholders. For a listed company, the number of shares listed on the stock exchange increases and the price per share falls in line with the bonus ratio. This makes it easy to trade in that stock.
Public offers:
Public offers means issuing the fresh shares of a company to general public listing on stock exchange. Company has to fulfill a lot of eligibility criteria to be able to get listed on the stock exchange. Even after listing, the company has to do a lot of compliances with the regulator: Securities and exchange Board of India (SEBI). Various varieties of public offers which are studied below.
Initial public offer (IPO)
Initial public offer means when a private limited company or a public limited company makes the first offered to the general public. There are two routes of initial public offer.
When is IPO route explored? When the company undertakes a very big expansion step and it requires funds for that growth initiative, it raises money through initial public offer. Full subscription of the offer is a big success event in the life of a company. A company being eligible to raise money from the general public under the laws of land is seen as the indication of it having reach a actual level.
Profitability Route:
To explore the profitability route, the company has to fulfill the following conditions: Minimum net worth of Rs 1 Crore in each preceding three full years; minimum net tangible assets, of at least Rs 3 Crores each, not more than 50% of which are held in monetary assets, in the preceding three full years; minimum Rs 15 Crores as average operating profit (before tax) in at least three out of five preceding years.
When is IPO under profitability route is undertaken? When a company is able to meet the stringent conditions of eligibility under this route and when the size of issue permitted is more or equal to the requirement of funds, profitability route is used.
Qualified institutional buyer (QIB) Route:
Qualified institutional buyers are by definition knowledgeable and aware investors. The regulator need not put restrictions on them in the way they invest. For all those companies who genuinely require a larger capital base, but fail to accomplish any of the rules laid down under the profitability route, SEBI has introduced an alternative. This route enables the companies to access the public interest through book building process. 75% of this net offer to the public is to be mandatorily allotted to Qualified Institutional Buyers (QIBs). If the minimum subscription of QIB is not achieved, the company shall refund the subscription fee to everyone.
When is QIB used? If the requirement of fund is more than the one permitted under the profitability route and if the management is able to convince the qualified institutional buyers, this route can be used.
Follow-on public offer (FPO):
A follow-on public offer (FPO) or further public offer is the one in which a fresh issue of shares to the public is made to raise funds. When a listed company goes for fresh issue of shares through FPO, it should ensure that the size of issue should not exceed five times the pre-issue net worth. Also, in the case of FPO, if the company changes its name, minimum 50% of the revenue in preceding one year should be from the activity denoted by the new name.
When is follow on public offer used? When a company wants to tab additional money from the general public after the initial public offer, it can explore this route of FPO.
Depository receipts (ADR GDR SDR):
When a Indian company taps the global equity market to raise foreign equity fund through listing on the stock markets there, it is called equity funding through depository receipts. They do not appear in the books of accounts of the issuing company directly. They are called depository receipts because all the new shares issued in foreign currency are kept with the depositary in that foreign country. The depository receipts trade on foreign exchanges in the same way shares of the companies are traded on Bombay Stock Exchange. There may be an over- the- counter market, too. These equities, also called Euro equity, represents shares that are denominated in a foreign currency and are issued by non-American/non-European companies such as Indian companies. These shares are then listed on American and European stock exchanges by complying to their regulations.
There are four types Euro equity issues:
Global Depository Receipts (GDR)
American Depository Receipts (ADR)
European Depository Receipts
Singapore Depository Receipts
These types indicate where they are issued and where they can be traded. The American Depository Receipts are the most popular.
When are depository receipts used to get equity funding? The companies issue depositary receipts if they have a very large client base in that geography. It serves as a marketing tool. It provides the international visibility and the discussions about the investment in the company among the global investor take the company to a different league. Also, the folders of depository receipts do not have any voting rights taking away the risk of interference.
Companies can raise funds via different methods/modes listed above. Apohan carries out professional, end-to-end, customized consultancy services for above classification of modes of issue of equities to achieve the objectives of the client business. Apohan carries out all these equity transactions, right from the problem identification phase, to the closure of deal with perfection.
Apohan Services:
Apohan provides consultancy services for all modes of placement of equity shares. The scope of work includes:
Strategy for issue
Study of applicable corporate laws
Identification of the mode of equity
Computation of premium or discount