UNIT I MERCHANT BANKING

Introduction An Over view of Indian Financial System Merchant Banking in India

Recent Developments and Challenges ahead Institutional Structure Functions of
Merchant Bank - Legal and Regulatory Framework Relevant Provisions of
Companies Act- SERA- SEBI guidelines- FEMA, etc. - Relation with Stock Exchanges
and OTCEI.
Financial System
The financial services can also be called financial intermediation. Financial
intermediation is a process by which funds are mobilized from a large number of savers
and make them available to all those who are in need of it and particularly to corporate
customers.
Functions of the Financial System
Its major functions can be explained as following:
1. Promotion of Liquidity
The major function of the financial system is the provision of money and monetary
assets for the production of goods and services.
2 Mobilizations of Savings
The financial system facilitates the transformation of savings into investment and
consumption.
Financial Concepts
An understanding of the financial system requires an understanding of the following
concepts:
1. Financial Assets
2. Financial Intermediaries
3. Financial markets
4. Financial Services
5. Financial instruments

1. FINANCIAL ASSETS
A financial asset is one, which is used for production or consumption or for further
creation of assets.
Classification of Financial Assets
Marketable Assets: Marketable assets are those which can be easily transferred from one
person to another without much hindrance.
Non-marketable Assets: If the assets cannot be transferred easily, they come under this
category.
Cash Assets: All coins and currencies issued by the Government or Central Bank are
cash assets.
Debt Asset: Debt asset is issued by a variety of organizations for the purpose of raising
their debt capital.

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 Stock Asset: Stock is issued by business organizations for the purpose of raising their
fixed capital. There are two types of stock namely equity and preference.
2. FINANCIAL INTERMEDIARIES
The term financial intermediaries include all kinds of organizations which intermediate
and facilitate financial transactions of both individuals and corporate customers. They
may also be classified in to two :
1. Capital Market Intermediaries
These intermediaries mainly provide long term funds to individuals and corporate
customers.
2. Money Market Intermediaries
Money market intermediaries supply only short term funds to individuals and
corporate customers.
3. FINANCIAL MARKETS
Wherever a financial transaction takes place it is deemed to have taken place in the
financial market. The classification of financial markets in India can be as following:
Unorganized Markets: In unorganized markets, there are a number of money lenders,
indigenous bankers, traders, etc. who lend money to the public. There are also private
finance companies, chit funds etc whose activities are not controlled by the RBI.
Organized Markets: In the organized markets, there are standardized rules and
regulations governing their financial dealings. These markets are subject to strict
supervision and control by the RBI or other regulatory bodies. These organized markets
can be further classified into two.
Capital Market
The capital market is a market for financial assets which have a long or indefinite
maturity. Generally, it deals with long term securities which have a maturity period of
above one year. Capital market may be further divided into three
1 Industrial Securities Market
It is a market for industrial securities, namely: (i) equity shares (ii) Preference shares and
(iii) Debentures or bonds. It is a market where industrial concerns raise their capital or
debt by issuing appropriate instruments. It can be further subdivided into two.
Primary Market
The primary market deals with those securities which are issued to the public for the first
time.
Secondary Market
Securities are quoted in the stock exchange and it provides a continuous and regular
market for buying and selling of securities.
2 Government Securities Market
It is otherwise called Gilt-Edged securities market. It is a market where government
securities are traded.
3 Long-term Loans Market
Development banks and commercial banks play a significant role in this market by
supplying long term loans to corporate customers.

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4. FINANCIAL INSTRUMENTS
Financial instruments include both instruments and products.
Classification of Financial Instruments
(a) Negotiable Instruments
A negotiable instrument is an instrument that is transferable from one person to another.
(b) Commercial Paper
A commercial paper is one which is issued by leading financial institution which can be
taken by any borrower and discounted with commercial banks.
(c) Bill of lading
It is a document signed by the carrier, acknowledging shipment of the goods and
containing the terms and conditions of carriage.
(d) Letter of Credit
It is a letter by the importer bank guaranteeing the credit worthiness of the importer.
(e) Travellers Cheques
It is a cheque issued by banks to the traveling public which can be cashed at ease.
5. FINANCIAL SERVICES
Financial service, as a part of financial system provides different types of finance through
various credit instruments, financial products and services. It enables the user to obtain
any asset on credit according to his convenience and at a reasonable interest rate.

Definition of merchant banker

A merchant banker has been defined as any person who is engaged in the business of
issue management either by making arrangements regarding selling, buying or
subscribing to securities or acting as manager, consultant, adviser or rendering corporate
advisory services in relation to such issue management.
Merchant banking
Merchant banking is the development of banking from commerce which frequently
encountered a prolonged intermediate stage known in England originally as merchant
banking
Merchant Banking In India
The first merchant bank was set up in 1969 by Grind lays Bank.
Initially they were issue mangers looking after the issue of shares and raising capital for
the company.
In 1973, SBI started the merchant banking and it was followed by ICICI. SBI capital
market was set up in August 1986 as a full-fledged merchant banker.
Between 1974 and 1985, the merchant banker has promoted lot of companies.
However they were brought under the control of SEBI in 1992.
Recent Developments in Merchant Banking and Challenges Ahead

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 The Merchant Banking was at its best during 1985-1992 being when there were many
new issues. It is expected that 2010 that it is going to be party time for merchant banks,
as many new issue are coming up.
The foreign investors both in the form of portfolio investment and through foreign direct
investments are venturing in Indian Economy. It is increasing the scope of merchant
bankers in many ways.
Disinvestment in the government sector in the country gives a big scope to the merchant
banks to function as consultants.
New financial instruments are introduced in the market time and again. This basically
provides more and more opportunity to the merchant banks.
The mergers and corporate restructuring along with MOU and MOA are giving immense
opportunity to the merchant bankers for consultancy jobs.
The challenges faced by merchant bankers in India are
1. SEBI guideline has restricted their operations to Issue Management and Portfolio
Management to some extent. So, the scope of work is limited.
2. In efficiency of the clients are often blamed on to the merchant banks, so they are into
trouble without any fault of their own.
3. The net worth requirement is very high in categories I and II specially, so many
professionally experienced person/ organizations cannot come into the picture.
4. Poor New issues market in India is drying up the business of the merchant bankers.
The functions of Merchant Banking.
1. Corporate Counseling
The set of activities that is undertaken to ensure the efficient running of a corporate
enterprise is known as corporate counseling. The merchant banker guides the clients on
various aspects like Locational factors, organizational size, operational scale, choice of
product, market survey, cost analysis, cost reduction, allocation of resources, investment
decision, capital management and expenditure control, pricing, etc.,
2. Project counseling
Project counseling relates to project counseling and is part of corporate counseling. The
study and analysis of the project viability and the steps required for its effective and
efficient implementation are broadly the subject matter of project counseling.
3. Pre-Investment Studies
Pre-investment studies relate to the activities that are concerned with making a detailed
feasibility exploration to evaluate alternative avenues of capital investment in terms of
growth and profit prospects.
4. Capital Structure
Here the Capital Structure is worked out i.e., the capital required, raising of the capital,
debt-equity ratio, issue of shares and debentures, working capital, fixed capital
requirements, etc.,
5. Credit Syndication

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 Credit syndication relates to activities connected with credit procurement and project
financing, aimed at raising Indian and foreign currency loans from banks and financial
institutions, are collectively known as credit syndication.
6. Issue Management and Underwriting
Issue management and underwriting concerns with the activities relating to the
management of the public issues of corporate securities, viz. equity shares, preference
shares, and debentures of bonds, and are aimed at mobilization of money from the capital
market.
7. Portfolio Management
It refers to the effective management of Securities i.e., the merchant banker helps the
investor in matters pertaining to investment decisions. Taxation and inflation are taken
into account while advising on investment in different securities. The merchant banker
also undertakes the function of buying and selling of securities on behalf of their client
companies. Investments are done in such a way that it ensures maximum returns and
minimum risks.
8. Working Capital Finance
The finance required for meeting the day-to-day expenses of an enterprise is known as
Working Capital finance.
9. Acceptance Credit and Bill discounting
Acceptance credit and bill discounting connotes the activities relating to the acceptance
and the discounting of bills of exchange, besides the advancement loans to business
concerns on the strength of such instruments, are collectively known as Acceptance
Credit and Bill of discounting.
10. Merger and Acquisition
This is a specialized service provided by the merchant banker who arranges for
negotiating acquisitions and mergers by offering expert valuation regarding the quantum
and the nature of considerations, and other related matters.
11. Venture Financing
Venture capital is the equity financing for high-risk and high-reward projects. The
concept of venture capital originated in the USA in the 1950s, when business magnates
like Rockefeller financed new technology companies. The concept became more popular
during the sixties and seventies, when several private enterprises undertook the financing
of high-risk and high reward projects.
12. Lease Financing
Leasing is an important alternative source of financing a capital outlay. It involves letting
out assets on lease for use by the lessee for a particular period of time.
13. Fixed Deposit

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 Merchant bankers assist the companies to raise finance by way of fixed deposits from the
public. However such companies should fulfill credit rating requirements.

Legal and Regulatory Framework

The SEBI has brought about a number of regulative measures for the purpose of
disciplining the functioning of the merchant bankers in India. The measures were
introduced by the SEBI in the year 1992. The measures were revised by SEBI in 1997.
The salient features of the regulative framework of merchant banking in India are
described below:
SEBI Regulations
1. Registration of Merchant Bankers
The relevant guidelines with regard to the registration of merchant bankers are as follows:
Application for Grant of Certificate
An application by a person for grant of a certificate shall be made to the Board in Form A.
The application shall be made for anyone of the following categories of the merchant
banker namely:
1. Category I, to carry on any activity of the issue management, which will inter-alia consist
of prepared of prospectus and other information relating to the issue, determining
financial structure, tie-up of financiers and final allotment and refund of the subscription;
and to act as adviser, consultant, manage underwriter, portfolio manager.
2. Category II, to act as adviser, consultant, co-manager, underwriter, portfolio manager.
3. Category III, to act as underwriter, adviser, consultant to an issue.
4. Category Iv, to act only as adviser or consultant to an issue.
Conformance to Requirements
Subject to the provisions of the regulations, any application, which is not complete in all
respects and does not conform to the instructions specified in the form, shall be rejected.
Furnishing of Information
The Board may require the applicant to furnish further information or clarification
regarding matters relevant to the activity of a merchant banker for the purpose of disposal
of the application.
Consideration of Application
The Board shall take into account for considering the grant of a certificate, all maters,
which are relevant to the activities relating to merchant banker and in particular whether
the applicant complied with the following requirement.
1. Body corporate other than a non-banking financial
2. That the merchant banker who has been granted registration by the Reserve Bank of
India to act as a primary or Satellite Dealer

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3. That the applicant has the necessary infrastructure like adequate office space,
equipments, and manpower to effectively discharge his activities;
4. That the applicant has in his employment minimum of two persons who have the
experience to conduct the business of the merchant banker;
5. That the applicant fulfills the capital adequacy requirement as specified in the relevant;
6. That the applicant is a fit and proper person; and
7. That the grant of certificate to the applicant is in the interest of investors.
Capital Adequacy Requirement
According to the regulations, the capital adequacy requirement shall not be less than the
net worth of the person making the application for grant of registration.
Procedure for Registration
The Board on being satisfied that the applicant is eligible shall grant a certificate in Form
B. On the grant of certificate the applicant shall be liable to pay the fees in accordance
with Schedule II.
Renewal of Certificate
Three months before expiry of the period of certificate, the merchant banker, may if he so
desires, make an application for renewal in form A. The application for renewal shall be
dealt with in the same manner as if it were a fresh application for grant of a certificate.
On the grant of a certificate the applicant shall be liable to pay the fees in accordance
with Schedule II.
Procedure where registration is not granted
Where an application for grant of a certificate under regulation 3 or of renewal under
regulation 9, does not satisfy the criteria set out in regulation 6, the Board may reject the
application after giving an opportunity being heard.
CODE OF CONDUCT FOR MERCHANT BANKERS
To protect the interests of investors
A merchant banker shall maintain high standards of integrity, dignity and fairness in the
conduct of its business.
A merchant banker shall fulfill its obligations in a prompt, ethical, and professional
manner.
A merchant banker shall at all times exercise due diligence, ensure proper care and
exercise independent professional judgment.
Grievances of investors are redressed
A merchant banker shall ensure that adequate disclosures are made to the investors
To ensure that copies of the prospectus, offer document, letter of offer or any other
related literature is made available to the investors
A Merchant Banker shall not discriminate amongst its clients,

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 A Merchant Banker shall avoid conflict of interest and make adequate disclosure of its
interest.
A Merchant Banker shall ensure that good corporate policies and corporate governance
are in place.
Sebi Guidelines
Submission of offer document : The offer documents of issue size up to Rs. 20 crores
shall be filed by lead merchant bankers with the concerned regional office of the Board
under the jurisdiction of which the registered office of the issuer company falls.
The lead merchant banker shall make available 10 copies of the draft offer document to
the Board and 25 copies to the stock exchange(s) where the issue is proposed to be listed.
The Lead Merchant Banker shall submit two copies of the printed copy of the final offer
document to dealing offices of the Board within three days of filing offer document with
Registrar of companies/concerned Stock Exchange(s) as the case may be.
Dispatch of issue material : Lead merchant bankers shall ensure that whenever there is
a reservation for NRIs, 10 copies of the prospectus together with 1000 application forms
are dispatched in advance of the issue opening date, directly along with a letter addressed
in person to Adviser (NRI), Indian Investment Centre, Jeevan Vihar Building Sansad Marg,
New Delhi.
Underwriting: The overall exposure of underwriter(s) belonging to the same group or
management in an issue shall be assessed carefully by the lead merchant banker. OTC
Dealers registered with the Board under SEBI (Stock Brokers and Sub-Brokers) Rules and
Regulations, 1992 shall be treated at par with the brokers of other stock exchanges in
respect of underwriting arrangement.
Compliance obligations
The merchant banker shall ensure compliance with the following post-issue obligations
a. Association of resource personnel: In terms of Clause 7.1 of Chapter VII of these
Guidelines, in case of over-subscription in public issues, a Board nominated public
representative shall be associated in the process of finalization of the basis of allotment.
b. Redressal of investor grievances: The merchant bankers shall assign high priority to
investor grievances, and take all preventive steps to minimize the number of complaints.
The lead merchant banker shall set up a proper grievance monitoring and redressal
system in co-ordination with the issuers and the Registrars to Issue.
c. Submission of post issue monitoring reports: The concerned lead merchant banker
shall submit, in duplicate, the Post Issue Monitoring Reports specified in Clause 7.2 of
Chapter VII of these Guidelines, within 3 working days from the due dates, either by
registered post or deliver them at the respective regional offices/head office give in
Schedule XXII.
d. Issue of No objection Certificate (NOC): In accordance with the Listing Agreement of the
Stock Exchanges, the issuer companies shall deposit 1% of the amount of securities
offered to the public and/or to the holders of the existing securities of the company, as
the case may be, with the regional Stock Exchange.

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e. Registration of merchant bankers: Application for renewal of Certificate of Registration
shall be made by the merchant bankers according to Regulation 9 of SEBI (Merchant
Bankers) Rules and Regulations, 1992.
f. Reporting requirements In terms of Regulation 28 of SEBI (Merchant Bankers
Regulation) 1992, the merchant bankers shall send a half yearly report, in the format
specified in Schedule XXVII, relating to their merchant banking activities.
g. Impositions of penalty points Penalty points may be imposed on the merchant banker
for violation of any of the provisions for operational guidelines.
Guidelines on Advertisement
1. Factual and truthful: An issue advertisement shall be truthful, fair and clear, and shall
not contain any statement that is untrue or misleading.
2. Clear and concise: An advertisement shall be set forth in a clear, concise and
understandable language.
3. Promise or profits: An issue advertisement shall not contain statements which promise
or guarantee rapid increase in profits.
4. Mode of advertising No models, celebrities, fictional characters, landmarks, caricatures
or the likes shall be displayed on or form part of the offer documents or issue
advertisements.
5. Financial data: If any advertisement carries any financial data, it shall also contain data
for the past three years and shall include particulars relating to sales, gross profit, not
profit, share capital, reserves, earnings per share, dividends, and book values.
6. Risk factors: All issue advertisements carried in the print media such as newspapers,
magazines etc., shall contain highlights relating to any issue, besides containing detailed
information on the risk factors. The print size of highlights and risk factors in issue
advertisements shall not be less than point 7 size.
7. Issue date No corporate advertisement of Issuer Company shall be issued after 21 days of
filing of the offer document with the Board until the closure of the issue.
8. Product advertisement: No product advertisement of the company shall contain any
reference.
9. Subscription: No advertisement shall be issued stating that the issue has been fully
subscribed or oversubscribed during the period.
10. Issue closure: No announcement regarding closure of the issue shall be made except on
the closing date.
11. Incentives: No incentives, apart from the permissible underwriting commission and
brokerage, shall be offered.
12. Reservation: In case there is a reservation for NRIs, the issue advertisement shall specify
the same.
13. Undertaking: An undertaking has to be obtained from the issuer as part of the
MoU between the lead merchant banker and the issue company.
14. Availability of copies: To ensure that the issuer company obtains approval for all
issue advertisements and publicity materials from the lead merchant banker

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STOCK EXCHANGE:
The stock exchange has been defined as anybody of individuals whether incorporated or
not, constituted for the purpose of assisting, regulating or controlling the business of
buying, selling or dealing in securities.
Functions of Stock Exchanges
Liquidity and marketability of Securities: Stock exchanges provide liquidity to
securities since securities can be converted into cash at any time according to the
discretion of the investor by selling them at the listed prices.
Safety of Funds: Stock exchanges ensure safety of funds invested because they have to
function under strict rules and regulations and the bye laws are meant to ensure safety of
investible funds.
Supply of Long term funds: The Company is assured of long term availability of funds
because the security is transacted one investor is substituted by another.
Flow of Capital to Profitable Ventures: The profitability and popularity of companies
are reflected in stock prices. The prices quoted indicate the relative profitability and
performance of companies
Motivation for improved performance: The performance of a company is reflected on
the prices quoted in the stock market. These prices are more visible in the eyes of the
public.
Promotion of Investment: Stock exchanges mobilize the savings of the public and
promote investment through capital formation.
Reflection of Business Cycle: The changing business conditions in the economy are
immediately reflected on the stock exchanges.
Marketing of New Issues: If the new issues are listed, they are readily acceptable to the
public, since, listing presupposes their evaluation by concerned stock exchange
authorities.
Miscellaneous Services: Stock exchange supplies securities of different kinds with
different maturities and yields. It enables the investors to diversity their risks by a wider
portfolio of investment.
Methods of Trading in a Stock Exchange
Choice of Broker: the investor who wants to sell his shares cannot enter into the hall of
exchange and transact business. They have to act through only member brokers. The first
task in transacting business on a stock exchange is to choose a broker of repute or a
banker.
Placement of Order: Placement of order refers to the purchase or sale of securities with
the broker. The order is usually placed by telegram, telephone, letter, fax etc., or in
person.
Execution of Orders: The Orders are executed through their authorized clerks. Orders
are executed in Trading ring of a stock exchange which works from 12 noon to 2 p.m. on
all working days from Monday to Friday and a special one hour session on Saturday.
Trading outside the trading hours is called kerb dealings.

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Preparation of Contract Notes: A contract note is a written agreement between the
broker and his client for the transactions executed. It contains the details of the contract
made for the purchase/sale of securities, the brokerage chargeable etc.,
Settlement of Transactions: The settlement of transactions is made by means of
delivering the share certificates along with the transfer deed. The transfer deed is duly
signed by the transferor, i.e., the seller.
At present, the settlement can be made by any one of the following methods;
Spot delivery settlement: i.e., the delivery of securities and payment for these are
affected on the date of the contract itself or on the next day.
Hand Delivery Settlement: i.e., the delivery of securities and payment are affected
within the time stipulated in the agreement or within 14 days from the date of the
contract whichever is earlier.
Clearing Settlement: i.e., the transactions are cleared and settled through the clearing
house.
Special Delivery Settlement: i.e., the delivery of securities and payment may take place
at any time exceeding 14 days following the date of the contract.
ONLINE TRADING
It is the trading over the net i.e., E-trading.
To overcome the wastage of time consumed and inefficient operations of the traditional
method and the limits on trading volumes the NSE has introduced a nation-wide on line
fully automated Screen Based Trading System (SBTS).
Under SBTS, a member can punch into the computers quantities of securities and the
prices at which he likes to transact the transaction. It is executed as soon as it finds a
matching sale or buy order from a counter party.
NSE has carried the trading platform further to the PCs at the residence of the investors
through the internet and the hand held devices through WAP for the convenience of the
mobile investors.
This system also provides complete market information on-line. The market screens at any
point of time provide complete information as to
(1) Total order depth in a security
(2) The best five buys and sells in the market
(3) The quantity traded during the day in that security
(4) The high and the low price for each security
(5) The last traded price for a security etc.,
OTCEI
Over the Counter Exchange of India
It is a Stock Exchange without a proper trading floor
All stock exchanges have a specific place for trading their securities through counters.
But, OTCEI is connected through a computer network and the transactions are taking
place through computer operations.
OTCEI has been incorporated under Section 25 of the companies Act. As a result of which
the word Limited need not be used since it is promoted for a common case of promoting

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 the interest of small and medium companies. This privilege has been given to the
company by the Central government.

UNIT II ISSUE MANAGEMENT

Role of Merchant Banker in Appraisal of Projects, Designing Capital Structure and
Instruments Issue Pricing Book Building Preparation of Prospectus Selection of
Bankers, Advertising Consultants, etc. - Role of Registrars Bankers to the Issue,
Underwriters, and Brokers. Offer for Sale Green Shoe Option E-IPO, Private
Placement Bought out Deals Placement with FIs, MFs, FIIs, etc. Off - Shore
Issues. Issue Marketing Advertising Strategies NRI Marketing Post Issue
Activities.

Role of Merchant Banker in Appraisal of Projects

The evaluation of industrial projects in terms of alternative variants in technology, raw
materials, production capacity and location of plant is known as Project Appraisal.
Financial appraisal: Financial appraisal involves assessing the feasibility of a new
proposal for setting up a new project or the expansion of existing production facilities.
Financial appraisal is undertaken through an analysis which takes into account the
financial features of a project, including sources of financing.
Financial analysis helps trace the smooth operation of the project over its entire life cycle.
Technical Appraisal: Technical appraisal is primarily concerned with the project concept
in terms of technology, design, scope and content of the plant, as well as inputs are
infrastructure facilities envisaged for the project.
Basically, the project should be able to deliver a marketable product for the resources
deployed, a t a cost which would leave a margin that would be adequate to service the
investment, and also plough back a reasonable amount into the project to enable the
enterprise to consolidate its positions.
Economic Appraisal: Economic appraisal of a project deals with the impact of the project
on economic aggregates. These may be classified under two broad categories. The first
deals with the effect of the project on employment and foreign exchange, and the second
deals with the impact of the project on net social benefits or welfare.
Issue Management
The management of issues for raising funds
The management of issues for raising funds through various types of instruments by
companies is known as issue management.
Classification Of Securites Issue
1. Public Issue of Securities: When capital funds are raised through the issue of a
prospectus, it is called public issue of securities.
2. Rights Issue: When shares are issued to the existing shareholders of a company on a
privileged basis, it is called as Rights Issue.

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3. Private Placement: When the issuing company sells securities directly to the investors,
especially institutional investors, it takes the form of private placement.
Merchant Bankers Functions
The different functions of merchant bankers towards the capital issues management are
1. Designing Capital Structures
2. Capital Market Instruments
3. Preparation of prospectus
4. Selection of bankers
5. Advertising Consultants
6. Choice regarding registrar to the issue
7. Arranging for underwriting the proposed issue
8. Choice for the bankers to the issue
9. Choice for the brokers.
1. DESIGNING CAPITAL STRUCTURE DECISIONS
The term capital structure refers to the proportionate claims of debt and equity in the
total long-term capitalization of a company.
OPTIMAL CAPITAL STRUCTURE
An ideal mix of various sources of long-term funds that aims at minimizing the overall
cost of capital of the firm, and maximizes the market value of shares of a firm is known as
Optimal capital structure
An optimal capital structure should possess the following characteristics:
a. Simplicity: An optimal capital structure must be simple to formulate and implement
by the financial executives.
b. Low Cost: A sound capital structure must aim at obtaining the capital required for the
firm at the lowest possible cost.
c. Maximum Return and Minimum Risks: An ideal capital structure must have a
combination of debt and equity in such a manner as to maximize the firms profits.
Similarly, the firm must be guarded against risks such as taxes, interest rates, costs, etc.
d. Maximum Control: The capital structure must aim at retaining maximum control with
the existing shareholders.
e. Liquidity: In order to have a sound capital structure, it is important that the various
components help provide the firm greater solvency through higher liquidity.
g. Equitable Capitalization: An equitable capitalization would help make full utilization
of the available capital at minimum cost.
h. Optimum Leverage: The firm must attempt to secure a balanced leverage by issuing
both debt and equity at certain ideal proportions.
Decisions On Capital Structure
The decisions regarding the use of different types of capital funds in the overall long term
capitalization of a firm are known as capital structure decisions.
Any decisions on Capital Structure are based on different principles.

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 a. Cost Principle: An ideal pattern of capital structure is one that costs the least. The
returns must be maximized and cost minimized.
b. Control Principle: The amount of control to be exercised by the shareholders over the
management is an important principle underlining capital structure decisions.
c. Return Principle: According to his principle, the patterns of capital structure must be
devised to allow for enhanced returns to the shareholders.
d. Flexibility Principle: For capital structure decisions to be efficient there must be
adequate flexibility in the capitalization. The addition of a capital fund must be such that
it should be possible for a firm to redeem or add capital to the existing capital structure.
e. Timing Principle: The quality of decisions depends on the time at which the capital
funds are either raised or returned. This would help minimize the cost of capital, and
thus help maximize returns to shareholders.
FACTORS AFFECTING CAPITAL STRUCTURE DECISIONS
Economy Characteristics: In order words, the way the economy of a country is managed
determines the way the capital structure of a firm will be determined.
1. Business activity : The quality of business activity prevailing in the economy
determines the capital structure pattern of a firm.
2. Stock market: Accordingly, if the stock market is expected to witness bullish trends,
the interest rates will go up and debt will become costlier.
3. Taxation: The rates and rules of taxation prevalent in an economy also affect capital
structure decisions.
4. Regulations: The regulations imposed by the state on the quantum, pricing etc. of
capital funds to be raised also influences the capital raised by a firm.
5. Credit policy: The credit policy pronouncements made by the central monetary
authority, such as the RBI, affects the way capital is raised in the market.
6. Financial institutions: The credit policy followed by financial institutions determines
the capital structure decisions of firms.
2. CAPITAL MARKET INSTRUMENTS
Financial instruments that are used for raising capital resources in the capital market are
known as Capital Market Instruments.
THE DIFFERENT TYPES OF CAPITAL MARKET INSTRUMENTS:
Financial instruments that are used for raising capital resources in the capital market are
known as Capital Market Instruments.
Preference Shares: Shares that carry preferential rights in comparison with ordinary
shares are called Preference Shares. The preferential rights are the rights regarding
payment of dividend and the distribution of the assets of the company in the event of its
winding up, in preference to equity shares.
Types of preference shares
1. Cumulative preference share: where the arrears of dividends in times of no and/or lean
profits can accumulated and paid in the year in which the company earns good profits.

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2. Non-cumulative preference shares: Shares where the carry forward of the arrears of
dividends is not possible.
3. Participating preference shares: Shares that enjoy the right to participate in surplus
profits or surplus assets on the liquidation of a company or in the both, if the Articles of
Association provides for its.
4. Redeemable preference shares: Shares that are to be repaid at the end of the term of
issue. The maximum period of a redemption being 20 years.
5. Preference shares with warrants attached: The attached warrants entitle the holder to
apply for equity shares for cash, at a premium, at any time, in one or more stages
between the third and fifth year from the date of allotment.
Equity Shares: Equity shares, also known as ordinary shares are the shares held by the
owners of a corporate entity.
Features of Equity shares
Since equity shareholders face greater risks and have no specific preferential rights.
A strikingly noteworthy feature of equity shares is that holders of these shares enjoy
substantial rights in the corporate democracy.
Equity shares in the hands of shareholders are mainly reckoned for determining the
managements control over the company
Equity shareholders represent proportionate ownership in a company.
Voting rights are granted under the Companies Act (Sections 87 to 89) wherein each
shareholder is eligible for votes proportionate to the number of shares held or the amount
of stock owned.
Capital
The maximum value of shares as specified in the Memorandum of Association of the
company is called the authorized or registered or nominal capital. Issued capital is the
nominal value of shares offered for public subscription.
Par Value and Book Value
The face value of a share is called its Par value. Although shares can be sold below the
par value, it is possible that shares can be issued below the par value
Par value is of use to the regulatory agency and the stock exchange. It can be used to
control the number of shares that can be issued by the company.
The par value of Rs.10 per shares serves as a floor price for issue of shares.
Cash Dividends
These are dividends paid in cash; a stable payment of cash dividend is the hallmark of
stability of shares prices.
Stock dividends
These are the dividends distributed as shares and issued by capitalizing shares reserves.

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 Non-Voting Equity Shares
Consequent to the recommendations of the Abid Hussain Committee and subsequent to
the amendment to the Companies Act, corporate managements are permitted to mobilize
additional capital without diluting the interest of existing shareholders with the help of a
new instrument called non-voting equity shares. Such shares will be entitled to all the
benefits except the right to vote in general meetings
Convertible Cumulative Preference Shares (CCPS)
These are the shares that have the twin advantage of accumulation of arrears of dividends
and the conversion into equity shares
Following are some of the terms and conditions of the issue of CCP shares:
1. Debt-equity ratio: For the purposes of calculation of debt-equity ratio as may be
applicable CCPS are be deemed to be an equity issue.
2. Compulsory conversion: The conversion into equity shares must be for the entire of
issue of CCP shares and shall be done between the period at the end of three years and
five years as may be decide by the company.
3. Fresh Issue: The conversion of CCP shares into equity would be deemed as being one
resulting from the process of redemption of the preference shares out of the proceeds of a
fresh issue of shares made for the purposes of redemption.
4. Preference dividend: The rate of preference dividend payable on CCP shares would be
10 percent.
5. Guideline ratio: The guidelines ratio of 1:3 as between preference shares and equity
shares would not be applicable to these shares.
6. Arrears of dividend: The right to receive arrears of dividend up to the date of conversion,
if any, shall devolve on the holder of the equity shares on such conversion.
7. Voting right: CCPS would have voting rights as applicable to preference shares under
the companies Act, 1956.
8. Quantum: The amount of the issue of CCP shares would be to the extent the company
would be offering equity shares to the public for subscription.
Company Fixed Deposits
Fixed deposits are the attractive source of short-term both for the companies and
investors as well. Corporates favor fixed deposits as an ideal form of working capital
mobilization without going through the process of mortgaging assets.
Regulations
The issue of fixed deposits is subject to the provisions of the Companies Act and he
companies (Acceptance of Deposits) Rules introduced in February 1975, some of the
important regulations in this regard as follows:

16
1. Advertisement: Issue of an advertisement (with the prescribed information) as approved
by the Board of Directors in dailies circulating in the state of incorporation.
2. Liquid assets: Maintenance of liquid assets equal to 15 percent (substituted for 10% by
Amendment Rules, 1992) of deposits (maturing during the year ending March 31) in the
form of bank deposits, unencumbered securities of State and Central Governments or
unencumbered approved securities.
3. Disclosure: Disclosure in the newspaper advertisement the quantum of deposits
remaining unpaid after maturity. This would help highlight the defaults, if any, by the
company and caution the depositors.
4. Deemed public Company: Private company would become a deemed public company
where such a private company, after inviting public deposits through a statutory
advertisement, accepts or renews deposits from the public other than the members,
directors or their relatives.
5. Default: Penalty under the law for default by companies in repaying deposits as and
when they mature for payment where deposits were accepted in accordance with the
Reserve Bank directions.
6. CLB: Empowerment to the Company Law Board to direct companies to repay deposits,
which have not been repaid as per the terms and conditions governing such deposits,
with a time frame and according to the terms and conditions of the order.
Warrants
An option issued by a company whereby the buyer is granted the right to purchase a
number of shares (usually one) of its equity share capital at a given exercise price during
a given period is called a warrant.
Both warrants and rights entitle a buyer to acquire equity shares of the issuing company.
However, they are different in the sense that warrants have a life span of three to five
years whereas; rights have a life span of only four to twelve weeks (duration between the
opening and closing date of subscription list).
Debentures and Bonds
A document that either creates a debt or acknowledges it is known as a debenture.
Features
Following are the features of a debenture:
1. Issue: In India, debentures of various kinds are issued by the corporate bodies,
Government, and others as per the provision of e Companies Act, 1956 and under the
regulations of the SEBI.
2. Negotiability: In the case of bearer debentures the terminal value is payable to its
bearer. Such instruments are negotiable and are transferable by delivery.

17
3. Security: Secured debentures create a charge on the assets of the company. Such a
charge may be either fixed or floating.
Debentures that are issued without any charge on assets of the company are called
unsecured or naked debentures.
4. Duration: Debentures, which could be redeemed after a certain period of time are called
Redeemable Debentures.
There are debentures that are not to be returned except at the time of winding up of the
company. Such debentures are called Irredeemable Debentures.
5. Convertibility: Where the debenture issue gives the option of conversion into equity
shares after the expiry of a certain period of time, such debentures are called Convertible
Debentures.
6. Return: Debenture have a great advantage in them, in that they carry a regular and
reasonable income for the holders
7. Claims: Debentures holders command a preferential treatment in the matters of
distribution of the final proceeds of the company at the time of its winding up.
KINDS OF DEBENTURES:
Innovative debt instruments that are issued by the public limited companies in India are
described below:
1. Participating debentures: Debentures that are issued by a body corporate which entitle
the holders to participate in its profits are called Participating Debentures.
2. Convertible debentures: Convertible debentures with options. Are a derivative of
convertible debentures that give an option to both the issuer, as well as investor, to exist
from the terms of the issue.
Third party convertible debentures are debts with a warrant that allow the investor to
subscribe to the equity of a third firm at a preferential price viz-a-vis market price, the
interest rate on the third party convertible debentures being lower than pure debt on
account of the conversion option.
3. Debt-equity swaps: They are offered from a n issuer of debt to swap it for equity. The
instrument is quite risky for the investor because the anticipated capital appreciation may
not materialize.
4. Zero-coupon convertible note: These are debentures that can be converted into shares
and on its conversion the investor forgoes all accrued and unpaid interest. The Zero-
coupon convertible notes are quite sensitive to changes in the interest rates.
5. SPN with detachable warrants: These are the Secured Premium Notes (SPN) with
detachable warrants. These are the redeemable debentures that are issued along with a
detachable warrant. The warrant entitles the holder to apply and get equity shares

18
 allotted, provided the SPN is fully paid. The warrants attached it assured the holder such
a right. No interest will be paid during the lock-in period for SPN.
6. NCDs with detachable equity warrants: These are Non-Convertible Debentures (NCDs)
with detachable equity warrants. These entitle the holder to buy a specific number of
shares from the company at a predetermined price within a definite time frame.
7. Zero interest FCDs: These are Zero-interest Fully Convertible Debentures on which no
interest will be paid by the issuer during the lock-in-period. However, there is a notified
period after which fully paid FDCs will be automatically and compulsorily converted into
shares.
Secured Zero interest PDCs with detachable and separately tradable warrants. These are
Secured Zero interest Partly Convertible Debentures with detachable and separately
tradable warrants.
8. Fully convertible debentures (FCDs) with interest (Optional): These are the
debentures that will not yield any interest for an initial short period after which the holder
is given an option to apply for equities at a premium.
9. Floating Rate Bonds (FRBs): These are the bonds where the yield is linked to a
benchmark interest rate like the prime rate in USA or LIBOR in the Euro currency
market. The floating rate is quoted in terms of a margin above or below the benchmark
rate. Interest rates linked to the benchmark ensure that neither the borrower nor the
lender suffer from the changes in interest rates. Where interest rates are fixed, they are
likely to be inequitable to the borrower when interest rates fall and inequitable to the
lender when interest rates rise subsequently.
Initial Public Offering (IPO)
IPO is when an unlisted company makes either a fresh issue of securities or an offer for
sale of its existing securities or both for the first time to the public. This paves way for
listing and trading of the issuers securities.
ISSUE PRICING
Indian primary market ushered in an era of free pricing in 1992. Following this, the
guidelines have provided that the issuer in consultation with Merchant Banker shall
decide the price. There is no price formula stipulated by SEBI. SEBI does not play any
role in price fixation. The company and merchant banker are however required to give full
disclosures of the parameters which they had considered while deciding the issue price.
There are two types of issues one where company and LM(lead manager) fix a price (called
fixed price) and other, where the company and LM stipulate a floor price or a price band
and leave it to market forces to determine the final price (price discovery through book
building process).
1. Fixed Price offers
An issuer company is allowed to freely price the issue. The basis of issue price is disclosed
in the offer document where the issuer discloses in detail about the qualitative and
quantitative factors justifying the issue price. The Issuer company can mention a price

19
 band of 20% (cap in the price band should not be more than 20% of the floor price) in the
Draft offer documents filed with SEBI and actual price can be determined at a later date
before filing of the final offer document with SEBI/ROCs.
2. Book-building Method
A method of marketing the shares of a company whereby the quantum and the price of
the securities to be issued will be decided on the basis of the bids received from the
prospective shareholders by the lead merchant bankers is known as book-building
method.
The option of book-building is available to all body corporate, which are otherwise eligible
to make an issue of capital of the public. The initial minimum size of issue through book-
building route was fixed at Rs.100 crores.
The book-building process involves the following steps:
1. Appointment of book-runners: the first step in the book-building is the appointment by
the issuer company, of the book-runner, chosen from one of the lead merchant bankers.
The book-runner in the forms a syndicate for the book building. A syndicate member
should be a member of National Stock Exchange (NSE) or Over-the-Counter Exchange of
India (OTCEI). Offers of bids are to be made by investors to the syndicate members, who
register the demands of investors.
2. Drafting prospectus: The draft prospectus containing all the information except the
information regarding the price at which the securities are offered is to be filed with SEBI
as per the prevailing SEBI guidelines. The offer of securities through this process must
separately be disclosed in the prospectus, under the caption placement portion category.
3. Circulating draft prospectus: A copy of the draft prospectus filed with SEBI is to be
circulated by the book-runner to the prospective institutional buyers who are eligible for
firm allotment and also to the intermediaries who are eligible to act as underwriters.
4. Maintain offer records: The book-runner maintain a record to the offers received.
Details such as the name and the number of securities ordered together with the price at
which each institutional buyer or underwriter is willing to subscribed to securities under
the placement portion must find place in the record. SEBI has the right to inspect such
records.
5. Intimation about aggregate orders: The underwriters and the institutional investors
shall give intimation on the aggregate of the offers received to the book-runner.
6. Bid analysis: The bid analysis is carried out by the book-runner immediately after the
closure of the bid offer date. An appropriate final price is arrived at after a careful
evaluation of demands at various prices and the quantity.
7. Mandatory underwriting: Where it has been decided to make offers of shares to public
under the category of Net offer of the Public, it is incumbent that the entire portion
offered to the public is fully underwritten.

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8. Filling with ROC: A copy of the prospectus as certified by the SEBI shall be filed with
the Registrar of Companies within two days of the receipt of the acknowledgement card
from the SEBI.
9. Bank accounts: The issuer company has to open two separate accounts for collection of
application money, one for the private placement portion and the other for the public
subscription.
10.Collection of completed applications: The book-runner collects from the institutional
buyers and the underwriters the application forms along with the application money to
the extent of the securities proposed to be allotted to them or subscribed by them.
11.Allotment of securities: Allotment for the private placement portion may be made on
the second day from the closure of the issue. The issuer company, however, has the
option to choose one date for both the placement portion and the public portion.
12.Payment schedule and listing: The book-runner may require the underwriters to the
net offer to the public to pay in advance all moneys required to be paid in respect of their
underwriting commitment by the eleventh day of the closure of the issue.
13.Under-subscription: In the case of under-subscription in the net offer to the public
category, any spillover to the extent of under subscription is to be permitted from the
placement portion category subject to the condition that preference is given to the
individual investors.
Advantages of book-building
Book building process is of immense use in the following ways:
1. Reduction in the duration between allotment and listing
2. Reliable allotment procedure
3. Quick listing in stock exchanges possible
4. No price manipulation as the price is determined on the basis of the bids received.
PREPARATION OF PROSPECTUS
Prospectus is defined a document through which public are solicited to subscribe to the
share capital of a corporate entity. Its purpose is inviting the public for the
subscription/purchase of any securities of a company.
SELECTION OF BANKERS
Merchant bankers assist in selecting the appropriate bankers based on the proposals or
projects.
ADVERTISING CONSULTANTS
Merchant bankers arrange a meeting with company representatives and advertising
agents to finalize arrangements relating to date of opening and closing of issue,
registration, of prospectus, launching publicity campaign and fixing date of board meeting
to approve and sign prospectus and pass the necessary resolutions.
THE ROLE OF A REGISTRAR

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The Registrar finalizes the list of eligible allottees after deleting the invalid applications
and ensures that the corporate action for crediting of shares to the demat accounts of the
applicants is done and the dispatch of refund orders to those applicable are sent. The
Lead manager coordinates with the Registrar to ensure follow up so that that the flow of
applications from collecting bank branches, processing of the applications and other
matters till the basis of allotment is finalized, dispatch security certificates and refund
orders completed and securities listed.
BANKERS TO THE ISSUE
Bankers to the issue, as the name suggests, carries out all the activities of ensuring that
the funds are collected and transferred to the Escrow accounts. The Lead Merchant
Banker shall ensure that Bankers to the Issue are appointed in all the mandatory
collection centers as specified in DIP Guidelines. The LM also ensures follow-up with
bankers to the issue to get quick estimates of collection and advising the issuer about
closure of the issue, based on the correct figures.
UNDERWRITERS
Another important intermediary in the new issue/primary market is the underwriters to
issues of capital who agree to take up securities which are not fully subscribed. They
make a commitment to get the issue subscribed either by others or by themselves.
Underwriters are appointed by the issuing companies in consultation with the lead
managers/merchant bankers to the issues. A statement to the effect that in the opinion of
the lead manager, the underwriters assets are adequate to meet their obligation should
be incorporated in the prospectus.
BROKERS TO THE ISSUE
Brokers are the persons mainly concerned with the procurement of subscription to the
issue from the prospective investors. The appointment of brokers is not compulsory and
the companies are free to appoint any number of brokers. The managers to the issue and
the official brokers organize the preliminary distribution of securities and procure direct
subscriptions from as large or as wide a circle of investors as possible.
Brokerage may be paid within the limits and according to other conditions prescribed.
The brokerage rate applicable to all types of public issue of industrial securities is fixed at
1.5 percent, whether the issue is underwritten or not.
Green-shoe Option
A Green Shoe option means an option of allocating shares in excess of the shares
included in the public issue and operating a post-listing price stabilizing mechanism for a
period not exceeding 30 days in accordance with the provisions of Chapter VIIIA of DIP
Guidelines, which is granted to a company to be exercised through a Stabilizing Agent.
This is an arrangement wherein the issue would be over allotted to the extent of a
maximum of 15% of the issue size.
E-IPO
A company proposing to issue capital to public through the on-line system of the stock
exchange for offer of securities can do so if it complies with the requirements under
Chapter 11A of DIP Guidelines. The appointment of various intermediaries by the issuer
includes a prerequisite that such members/registrars have the required facilities to
accommodate such an online issue process.

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 PRE-ISSUE ACTIVITIES

There are several activities that have to be performed by the issue manager in order to
raise money from the capital market. Adequate planning needs to be done while chalking
out an appropriate marketing strategy. The various activities involved in raising funds
from the capital markets are described below:

1. Signing of Memorandum of Understanding (MOU): Signing of MOU between the client

company and the merchant banker-issue management activities, marks the award of the
contract. The role and responsibility of the merchant banker as against the issuing
company are clearly spelt out in the MOU.

2. Obtaining appraisal note: An appraisal note containing the details of the proposed
capital outlay of the project and the sources of funding is either prepared in-house or is
obtained from external appraising agencies, viz, financial institutions/banks, etc.

3. Optimum capital structure: The level of capital that would maximize the shareholders
vale and minimize the overall cost of capital has to be determined.

4. Convening Meeting: A meeting of the Board of Directors of the issuing company is

convened. This is followed by an EGM of its members.

5. Appointment of financial intermediary: Financial intermediaries such as

Underwriters, registrars, etc have to be appointed. Necessary contracts need to be made
with the underwriter to ensure due subscription to the offer. Similar contracts, when
entered into with the Registrars to an issued, will help in share allotment related work.

6. Preparing documents: As part of the issue management procedure, the documents to be

prepared are initial listing application for submission to those stock exchanges where the
issuing company intends to get its securities listed, MoU with the registrar, with bankers
to the issue, with advisors to the issue and co-managers to the issue, agreement for
purchase or properties, etc.

7. Due diligence certificate: The lead manager issues a due diligence certificate which
certifies that the company has scrupulously following all legal requirements, has
exercised utmost care while preparing the offer document and has made a true, fair and
adequate disclosure in the draft offer document.

8. Submission of offer document: The draft offer document along with the due diligence
certificate is filed with SEBI. The SEBI, in turn, makes necessary corrections in the offer
document and returns the same with relevant observations, if any, within 21 days from
the receipt of the offer document.

23
9. Finalization of collection centers: In order to collect the issue application forms from
the prospective investors, the lead manager finalizes the collection centers.

10.Filing with RoC: The offer document, completed in all respects after incorporating SEBI
observations, is filed with Registrar of Companies (RoC) to obtain acknowledgement.

11.Launching the issue: The process of marketing the issue starts once the legal formalities
are completed and statutory permission for issue of capital is obtained. The lead manager
has to arrange for the distribution of public issue stationery to various collecting banks,
brokers, investors, etc. the issue is opened for public immediately after obtaining the
observation letter from SEBI, which is valid for a period of 365 days from the date of
issue.

12.Promoters contribution: a certificate to the effect that the required contribution of the
promoters has been raised before opening of the issue, has to be obtained from a
Chartered Accountant, and duly filed with SEBI.

13.Issue closure: An announcement regarding the closure of the issue should be made in
the newspapers.
Methods of Marketing Securities
Following are the various methods being adopted by corporate entities for marketing the
securities in the New Issue Market:
1. Pure Prospectus Method
2. Offer for Sale Method
3. Private Placement Method
4. Initial public Offers (IPOs) Method
5. Rights Issue Method
6. Bonus Issue Method
7. Book-building Method
8. Stock Option Method and
9. Bought-out Deals Method
PURE PROSPECTUS METHOD
Meaning
The method whereby a corporate enterprise mops up capital funds from the general
public by means of an issue of a prospectus, is called Pure Prospectus Method. It is the
most popular method of making public issue of securities by corporate enterprises.
Features

24
Exclusive subscription: Under this method, the new issues of a company are offered for
exclusive subscription of the general public.
Issue Price: Direct officer is made by the issuing company to the general public to
subscribe to the securities as a stated price.
Underwriting: Public issue through the pure prospectus method is usually
underwritten. This is to safeguard the interest of the issuer in the event of an
unsatisfactory response from the public.
Prospectus: A document that contains information relating to the various aspects of the
issuing company, besides other details of the issue is called a Prospectus. The document
is circulated to the public. The general details include the companys name and address
of its registered office, the names and addresses of the companys promoters, manager,
managing director, directors, company secretary, legal adviser, auditors, bankers, brokers,
etc.
Advantages
The pure prospectus method offers the following advantages to the issuer and the
investors alike:
Benefits to investors: The pure prospectus method of marketing the securities serves as
an excellent mode of disclosure of all the information pertaining to the issue. Besides, it
also facilitates satisfactory compliance with the legal requirements of transparency, etc.
Benefits to issuers: The pure prospectus method is the most popular method among the
larger issuers. In addition, it provides for wide diffusion of ownership of securities
contributing to reduction in the concentration of economic and social power.
Drawbacks
The raising of capital through the pure prospectus method is fraught with a number of
drawbacks as specified below:
High issue costs: A major drawback of this method is that it is an expensive mode of
raising funds from the capital market. Costs of various hues are incurred in mobilizing
capital.
Time Consuming: The issue of securities through prospectus takes more time, as its
requires the due compliance with various formalities before an issue could take place.
OFFER FOR SALE METHOD
Meaning
Where the marketing of securities takes place through intermediaries, such as issue
houses, stockholders and others, it is a case of Offer for sale Method.
Features
Under this method, the sale of securities takes place in two stages. Accordingly, in the
first stage, the issuer company makes an en-block sale of securities to intermediaries

25
 such as the issue houses and share brokers of an agreed price. Under the second stage,
the securities are re-sold to ultimate investors at a market-related price.
The issue is also underwritten to ensure total subscription of the issue. The biggest
advantage of this method is that it saves the issuing company the hassles involved in
selling the shares to the public directly through prospectus.
Private Placement Method
Meaning
A method of marketing of securities whereby the issuer makes the offer of sale of
individuals and institutions privately without the issue of a prospectus is known as
Private Placement Method.
Features
Under this method, securities are offered directly to large buyers with the help of share
brokers. This method works in a manner similar to the Offer for Sale Method whereby
securities are first sold to intermediaries such as issues houses, etc.
Advantages
Private placement of securities offers the following advantages:
1. Less expensive as various types of costs associated with the issue are borne by the issue
houses and other intermediaries.
2. Placement of securities suits the requirements of small companies.
3. The method is also resorted to when the stock market is dull and the public response to
the issue is doubtful.
Disadvantages
The major weaknesses of the private placement of securities are as follows:
1. Concentration of securities in a few hands.
2. Creating artificial scarcity for the securities thus jacking up the prices temporarily and
misleading general public.
3. Depriving the common investors of an opportunity to subscribe to the issue, thus
affecting their confidence levels.
Initial Public Offer (IPO) Method
The public issue made by a corporate entity for the first time in its life is called Initial
public Offer (IPO), Under this method of marketing, securities are issue to successful
applicants on the basis of the orders placed by them, through their brokers.
When a company whose stock is not publicly traded wants to offer that stock to the
general public, it takes the form of Initial public offer. The job of selling the stock is
entrusted to a popular intermediary, the underwriter. The underwriters charge a fee for
their services.

26
 Stocks are issued to the underwriter after the issue of prospectus which provides details
of financial and business information as regards the issuer.
The issuer and the underwriting syndicate jointly determine the price of a new issue. IPO
stock at the release price is usually not available to most of the public. Good relationship
between, the broker and the investor is a pre-requisite for the stock being acquired.
Full disclosure of all material information in connection with the offering of new
securities must be made as part of the new offerings. A statement and preliminary
prospectus (also known as a red herring) containing the following information is to be
filled with the Registrar of Companies:
1. A description of the issuers business.
2. The names and addresses of the Key company officers, with salary and a 5 year business
history on each.
3. The amount of ownership of the key officers
4. Any legal proceedings that the company is involved in
The essential steps involved in this method of marketing of securities are as follows:
1. Order: Broker receives order from the client and places orders on behalf of the client with
the issuer.
2. Share Allocation: The issuer finalizes share allocation and informs the broker regarding
the same.
3. The Client: The broker advises the successful clients of the share allocation. Clients
then submit the application forms for shares and make payment to the issuer through the
broker.
4. Primary issue account: The issuer opens a separate escrow account (primary issue
account) for the primary market issue. The clearing house of the exchange debits the
primary issue account of the broker and credits the issuers account.
5. Certificates: Certificates are then delivered to investors. Otherwise depository account
may be credited.
Rights issue Method
Where the shares of an existing company are offered to its existing shareholders. It takes
the form of rights issue. Under this method, the existing company issues shares to its
existing shareholder sin proportion in the number of shares already held by them.
The relevant guidelines issued by the SEBI in this regard are as follows:
1. Shall be issued only by listed companies.
2. Announcement regarding rights issue once made, shall not be withdrawn and where
withdrawn, no security shall be eligible for listing upto 12 months.
3. Underwriting as to rights issue is optional and appointment of Registrar is compulsory.

27
4. Appointment of category I Merchant Bankers holding a certificate of registration issued by
SEBI shall be compulsory.
5. Rights share shall be issued only in respect of fully paid share.
6. Letter of Offer shall contain disclosures as per SEBI requirements.
7. Issue shall be kept open for a minimum period of 30 days and for a maximum period of
60 days.
8. A No complaints Certificate is to be filed by the Legal Merchant Banker with the SEBI
after 21 days from the date of issue of the document.
9. Obligatory for a company where increase in subscribed capital is necessary after two
years of its formation of after one year of its first issue of shares, whichever is earlier (this
requirement may be dispensed with by a special resolution).
Advantages
Rights issue offers the following advantages
1. Economy: Rights issue constitutes the most economical method of raising fresh capital,
as it involves no underwriting and brokerage costs.
2. Easy: The issue management procedures connected with the rights issue are easier as
only a limited number of applications are to be handled.
3. Advantage to shareholders: Issue of rights shares does not involve any dilution of
ownership of existing shareholders.
Drawbacks
The method suffers from the following limitations:
1. Restrictive: The facility of rights issue is available only to existing companies and not to
new companies.
2. Against society: the issue of rights shares runs counter to the overall societal
consideration of diffusion of share ownership for promoting dispersal of wealth and
economic power.
Bonus Issues Method
Where the accumulated reserves and surplus of profits of a company are converted into
paid up capital, it takes the form of issue of bonus shares. It merely implied
capitalization of existing reserves and surplus of a company.
Issue under Section 205 (3) of the companies Act, such shares is governed by the
guidelines issued by the SEBI (applicable of listed companies only) as follows:
SEBI Guidelines
Following are the guidelines pertaining to the issue of bonus shares by a listed corporate
enterprise:
1. Reservation: In respect of FCDs and PCDs, bonus shares must be reserved in proportion
to such convertible part of FCDs and PCDs. The shares so reserved may be issued at the

28
 time of conversion(s) of such debentures on the same terms on which the bonus issues
were made.
2. Reserves: the bonus issue shall be made out of free reserves built out of the genuine
profits or share premium collected in cash only.
3. Dividend mode: the declaration of bonus issue, in lieu of dividend, is not made.
4. Fully paid: The bonus issue is not made unless the partly paid shares, if any are made
fully paid-up.
5. No default: The Company has not defaulted in payment of interest or principal in respect
of fixed deposits and interest on existing debentures or principal on redemption thereof
and has sufficient reason to believe that it has not defaulted in respect of the payment of
statutory dues of the employees such as contribution to provident fund, gratuity, bonus,
etc.
6. Implementation: A company that announces its bonus issue after the approval of the
Board of Directors must implement the proposal within a period of 6 months from the
date of such approval and shall not have the option of changing the decision.
7. The articles: The articles of Association of the company shall contain a provision for
capitalization of reserves, etc. if there is no such provision in the articles, the company
shall pass a resolution at is general body meeting making provision in the Articles of
Association for capitalization.
8. Resolution: consequent to the issue of bonus shares if the subscribed and paid-up
capital exceeds the authorized share capital, the company at its general body meeting for
increasing the authorized capital shall pass a resolution.
Book-building Method
A method of marketing the shares of a company whereby the quantum and the price of
the securities to be issued will be decided on the basis of the bids received from the
prospective shareholders by the lead merchant bankers is known as book-building
method.
Stock Option or employees Stock Option Scheme (ESOP)
A method of marketing the securities of a company whereby its employees are encouraged
to take up shares and subscribe to it is know as stock option. It is a voluntary scheme
on the part of the company to encourage employees participation in the company. The
scheme also offers an incentive to the employees to stay in the company.
SEBI Guidelines
Company whose securities are listed on any stock exchange can introduce the scheme of
employees stock option. The offer can be made subject to the conditions specified below:
1. Issue at discount: Issue of stock options at a discount to the market price would be
regarded as another form of employee compensation and would be treated as such in the

29
 financial statements of the company regardless the quantum of discount on the exercise
price of the option.
2. Approval: The issue of ESOPs is subject to the approval by the shareholders through a
special resolution.
3. Maximum limit: There would be no restriction on the maximum number of shares to be
issued to a single employee.
4. Minimum period: A minimum period of one year between grant of options and its
vesting has been prescribed. After one year, the company would determine the period
during which the option can be exercised.
5. Superintendence: The operation of the ESOP Scheme would have to be under the
superintendence and direction of a Compensation Committee of the Board of Directors in
which there would be a majority of independent directors.
6. Eligibility: ESOP scheme is open to all permanent employees and to the directors of the
company but not to promoters and large shareholders.
7. Directors report: The Directors report shall make a disclosure of the following:

a. Total number of shares as approved the shareholders

b. The pricing formula adopted
c. Details as to options granted, options vested, options exercised and options forfeited,
extinguishments or modification of options, money realized by exercise of options, total
number of options in force, employee-wise details of options granted to senior managerial
personnel and to any other employee who received a grant in anyone year of options
amounting to 5 percent or more of options granted during that year.
d. Fully diluted EPS computed in accordance with the IAS
8. IPO: SEBIs stipulations prohibiting initial public offerings by companies having
outstanding options should not apply to ESOP.

Stock Option Norms for Software Companies

The relevant guidelines issued by the SEBI as regards employees stock option for
software companies are as follows:
1. Minimum issue: A minimum issue of 10 percent of its paid-up capital can be made by a
software company which has already floated American Depository Receipts (ADRs) and
Global Depository Receipts (GDRs) or a company which is proposing to float these is
entitled to issue ADR/GDR linked stock options to its employees.
2. Mode of Issue: Listed stock options can be issued in foreign currency convertible bonds
and ordinary shares (through depository receipt mechanism) to the employees of
subsidiaries of Info Tech Companies.

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3. Permanent employees: Indian IT companies can issue ADR/GDR linked stock options to
permanent employees, including Indian and overseas directors, of their subsidiary
companies incorporated in India or outside.
4. Pricing: The pricing provisions of SEBIs preferential allotment guidelines would not
cover the scheme. The purpose is to be enable the companies to issue stock options to its
employees at a discount to the market price which serves as another form of
compensation.
5. Approval: Shareholders approval through a special resolution is necessary for issuing
the ESOPs. A minimum period of one year between grant of option and its vesting has
been prescribed. After one year, the company would determine the period in which option
can be exercised.
Bought-out Deals
Meaning
A method for marketing of securities of a body corporate whereby the promoters of an
unlisted company make an outright sale of a chunk of equity shares to a single sponsor or
the lead sponsor is known as bought-out deals.
Features
1. Parties: There are three parties involved in the bought-out deals. They are promoters of
the company sponsors and co-sponsors who are generally merchant bankers and
investors.
2. Outright Sale: Under this arrangement, there is an outright sale of a chunk of equity
shares to a single sponsor or the lead sponsor.
3. Syndicate: Sponsor forms a syndicate with other merchant bankers for meeting the
resource requirements and for distributing the risk.
4. Sale price: The sale price is finalized through negotiations between the issuing company
and the purchaser, the sale being influenced by such factors as project evaluation,
promoters image and reputation, current market sentiments, prospects of off-loading
these shares at a future date, etc.
5. Listing: The investor-sponsor make a profit, when at a future date, the shares get listed
and higher prices prevail. Listing generally takes place at a time when the company is
performing well in terms of higher profits and larger cash generations from projects.
6. OTCEI: Sale of these share at Over-the-Counter Exchange of India (OTCEI) or at a
recognized stock exchanges, the time of listing these securities and off-loading them
simultaneously are being generally decided in advance.

MARKETING OF NEW ISSUES

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Following are the steps involved in the marketing of the issue of securities to be
undertaken by the lead manager:
1. Target market: The first step towards the successful marketing of securities is the
identification of a target market segment where the securities can be offered for sale. This
ensures smooth marketing of the issue. Further, it is possible to identify whether the
market comprises of retail investors, wholesale investors or institutional investors.
2. Target concentration: After having chosen the target market for selling the securities,
steps are to be taken to assess the maximum number of subscriptions that can be
expected from the market. It would work to the advantage of the company if it
concentrates on the regions where it is popular among prospective investors.
3. Pricing: After assessing market expectations, the kind and level of price to be charged
for the security must be decided. Pricing of the issue also influences the design of capital
structure. The offer has to be made more attractive by including some unique features
such as safety net, multiple options for conversion, attaching warrants, etc.
4. Mobilizing intermediaries: For successful marketing of public issues, it is important
that efforts are made to enter into contracts with financial intermediaries such as an
underwriter, broker/sub-broker, fund arranger, etc.
5. Information contents: Every effort should be mad3e to ensure that the offer
document for issue is educative and contains maximum relevant information.
Institutional investors and high net worth investors should also be provided with detailed
research on the project, specifying its uniqueness and its advantage over other existing or
upcoming projects in a similar field.
6. Launching advertisement campaign: In order to push the public issue, the lead
manager should undertake a high voltage advertisement campaign.
7. Brokers and investors conferences: As part of the issue campaign, the lead
manager should arrange for brokers and investors conferences in the metropolitan cities
and other important centres which have sufficient investor population. In order to make
such endeavors more successful, advance planning is required.
ADVERTISING STRATEGIES
SEBI issued Guidelines in 1993 to ensure that the advertisement are truthful fair and
clear and do not contain statements to mislead the investors to imitate their judgment. All
lead managers are expected to ensure that issuer companies strictly observe the code of
advertisement set-out in the guidelines.
CODE OF ADVERTISEMENTS- CAPITAL ISSUES
1. An issue advertisement shall be truthful fair and clear and shall not contain any
statement which is untrue or misleading.
2. As investors may not be well versed in legal or financial matter, care should be taken to
ensure that the advertisement is set forth in a clear, concise and understandable
language.
3. No model, celebrities, fictional characters, landmarks or caricatures or the like shall be
displayed on or form part of the offer documents or issue advertisements.
4. An issue advertisement shall not contain statements which promise or guarantee an
appreciation or rapid profits.

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5. An issue advertisement shall not contain any inform or language that not contained in
the offer documents.
6. All issue advertisement in newspapers, magazines, brochures, pamphlets containing
highlights relating to any issue should also contain risk factors with the same print size.
It should mention the names of lead Managers, Registers to the issue.
7. No corporate advertisement except product advertisements shall be issued between the
date of opening and closing of subscription of any public issue.
8. No slogans, expletives or non-factual and unsubstantiated titles should appear in the
issue advertisement or offer documents.
9. If any advertisements carries any financial data it should also contain data for last
three years and shall include particulars relating to sales, gross profits, net profit share
capital reserves, earning per share, dividends and book values.
10. No incentives, apart from the permissible underwriting commission and brokerages,
shall be offered through any advertisements to anyone associated with marketing the
issue.
MERCHANT BANKING AND POST ISSUE ACTIVITIES
The major activities covered are :
Finalization of Basis of Allotment
If the public issue is oversubscribed to the extent of greater than five times, a SEBI
nominated public representative is required to participate in the finalization of Basis of
allotment (BoA).
Dispatch of Share Certificates
Immediately after finalizing the BoA, share certificates are dispatched to the eligible
allotees, and refund orders made to unsuccessful applications. In addition, a 78 days
report is to be filed with SEBI. Permission for listing of securities is also obtained from the
stock exchange.
Advertisement
An announcement in the newspaper has to be made regarding the basis of allotment, the
number of applications received and the date of dispatch of share certificates and refund
orders, etc.

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 UNIT III OTHER FEE BASED MANAGEMENT
Mergers and Acquisitions Portfolio Management Services Credit Syndication Credit
Rating Mutual Funds - Business Valuation.

MERGERS
A type of business combination where two or more firms amalgamate into one single firm
is known as a merger. In a merger, one or more companies may merge with an existing
company or they may combine to form a new company. In India mergers and
amalgamations are used interchangeably.
In the wider sense, merger includes consolidation, amalgamation, absorption and
takeover. It signifies the transfer of all assets and liabilities of one or more existing
companies to another existing or new company.
THE STEPS INVOLVED IN M&A
Following are the steps involved in M&A:
1. Review of objectives: Major objectives of merger include attaining faster growth,
improving profitability, improving managerial effectiveness, gaining market power and
leadership, achieving cost reduction, etc. the review of objectives is done to assess the
strengths and weaknesses, and corporate goals of the merging enterprise.
2. Data for analysis: After reviewing the relevant objective of acquisition the acquiring firm
needs to collect detailed information pertaining to financial and other aspects of the firm
and the industry. Industry centric information will be needed to make an assessment of
market growth, nature of competition, ease of entry, capital and labour intensity, degree of
regulation, etc. similarly, firm-centric information will be needed to assess quality of
management, market share, size, capital structure, profitability, production and
marketing capabilities etc. the date to be collected serves as the criteria for evaluation.
3. Analysis of Information: After collecting both industry-specific and firm-specific
information, the acquiring firm undertakes analysis of data and the pros and cons are
weighed. Data is to be analyzed with a view of determine the earnings and cash flows,
area of risk, the maximum price payable to the target company and the best way to
finance the merger.
4. Fixing price: Price to be paid for the company being acquired shall be fixed taking into
consideration the current market value of share of the company being acquired. The
price shall usually be above the current market price of the share. A merger may take
place at a premium. In such a case, the firm would pay an offer price which is higher
that the target firms pre-merger market value.
5. Finding merger value: Value created by merger is to be found so that it is possible for
the merging firms to determine their respective share. Merger value is equal to the excess
of combined present value of the merged firms over and above the sum of their individual
present values as separate entities. Any cost incurred towards the merging process is

34
subtracted to arrive at the figure of net economic advantage of the merging this advantage
is shared between the shareholders of the merging firms
TAKE OVERS
Takeover is the case where one company obtains control over the management of another
company. Under both acquisition and takeover, it is possible for a company to have
effective control over another company even by holding minority ownership.
HOSILE TAKEOVERS
Where in a merger one firm acquires another firm without the knowledge and consent of
the management of the target firm, it takes the form of a hostile takeover. The acquiring
firm makes a unilateral attempt to gain a controlling interest in the target firm, by
purchasing shares of the later firm directly in the open (stock) market.
DISTINCTION BETWEEN MERGERS Vs. TAKEOVERS

35
36
 THE DIFFERENT TYPES OF MERGER
Mergers are of different types as discussed below:

1. Horizontal merger: Where two or more companies that complete in the same industry
amalgamate, it is a case of horizontal merger. For instance where two or more cement
manufacturing companies are combined, it makes the form of horizontal merger.
2. Vertical merger: Where two or more companies that operate in the same industry but at
different stages of production or distribution system amalgamate, it is a case of vertical
merger. Vertical merger may take the form of either a forward merger or a backward
merger. A backward merger happens where a manufacturing company joins with a
company that supplier raw material. On the other hand, a forward merger happens
where a company that supplies raw material joints hands with a company the
manufacturers.
3. Diagonal Merger: A company is said to be adopting a diagonal integration strategy where
it pursues an acquisition that involves both horizontal and vertical elements. Under this
merger strategy, content and intellectual property ownership is combined with
distribution technology and infrastructure, resulting in so entirely new media industry.
4. Forward merger: In a forward merger, the shareholders of the target company exchange
their shares for the shares of the acquiring company and all of the assets and liabilities of
the target company are automatically transferred to the acquire.
5. Reverse merger: In a reverse merger, the shareholders of the acquiring company
exchange their shares for shares of the target company. It is a case of the acquiring
company merging into the target company. Where a prosperous and profit making
company acquires a loss-making sick company with substantial erosion in its net worth,
it is a case of reverse merger.
6. Forward triangular merger: In a forward triangular merger, a subsidiary company is
formed by the parent company for the purpose of engaging in the merger deal. A parent
company funds a subsidiary formed for this purpose. The stock of the parent company is
transferred to the target company by the subsidiary.
7. Reverse triangular merger: In a reverse triangular merger, the parent company funds a
subsidiary company with stock of the parent. The shareholders of the target company
exchange their stock for the stock of the parent company, which is held by the subsidiary
company.
8. Conglomerate merger: A company is said to be adopting a conglomerate merger strategy
where it makes acquisitions across different industries. Where several firms engaged in
unrelated lines of business activity combine together to for a new company, it takes the
form of conglomerate merger.

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9. Negotiated merger: Where merger of two or more companies takes place after protracted
negotiations, it is a case of negotiated merger. Under this type of merger, the acquiring
firm negotiates directly with the management of the target firm.
10.Arranged merger: Where merger of a financially sick company takes place with another
sound company as part of package of financial rehabilitation under the initiative of a
financial body, it is a case of an arranged merger.
11.Agreed merger: Where the directors of target firm agree to the takeover or merger, accept
the offer in respect of their own shareholdings (which might range from nil or negligible to
controlling shareholdings) and recommend other shareholders to accept the offer, it is a
case of agreed takeover or merger.
12.Unopposed merger: Where the directors of the target firm, while making a deal with the
acquiring firm, do not oppose the offer or recommend rejection, it is a case of unopposed
merger.
13.Defended merger: Where the directors of a target firm decide to oppose the bid,
recommending shareholders to reject the offer and perhaps taking further defensive
action, it takes the form of a defending merger.
14.Competitive merger: Where a second bidder (and perhaps even a third bidder) comes
into the scene with a rival bid, it is a case of a competitive merger.
15.Tender offer: Where a bid is made by an acquiring firm to acquire controlling interest in
a target firm by purchasing the shares of the target firm at a fixed price. It is a case of
tender offer
16.Diversification: Diversification is a case of conglomerate merger. Diversification
consists of a company, deriving all or the greater part of its revenue from the particular
industry, acquiring subsidiaries operating in other industries.
MAJOR ISSUES OF M&A IN INDIA
The major issues of M&A are as follows:
Depreciation
The acquiring firm claims depreciation in respect of fixed assets transferred to it by the
target firm. The depreciation allowance is available on the written down value of fixed
assets. Further, the depreciation charge is based on the consideration paid and without
any revaluation.
R&D Expenditure
It is possible for the acquiring firm to claim the benefit of tax deduction under section 35
of the Income Tax Act, 1961 in respect of transfer of any asset representing capital
expenditure on R&D.
Tax Exemption
The fixed assets transferred to the acquiring firm by the target firm are exempt from
capital gains tax. This is however subject to the condition that the acquiring firm is an
Indian Company and that shares are swapped for shares in the target firm.

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Carry Forward Losses
The Indian Income Tax Act, 1961 contains highly favourable provision with regard to
merger of a sick company with a healthy company. For instance, section 72A(1) of the Act
gives the advantage of carry forward of losses of the target firm.

PORTFOLIO MANAGERS
Portfolio manager are defined as persons who in pursuance of a contract with clients,
advise, direct, undertake on their behalf the management/ administration of portfolio of
securities/ funds of clients. The term portfolio means the total holdings of securities
belonging to any person.
The portfolio management can be (i) Discretionary or (ii) Non-discretionary. The first type
of portfolio management permits the exercise of discretion in regard to investment /
management of the portfolio of the securities / funds. In order to carry on portfolio
services, a certificate of registration from SEBI is mandatory.
The certificate of registration for portfolio management services is granted to eligible
applicants on payment of Rs.5 lakh as registration fee. Renewal may be granted by SEBI
on payment of Rs. 2.5 lakh as renewal fee (every three years).
FUNCTIONS OF PORTFOLIO MANAGER:
Risk Diversification: An essential function of portfolio management is spread risk akin
to investment of assets. Diversification could take place across different securities and
across different industries.
Asset Allocation: It deals with attaining the operational proportions of investments from
asset categories. Portfolio managers basically aim of stock-bond mix. For this purpose,
equally weighted categories of assets are used.
Beta Estimation: Another important function of a portfolio manager is to make an
estimate of beta coefficient. It measurers and ranks the systematic risk of different assets.
Beta coefficient is an index of the systematic risk.
Rebalancing Portfolios: Rebalancing of portfolios involves the process of periodically
adjusting the portfolios to maintain the original conditions of the portfolio. The
adjustment may be made either by way of Constant proportion portfolio or by way of
Constant beta portfolio.
In Constant proportion portfolio, adjustments are made in such a way as to maintain the
relative weighing in portfolio components according to the change in prices.
Under the constant beta portfolio, adjustments are made to accommodate the values of
component betas in the portfolio.
STRATEGIES
Buy and Hold Strategy: Under the buy and hold strategy, the portfolio manager builds
a portfolio of stock which is not disturbed at all for a long period of time. This practice is
common in the case of perpetual securities such as common stock.
Indexing: Another strategy employed by portfolio managers is indexing. Indexing involves
an attempt to replicate the investment characteristics of a popular measure of the bond
market. Securities that are held in best-known bond indexes are basically high grade
issues.

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 Laddered Portfolio: Under the laddered portfolio, bonds are selected in such a way as
that their maturities are spread uniformly over a long period of time. This way a portfolio
manager aims at distributing the funds throughout the yield curve.
Barbell Portfolio: Under the laddered portfolio, bonds are selected in such a way as that
their maturities are spread uniformly over a long period of time. This way a portfolio
manager aims at distributing the funds throughout the yield curve.
THE GENERAL OBLIGATION OF PORTFOLIO MANAGERS AS ENUNCIATED BY THE
SEBI
A. Contract with Clients
Every portfolio manager shall, before taking up an assignment of management of funds or
portfolio of securities in writing on behalf of a client, enter into an agreement in writing
with such client clearly defining the interrelationship, and setting out their mutual rights,
liabilities and obligation relating to management of funds or portfolio of securities
containing the details as specified in Schedule IV. The agreement between the portfolio
manager and the client shall, inter alia, contain the following:

The funds of all clients shall be placed by the portfolio manager in a separate account to
be maintained by him in a scheduled commercial bank (any bank included in the
Second Schedule to the Reserve bank of India Act, 1934 (2 f 1934)
Notwithstanding anything contained in the agreement between a portfolio manager and
his client referred to in regulation 14 hereof, the portfolio funds can be withdrawn or
taken back by Portfolio client at his risk before the maturity date of the contract the
following circumstances:
1. Voluntary or compulsory, termination of Portfolio management services by the Portfolio
manager;
2. Suspension or termination of registration of Portfolio manager by the Board;
3. Bankruptcy or liquidation in case the portfolio manager is a body corporate; and
4. Permanent disability, lunacy or insolvency in case the portfolio manager is an individual.
The portfolio manager shall not, while dealing with clients funds, indulge in speculative
transactions, that is, he shall not enter into any transaction for purchase or sale of any
security, which transaction is periodically or ultimately settled otherwise than by actual
delivery or transfer of security.
In the even of any dispute between the portfolio manager and his clients, the client shall
have the right to obtain details of his portfolio from the portfolio manager.
Contents
The contents of agreement between the Portfolio Manager and His clients are as follows:
1. Appointment of Portfolio manager.
2. Scope of services to be provided by the Portfolio Manager subject to the activities
permitted under SEBI (Portfolio Managers) regulations, 1993, viz. advisory, investment

40
 management, custody of securities and keeping track of corporate benefits associated
with the securities. The portfolio Manager shall act in a fiduciary capacity and as a
trustee and agent of the clients account.
3. Function, obligations, duties and responsibilities (as discretionary and non-
discretionary to be given separately) with specific provisions regarding instruction for
nondiscretionary portfolio manager inter alia:
a) Terms in compliance with the Act, SEBI (Portfolio Managers) Regulations, 1993, rules,
regulations guidelines made under the Act and any other
laws/rules/regulations/guidelines etc.
b) Providing reports to clients.
c) Maintenance of client-wide transactions and related books of accounts.
d) Provisions regarding audit of accounts as required under the SEBI (Portfolio Manager
Regulations, 1993).
e) Settlement of accounts and procedure therefore, including the provisions for payment of
maturity or early termination of contract.
4. Investment objectives and guidelines such as following:
a. Types of securities in which investment would be made specifying restrictions, if any.
b. Particulars regarding amount, period of management, repayment or withdrawal
c. Taxation aspects such as Tax Deducted at Source, etc. if any.
d. Condition that the portfolio manager shall not lend the securities of the client unless
authorized by him in writing.
5. Risk factors: A detailed statement of risks associated with each type of investment
including the standard risks associated with each type of investment risk factors specific
to the scheme as well as the attendant to specific investment policies and objectives of the
scheme are to be mentioned.
6. Period of agreement: Minimum period of any, and provision for renewal, if any.
7. Conditions under which agreement may be altered, terminated and implications thereof,
such as settlement of amounts invested, repayment obligations, etc.
8. Maintenance of Accounts: Maintenance of accounts separately in the name of the client
as are necessary of account for the assets and any additions, income, receipts and
disbursements in connection therewith, as provided under SEBI (Portfolio Managers)
regulations, 1993.
9. Terms of Fees: The quantum and manner of payment of fees and charges for each
activity for which services are rendered by the Portfolio Manager directly or indirectly
(where such service is outsourced) such as invest management, advisory, transfer,
registration and transaction costs with specific references to brokerage costs, custody
charges, cost related to furnishing regular communication, accountant statement,

41
 miscellaneous expenses (individual expenses in excess of 5 percent to be indicated
separately). Etc.
10. Billing: Periodicity of billing, whether payment to be made in advance, manner of
payment of fees, whether setting off against the account, etc. type of documents
evidencing receipt of payment of fees.
11. Liability of Portfolio Manager: Liability of Portfolio Manager in connection with
recommendations made, to cover errors of judgment, negligence, willful misfeasance in
connection with discharge of duties, acts of other intermediaries, brokers, custodian, etc.
12. Liability of client restricting the liability of the client to the extent of his
investment.
13. Death or disability: Providing for continuation/termination of the agreement in
the event of clients death/disability, succession, nomination, representation, etc. to be
incorporated.
14. Assignment conditions for assignment of the agreement by client.
15. Governing Law: The law/jurisdiction of country/State which governs the
agreement are to be stated.
16. Settlement of grievances/disputes and provision for arbitration:
Provisions to cover protection of act done in good faith, risks and losses, rederessal of
grievances, dispute resolution mechanism reference for arbitration and the situations
under which such rights may arise, may be made.
B. Disclosures
The Portfolio Manager shall provide to the client the Disclosure Document as specified in
Schedule V, along with a certificate in Form C as specified in Schedule I, at least two days
prior to entering into an agreement with the client as referred to in sub-regulation (1).
The disclosure document shall inter alia contain the following:
1. The quantum and manner of payment of fees payable by y the client for each activity for
which service is rendered by the Portfolio Manager in Schedule I, at least two days prior to
entering into an agreement with the client as referred to in sub-regulation (1). The
Disclosure Document shall inter alia contain the following:
2. Portfolio risks;
3. Complete disclosures in respect of transactions with related parties as per the accounting
standards specified by the institute of chartered accountants of India in this regard.
4. The performance of the Portfolio Manager; and
5. The audited financial statements of the Portfolio Manager for the immediately preceding
three years.
The Portfolio Manager shall charge an agreed fee from the clients for rendering portfolio
management services without guaranteeing or assuring, either directly or indirectly, any

42
return and the fee so charged may be a fixed fee or a return based fee or a combination of
both.
The Portfolio Manager may, subject to the disclosure in terms of the disclosure Document
and specific permission from the client, charge such fees from the client for each activity
for which service is rendered by the Portfolio Manager directly or indirectly (where such
service is out sourced).
CREDIT SYNDICATION SERVICES
Credit syndication services are services rendered by the merchant bankers in the form of
organizing and procuring the financial facilities form financial institutions, banks or other
lending agencies.
Financing arranged on behalf of the client for meeting both fixed capital as well as
working capital requirements is known as loan syndication service.
Credit Syndication Services
Merchant bankers provide various services towards syndication of loans. The services
vary depending on whether loans sought or of long-term fixed capital or of working capital
funds. Following are the credit syndication services rendered by merchant bankers with
regard to long-term loans:
1. Ascertaining promoter details
2. Ascertaining of cost details
3. Comparison of cost details
4. Identification of funding sources
5. Ascertainment of loan details
6. Furnishing beneficiary details
7. Making application
8. Project appraisal
9. Compliance for loan disbursement
10.Documentation and creation of security
11.Pre-disbursement compliance
Ascertaining of Promoter Details
This is the fundamental credit syndication service extended by merchant bankers,
whereby attempts are made to gain an understanding about the promoters, who are
involved in the launch and running of the project. Information is collected about the
promoters, their knowledge, reputation, creditworthiness, experience in trade or industry
and relevance of such skills and competence, etc. For this purpose, the merchant banker
holds discussions with promoters. Information is also gleaned to know the extent of
contribution made by promotes to fund the project. The contributions may include the
quantum of preliminary expenses already incurred by them. Etc.
Ascertainment of Project Cost Details

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Here, the merchant banker investigates about the project for which finance is to be
arranged. Details about the project are collected with the help of information given by the
consultant in the project report.
Merchant banks make an estimate of the capital cost of the project. This involves
ascertaining the cost details of different items of expenditure. Some of the important
items of costs that need to be ascertained by merchant banker are preliminary expenses
connected with cost of promotion, incorporation, legal expenses etc., as applicable to
setting up of new units.
Comparison of cost Details
Here, the merchant banker investigates about the project for which finance is to be
arranged. Details about the project are collected with the help of information given by the
consultant in the project report.
Merchant banks make an estimate of the capital cost of the project. This involves
ascertaining the cost details of different items of expenditure. Some of the important
items of costs that need to be ascertained by merchant banker are preliminary expenses
connected with cost of promotion, incorporation, legal expenses etc., as applicable to
setting up new units. Cost details pertaining to expansion, renovation, modernization of
diversification programmes of existing units include cost of fixed assets that include cost
of acquisition of land, construction of building, roads, railway siding, procurement of
plant and equipment, furniture and fixtures of other miscellaneous fixed assets.
Comparison of cost Details
Another important function undertaken by merchant bankers is the comparison of the
details of costs with the benchmarks available in the same industry. Other aspects such
as the geographical area, size of scale of operations, etc. are also used for comparison.
Adjustments are also made for inflationary conditions which help capturing rising prices
of different elements of cost.
Identification of Funding Sources
Identifying appropriate sources of capital required for financing the project is another
function of a merchant banker in his credit syndication services. Many factors determine
the choice of capital funding source. Most important among them are the nature of the
project, and the quantum of the project cost. Nature of a project helps determine the
quantum of project cost. For instance, scale of cost involved in a project would vary
depending on whether the project is a small or medium or a large-sized project.
The sources of capital required for a project would be short-term, medium term, or long-
term. A brief description of each source of fund is attempted below:
Short term source: Short-term funding source refers to funds required for a period upto
one year short-term funds are required for meeting the working capital requirements or

44
 special seasonal needs of a industrial unit the popular sources of short-term funds are
commercial banks, trade credit, public deposits, finance companies and also customers.
Medium-term source: Medium-term funding source refers to funds required for a period
ranging from one to five years. Medium-term funds are needed for permanent working
capital, expansion or replacement assets, or acquisition of balancing equipments. Such
funding is made available by banks and financial institutions loans. Medium-term loans
are provided under the auspices of various lending schemes designed and operated by the
all-India financial institutions.
Long-term source: Long-term funding source refers to funds required for a period of
more than five years long-term funding is needed for undertaking the establishment of
new units, for permanent investment, fixed assets, modernization, major expansion,
diversification or rehabilitation of the existing projects. The chief source of long-term
capital funds are debt funds and equity funds.
In addition to domestic sources available such as IDBI, ICICI, LIC, UTI, IRBI, SFCs, SIDCs
etc., for securing long-term debt funds, international capital market sources are also
tapped for raising debt fund.
Ascertainment of Loan Details
Merchant bankers ascertain details of criteria followed by the term-lending institutions to
entertain projects for granting assistance. The objective is to pave way for the expeditious
and favorable considerations of the loan application by the development finance
institutions. For this purpose, merchant bankers hold preliminary discussions with the
executives of the lending institutions. The preliminary discussions help the merchant
banker clear the clouds as regards various aspects of seeking syndicated loan
arrangements with the financial institutions.
The merchant banker also discusses matters connected with process of production,
technical arrangements, plant capacity, professional skill required, procurement of
license/DGTD registration, import license in case of any import of capital goods/raw
material is involved, foreign collaboration, etc. Consultations are also held with the
officials of the development finance institutions on the status of Foreign Exchange
Management Act compliance, etc.
Furnishing Beneficiary Details
An important function of credit syndication is furnishing of information relating to the
borrower-beneficiary to the financial institution. The information is to be furnished in the
application to be submitted by the merchant banker to the lending agency as part of the
credit syndication arrangements. Following details are furnished by the merchant banker
in this regard.
1. General Information: The purpose of furnishing general information is to enable the
financing company to obtain a general idea about the applicant company and its proposed

45
 project. The information to be furnished by the merchant banker in this regard is stated
below:
a. Name of constitution, date of incorporation and commencement of business.
b. Nature of organization, viz, public/private/joint/cooperative sectors
c. Name of the business house/group to which it belongs.
d. Location of registered office/head office
e. Nature of concessions to which the project seeking financial assistance is eligible.
f. Nature of industry and product
g. Installed capacity, both existing and proposed
h. Nature of currency loans applied for (whether rupee loans or foreign currency loans)
i. License issued by the government for undertaking production.
j. Financial assistance applied for by way of underwriting for equity capital/preference
capital/ debenture.
2. Promoter Information: Information about promoters is furnished by the merchant
banker with the objective of helping the lending agency to gain an understanding of the
promoter, his activities, economic background, credibility and integrity.
a. Brief account of activities and past performance/other expansion programmes
b. Certified copies of Memorandum of Association. Articles of Association, audited
balance Sheet and Profit and Loss Account for last five years.
3. Company Information: The merchant banker has to furnish the following information as
regards the company for loan syndication arrangements to be made:
a. Brief history of the concern.
b. Schemes already executed in the case of existing company
c. Expansion/diversification plans in the case of an existing company
d. Nature, size and status of the project to assess the funds requirement in the case of a
new company
e. List of subsidiaries (with percentage of holding s and nature of business)
f. Directors of the company, their names, age, address, qualifications, past experience,
business or industrial background, existing proposed shareholding in the company.
g. Certified copies of audited balance sheet and profit and loss account for the last five
years with proformas balance sheet and profit and loss account of a recent date.
h. Tax status of the company
i. Export of product (destination, export sales for past five years with export incentives
available)
j. Insurance of fixed/other assets and risk covered and details of research and
development activities of the company.

46
4. Project profile information: Full information relating to the project for which financial
assistance is sought is furnished by the merchant banker. The type of information may
pertain to plant capacity, nature of production process to be employed, nature of technical
arrangements available for the project, and other information as specified below:
a. Plant capacity information about the product-wise installed capacity/proposed capacity/
maximum production envisaged, section wise capacities for major sections of the plant.
b. Plant process: Information about the technical process to be employed by the plant with
a flow chart depicting material process and results.
c. Plant technical arrangements: Details of technical arrangements made/proposed for
implementation of the project, details of collaboration, if any, with write-up on their
activities, size, turnover, particulars of existing plant, other projects in India and abroad
along with copies of broachers as published by them for the last 3 years/ collaboration
agreement/Government approval for collaborators/foreign technicians to be employed;
name of consultants manner of payment, brief particulars of consultants (bio-data of
senior personnel, names of directors), partners, particular of work done in the past and
work on hand with copies of published material of consultant/ agreements with them and
Government approval for foreign consultants.
d. Plant management: Details of arrangements for executive management, particulars of
proposed key technical / administrative and accounting personnel (with proposed
organization chart indicating lines of authority).
e. Plant assets: Details about various assets used by the borrowing firm are to be
furnished by the merchant banker. The details as regards land and building include
location of plant/requirement of land, Locational advantages of the land, details of the
land area and cost, basis of valuation, mode of payment, date of purchase, lease, previous
owner and relationship with promoters/ directors, conversion of land to industrial use,
along with copies of sale/lease deeds/ soil test reports/Government order converting land
into industrial use/location map/site plan showing contour lines/internal roads/ power
receiving station/railway siding/tube wells, arrangements made proposed for
constructions of buildings, etc.
f. Plant transport: Arrangements proposed for carrying raw materials/ finished goods by
own trucks/railway siding, etc/private trucks should be furnished by the merchant
banker.
g. Other details: In addition to the above, the merchant banker has to furnish information
pertaining to the type and the nature of raw materials used and the source of availability,
whether domestic or foreign. Details as to be demand, availability, tariff, cost, and the
supply sources of utilities such as water, power, steam, compressed air, etc. should be
furnished.

47
5. Project cost information: Details of the estimated cost of the project should be provided
to the lending institution. This includes information as regards rupee cost/ rupee
equivalent of foreign exchange cost/total cost for land or site development/ buildings/
plant and machinery, imported/indigenous, technical know-how etc. to be furnished.
6. Project marketing information: As part of the credit syndication exercise, it is
incumbent on the part of the merchant banker to furnish adequate information about the
marketing arrangements made for the products of the borrowing unit. Following are the
information to be provided to the fund supplier in this regard.
a. Brief profile of the products beings offered
b. Scope of market for the products
c. Price aspects of the product
d. Estimates of existing and future demands and supply of proposed product
e. Special and the outstanding feature of the product that would give the firm a competitive
advantage.
f. International CIF, FOB prices and landed cost of the propose product
g. List of principal customers and particulars of firms with whom such sale arrangements
have been made
h. Details of restrictions imposed by the Government as regards price, distribution, export,
etc.
7. Cash Flow information: The merchant banker has to furnish details as to profitability
and expected stream of cash flows and cost of the propose project. For this purpose, it is
essential that working results of operations, cash flow statements and project balance
sheet are given in prescribed form along with the basis of the calculations.
8. Other information: The merchant banker has to indicate as to how the purpose of the
economic and national importance of the proposed project will be realized. Besides,
following are the other details to be furnished by the merchant banker to the lending
agency:
a. CIF/FOB international price of inputs to be imported/exported
b. Excise duty, export duty, export assistance (replenishment license, duty drawback, cash
subsidy, etc.)
c. Expected contribution to the growth, if any of ancillary industries in the region.
d. Government consent by way issue of letter of intent, industrial license, foreign exchange
permission, approval of technical financial collaboration, etc.
In addition to the above, merchant banker has to furnish a declaration stating that all the
necessary details have been furnished and that all the information so provided is correct.
CREDIT RATING
Credit rating is a mechanism by which the reliability and viability of a credit instrument is
brought out. When a company borrows or when a businessman raises loan, the lenders

48
are interested in knowing the credit worthiness of the borrower not only in the present
condition but also in future.
Credit ratings help investors by providing an easily recognizable, simple tool that couples
a possibly unknown issuer with an informative and meaningful symbol of credit quality.

Include notes for book..

CREDIT RATING AGENCIES IN INDIA

Credit Rating Information Services of India Limited (CRISIL)
Investment Information and Credit Rating Agency of India (ICRA)
Credit Analysis and Research Limited (CARE)
TYPES OF CREDIT RATING
1. Equity rating
2. Bond rating
3. Promissory note rating
4. Commercial paper rating
5. Sovereign rating.
1. EQUITY RATING: While judging the equity rating, the past performance of the
company, the earning per share and the turn-over of the company will be taken into
account. If a loss making company turns into a profit making one, after wiping off its
losses, its equity rating will go up. At the same time, if there is a decline in the dividend
rate of an existing concern, compared to its previous years, its rating will get a beating.
2. BOND RATING: Bonds are issued both by Government as well as by private sector
companies. In the international market, rating of bonds will depends on the rate of
interest offered and the value of the currency it represents.
3. PROMISSORY NOTE RATING: In order to raise short-term loans, promissory note are
issued by different commercial companies and depending upon their resources, these
promissory notes will have credit rating. Depending upon the credit rating, ranging from
P1 to P6, promissory notes are preferred as a short-dated instrument.
4. COMMERCIAL PAPERS: In order to enable the commercial banks to discount
commercial papers, credit rating is provided to the commercial papers which depends
upon the standing of the non-banking financial company NBFC) which is issuing the
commercial paper.
5. SOVEREIGN RATING: When countries are issuing credit instruments in the
international market such as Treasury bills and Bonds, they will be rated according to the
economic condition of the country. Generally, the countries in the world are grouped
under three categories, viz.,
(a) Countries which are politically and economically well developed.
(b) Countries which are politically stable but economically week.
(c) Countries which are politically and economically unstable or weak.

MUTUAL FUNDS

49
The Securities and Exchange Board of India (Mutual Funds)Regulations, 1996 defines a
mutual fund as a a fund established in the form of a trust to raise money through the
sale of units to the public or a section of the public under one or more schemes for
investing in securities, including money market instruments.
A mutual fund serves as a link between the investor and the securities market by
mobilising savings from the investors and investing them in the securities market to
generate returns.
Mutual Funds Set Up In India
Sponsoring Institution: The Company which sets up the Mutual Fund is called the
sponsor. The SEBI has laid down certain criteria to be met by the sponsor. These criteria
mainly deal with adequate experience, good past tract record, net worth etc.
Trustees: Trustees are people with long experience and good integrity in their respective
fields.
They carry the crucial responsibility of safeguarding the interest of investors. For this
purpose, they monitor the operations of the different schemes. They have wide ranging
powers and they can even dismiss Asset Management Companies with the approval of the
SEBI.
Asset Management Company (AMC): The AMC actually manages the funds of the
various schemes. The AMC employs a large number of professionals to make investments,
carry out research and to do agent and investor servicing. Infact, the success of any
Mutual Fund depends upon the efficiency of this AMC. The AMC submits a quarterly
report on the functioning of the mutual fund to the trustees who will guide and control
the AMC.
Benefits of Mutual Funds
1. Professional management: An average investor lacks the knowledge of capital market
operations and does not have large resources to reap the benefits of investment. Mutual
funds are managed by professional managers who have the requisite skills and experience
to analyse the performance and prospects of companies. They make possible an organised
investment strategy, which is hardly possible for an individual investor.
2. Portfolio diversification: An investor undertakes risk if he invests all his funds in a
single scrip. Mutual funds invest in a number of companies across various industries and
sectors. This diversification reduces the riskiness of the investments.
3. Reduction in transaction costs: Compared to direct investing in the capital market,
investing through the funds
is relatively less expensive as the benefit of economies of scale is passed on to the
investors.
4. Liquidity: Often, investors cannot sell the securities held easily, while in case of
mutual funds, they can easily encash their investment by selling their units to the fund if
it is anopen-ended scheme or selling them on a stock exchange if it is a close-ended
scheme.
5. Convenience: Investing in mutual fund reduces paperwork, saves time and makes
investment easy.

50
6. Flexibility: Mutual funds offer a family of schemes, and investors have the option of
transferring their holdings from one scheme to the other.
7. Tax benefits Mutual fund investors now enjoy income-tax benefits. Dividends received
from mutual funds debt schemes are tax exempt to the overall limit of Rs 9,000 allowed
under section 80L of the Income Tax Act.
8. Transparency Mutual funds transparently declare their portfolio every month. Thus
an investor knows where his/her money is being deployed and in case they are not happy
with the portfolio they can withdraw at a short notice.
9. Stability to the stock market Mutual funds have a large amount of funds which
provide them economies of scale by which they can absorb any losses in the stock market
and continue investing in the stock market. In addition, mutual funds increase liquidity in
the money and capital market.
10. Equity research Mutual funds can afford information and data required for
investments as they have large amount of funds and equity research teams available with
them.
Types of Mutual Fund Schemes
The objectives of mutual funds are to provide continuous liquidity and higher yields with
high degree of safety to investors. Based on these objectives, different types of mutual
fund schemes have evolved.
Functional Portfolio Geographical Other
Open-Ended Event Income Funds Domestic Sectoral Specific
Close-Ended Scheme Growth Funds Off-shore Tax Saving
Interval Scheme Balanced Funds ELSS
Money Market Special
Mutual Funds Gilt Funds
Load Funds
Index Funds
ETFs
PIE Ratio Fund
Functional Classification of Mutual Funds
1. Open-ended schemes: In case of open-ended schemes, the mutual fund continuously
offers to sell and repurchase its units at net asset value (NAV) or NAV-related prices.
Unlike close-ended schemes, open-ended ones do not have to be listed on the stock
exchange and can also offer repurchase soon after allotment. Investors can enter and exit
the scheme any time during the life of the fund.
2. Close-ended schemes: Close-ended schemes have a fixed corpus and a stipulated
maturity period ranging between 2 to 5 years. Investors can invest in the scheme when it
is launched. The scheme remains open for a period not exceeding 45 days. Investors in
close-ended schemes can buy units only from the market, once initial subscriptions are
over and thereafter the units are listed on the stock exchanges where they can be bought
and sold.
3. Interval scheme: Interval scheme combines the features of open-ended and close-
ended schemes. They are open for sale or redemption during predetermined intervals at
NAV related prices.

51
Portfolio Classification
Here, classification is on the basis of nature and types of securities and objective of
investment.
1. Income funds: The aim of income funds is to provide safety of investments and regular
income to investors. Such schemes invest predominantly in income-bearing instruments
like bonds, debentures, government securities, and commercial paper. The returns as well
as the risk are lower in income funds as compared to growth funds.
2. Growth funds: The main objective of growth funds is capital appreciation over the
medium-to-long- term. They invest most of the corpus in equity shares with significant
growth potential and they offer higher return to investors in the long-term.
3. Balanced funds: The aim of balanced scheme is to provide both capital appreciation
and regular income. They divide their investment between equity shares and fixed nice
bearing instruments in such a proportion that, the portfolio is balanced. The portfolio of
such funds usually comprises of companies with good profit and dividend track records.
Their exposure to risk is moderate and they offer a reasonable rate of return.
4. Money market mutual funds: They specialise in investing in short-term money market
instruments like treasury bills, and certificate of deposits. The objective of such funds is
high liquidity with low rate of return.
Geographical Classification
1. Domestic funds: Funds which mobilise resources from a particular geographical
locality like a country or region are domestic funds. The market is limited and confined to
the boundaries of a nation in which the fund operates. They can invest only in the
securities which are issued and traded in the domestic financial markets.
2. Offshore funds: Offshore funds attract foreign capital for investment in the country of
the issuing company. They facilitate cross-border fund flow which leads to an increase in
foreign currency and foreign exchange reserves. Such mutual funds can invest in
securities of foreign companies.
Others
1. Sectoral: These funds invest in specific core sectors like energy, telecommunications,
IT, construction, transportation, and financial services. Some of these newly opened-up
sectors offer good investment potential.
2. Tax saving schemes: Tax-saving schemes are designed on the basis of tax policy with
special tax incentives to investors. Mutual funds have introduced a number of tax saving
schemes.
3. Equity-linked savings scheme (ELSS): In order to encourage investors to invest in
equity market, the government has given tax-concessions through special schemes.
Investment in these schemes entitles the investor to claim an income tax rebate, but these
schemes carry a lock-in period before the end of which funds cannot be withdrawn.
4. Special schemes: Mutual funds have launched special schemes to cater to the special
needs of investors. UTI has launched special schemes such as Childrens Gift Growth
Fund, 1986, Housing Unit Scheme, 1992, and Venture Capital Funds.
5. Gilt funds: Mutual funds which deal exclusively in gilts are called gilt funds. With a
view to creating a wider investor base for government securities, the Reserve Bank of India

52
encouraged setting up of gilt funds. These funds are provided liquidity support by the
Reserve Bank.
6. Load funds: Mutual funds incur certain expenses such as brokerage, marketing
expenses, and communication expenses. These expenses are known as load.
Loads can be of two types-Front-end-load and back-end load. Front-end-load, or sale
load, is a charge collected at the time when an investor enters into the scheme. Back-end,
or repurchase, load is a charge collected when the investor gets out of the scheme.
Schemes that do not charge a load are called No load schemes.
7. Index funds: An index fund is a mutual fund which invests in securities in the index
on which it is based BSE Sensex or S&P CNX Nifty. It invests only in those shares which
comprise the market index and in exactly the same proportion as the
companies/weightage in the index so that the value of such index funds varies with the
market index.
8. PIE ratio fund: PIE ratio fund is another mutual fund variant that is offered by
Pioneer IT! Mutual Fund. The PIE (Price-Earnings) ratio is the ratio of the price of the
stock of a company to its earnings per share (EPS).
9. Exchange traded funds: Exchange Traded Funds (ETFs) are a hybrid of open-ended
mutual funds and listed individual stocks. They are listed on stock exchanges and trade
like individual stocks on the stock exchange.
Business Valuation
The basic valuation methods of holdings by the Mutual funds should be done by keeping
in view the following elements:
For listed securities take last sale price quoted in the stock exchange dealing list
For OTCEI securities take bid/ask price as may be relevant on case to case basis
Trustees may determine market value at a reasonable price as per current market at
which the investors would buy at fairly reasonable rate.
For short term investments the basis of valuation should be the amortized cost.
NET ASSETS VALUE
The net asset value of a fund is the market value of the assets minus the liabilities on the
day of valuation. In other words, it is the amount which the shareholders will collectively
get if the fund is dissolved or liquidated. The net asset value of a unit is the net asset
value of fund divided by the number of outstanding units.
Thus NAV = Market Price of Securities + Other Assets Total Liabilities + Units
Outstanding as at the NAV date.
NAV = Net Assets of the Scheme + Number of units outstanding, that is, Market value of
investments + Receivables + Other Accrued Income + Other Assets - Accrued Expenses -
Other Payables - Other Liabilities + No. of units outstanding as at the NAV date.

53
UNIT-IV FUND-BASED FINANCIAL SERVICES
Leasing and Hire Purchasing Basics of Leasing and Hire purchasing Financial
Evaluation.

LEASING
A Lease is a transfer of a right to enjoy the property. The consideration may be a
price or a rent. The rent may be either money, or share of crops, service of anything
of value, to be rendered periodically by the transferee to the transferor.
Meaning: Lease is a contractual arrangement/ transaction in which a party (lessor)
owning an asset/equipment provides the asset for use to another party/ transfer the right
to use the equipment to the user (lessee) over a certain/for an greed period of time for
consideration in form of / in return for periodic payments / rental with or without a
further payment (premium). At the end of the contract period (lease period) the
asset/equipment is returned to the lessor.
Main characteristics of lease financing can be explained as following:
Parties to Contract: There are essentially two parties to the contract of leasing i.e.
financer (or owner - Lessor) and user (lessee). Also, there could be lease-broker who works
as an intermediary in arranging lease finance deals, in case of exposure to large funds.
Apart from above three there are some times lease-financers also, who refinances to the
lessor (owner).
Ownership Separated from User: The essence of a lease finance deal is that during the
lease-period, the ownership of assets 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.
Lease Rentals: The consideration which the lessee pays to the lessor for the lease
transaction is the lease rental. The lease rentals are so structure as to compensate the
lessor the investment made in the asset (in the form of depreciation), the interest on the
investment, repairs and so forth, borne by the lessor, and servicing chares over the lease
period.
Term of lease: The term of lease is the period for which the agreement of lease remains in
operations. Every lease should have a definite period otherwise it will be legally
inoperative. The lease can be renewed after expiry of the term.
Classification of Lease: A lease contract can be classified on various characteristics in
following categories:
A. Finance Lease and Operating Lease
B. Sales & Lease back and Direct Lease
C. Single investor and Leveraged lease
D. Domestic and International lease
Finance Lease: A Finance lease is mainly an agreement for just financing the
equipment/asset, through a lease agreement. The owner /lessor transfers to lessee
substantially all the risks and rewards incidental to the ownership of the assets (except
for the title of the asset). In such leases, the lessor is only a financier and is usually not
interested in the assets. These leases are also called Full Payout Lease as they enable a
lessor to recover his investment in the lease and derive a profit. Finance lease are mainly

54
done for such equipment/assets where its full useful/ economic life is normally utilized
by one user i.e. Ships, aircrafts, wagons etc.
Generally a finance lease agreement comes with an option to transfer of ownership to
lessee at the end of the lease period. Normally lease period is the major part of economic
life of the asset.
Operating Lease: An operating lease is one in which the lessor does not transfer all risks
and rewards incidental to the ownership of the asset and the cost of the asset is not fully
amortized during the primary lease period. The operating lease is normally for such
assets which can be used by different users without major modification to it. The lessor
provides all the services associated with the assets, and the rental includes charges for
these services. The lessor is interested in ownership of asset/equipment as it can be lent
to various users, during its economic life. Examples of such lease are Earth moving
equipments, mobile cranes, computers, automobiles etc.
Sale and Lease Back: In this type of lease, the owner of an equipment/asset sells it to a
leasing company (lessor) which leases it back to the owner (lessee).
Direct Lease: In direct lease, the lessee and the owner of the equipment are two different
entities. A direct lease can be of two types: Bipartite and Tripartite lease.
Bipartite lease: There are only two parties in this lease transaction, namely (i) Equipment
supplier-cum-financer (lessor) and (ii) lessee. The lessor maintains the assets and if
necessary, replaces it with similar equipment in working condition.
Tripartite lease: In such lease there are three different parties (i) Equipment supplier (ii)
Lessor (financier) and (iii) Lessee. In such leases sometimes the supplier ties up with
financiers to provide financing to lessee, as he himself is not in position to do so.
Single investor lease: This is a bipartite lease in which the lessor is solely responsible for
financing part. The funds arranged by the lessor (financier) have no recourse to the
lessee.
Leveraged lease: This is a different kind of tripartite lease in which the lessor arranges
funds from another party linking the lease rentals with the arrangement of funds. In such
lease, the equipment is part financed by a third party (normally through debt) and a part
of lease rental is directly transferred to such lender towards the payment of interest and
installment of principal.
Domestic Lease: A lease transaction is classified as domestic if all the parties to such
agreement are domiciled in the same country.
International Lease: If the parties to a lease agreement domiciled in different countries,
it is known as international lease. This lease can be further classified as (i) Import lease
and (ii) cross border lease.
Import lease: In an import lease, the lessor and the lessee are domiciled in the same
country, but the equipment supplier is located in a different country. The lessor imports
the assets and leases it to the lessee.
Cross border lease: When the lessor and lessee are domiciled in different countries, it is
known as cross border lease. The domicile of asset supplier is immaterial.
Advantages of Leasing

55
Leasing offers advantages to all the parties associated with the agreement. These
advantages can be grouped as (i) Advantages to Lessee (ii) Advantages to lessor.
Advantages to the Lessee:
Financing of Capital Goods: Lease financing enables the lessee to have finance for huge
investments in land, building,
plant & machinery etc., up to 100%, without requiring any immediate down payment.
Additional Sources of Funds: Leasing facilitates the acquisition of equipments/ assets
without necessary capital outlay and thus has a competitive advantage of mobilizing the
scarce financial resources of the business enterprise. It enhances the working capital
position and makes available the internal accruals for business operations.
Less costly: Leasing as a method of financing is a less costly method than other
alternatives available. Ownership preserved: Leasing provides finance without diluting the
ownership or control of the promoters. As against it, other modes of long-term finance,
e.g. equity or debentures, normally dilute the ownership of the promoters.
Avoids conditionality: Lease finance is considered preferable to institutional finance, as
in the former case, there are no strings attached. Lease financing is beneficial since it is
free from restrictive covenants and conditionality, such as representation on board etc.
Flexibility in structuring rental: The lease rentals can be structured to accommodate
the cash flow situation of the lessee, making the payment of rentals convenient to him.
The lease rentals are so tailor made that the lessee is bale to pays the rentals from the
funds generated from operations.
Simplicity: A lease finance arrangement is simple to negotiate and free from cumbersome
procedures with faster and simple documentation.
Tax Benefit: By suitable structuring of lease rentals a lot of tax advantages can be
derived. If the lessee is in tax paying position, the rental may be increased to lower his
taxable income. The cost of asset is thus amortized faster to than in a case where it is
owned by the lessee, since depreciation is allowable at the prescribed rates.
Obsolescence risk is averted: In a lease arrangement the lessor being the owner bears
the risk of obsolescence and the lessee is always free to replace the asset with latest
technology.
Advantage to the Lessor:
Full security: The lessors interest is fully secured since he is always the owner of the
leased asset and can take repossession of the asset in case of default by the lessee.
Tax benefit: The greatest advantage to the lessor is the tax relief by way of depreciation.
High profitability: The leasing business is highly profitable, since the rate of return is
more than what the lessor pays on his borrowings. Also the rate of return is more than in
case of lending finance directly.
Trading on equity: The lessor usually carry out their business with high financial
leverage, depending more on debt fund rather equity.
High growth potential: The leasing industry has a high growth potential. Lease financing
enables the lessee to acquire equipment and machinery even during a period of
depression, since they do not have to invest any capital.

56
Limitations of Leasing
Restrictions on use of limitations: Under a lease agreement, sometimes restrictions are
imposed related to uses, alteration and additions to asset even though it may be essential
for the lessee.
Limitations of Financial Lease: A financial lease may entail higher payout obligations, if
the equipment is found not useful and the lessee opts for premature termination of the
lease. Besides, the lessee is not entitled to the protection of express or implied warranties
since he is not the owner of the asset.
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.
Consequences 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. In case of finance lease, the lessee may be required to pay
for damages and accelerated rental payments.
Understatement of Lessees assets: Since the leased asset do not form part of lessees
assets, there is an effective understatement of his assets, which may sometimes lead to
gross underestimation of the lessee. However, there is now an accounting practice to
disclose the leased assets by way of footnote to the balance sheet.
Double sales tax: With the amendment of sales tax law of various states, a lease
financing transaction may be charged to sales-tax twice once when the lessor purchases
the equipment and again when it is leased to the lessee.
PLAYERS IN LEASING
Lessor
Lessee
Financial Institutions (FIs)
FIs are term lending institutions. There are over 10 such institutions handling project
finance on an all-India basis and over 20 State-level institutions. While FIs have over 30
per cent of the total lease market, it is not their main line of business.
Commercial Banks
State Bank of India, Indias largest commercial bank, entered the market in 1997. This
has altered market dynamics considerably because State Bank of India has a very large
deposit base from savings accounts and deposit accounts, leading to the lowest cost of
capital amongst all players.
Foreign banks
The role of foreign banks is very limited in the leasing market. Few foreign banks such as
ABN-AMRO and ANZ Grind lays have organized aircraft leasing for private airlines.
Regulatory Framework of Leasing in India
As such there is no separate law regulating lease agreements, but it being a contract, the
provisions of The Indian Contract Act, 1872 are applicable to all lease contracts.

57
Contract: A contract is an agreement enforceable by law. The essential elements of a valid
contract are Legal obligation, lawful consideration, competent parties, free consent and
not expressly declared void.
Discharge of Contracts: A contract me by discharged in following ways By performance,
by frustration (impossibility of performance), by mutual agreement, by operation of law
and by remission.
Remedies for Breach of Contract: Non-performance of a contract constitutes a breach of
contract. When a party to a contract has refused to perform or is disabled from
performing his promise, the other party may put an end to the contract on account of
breach by the other party.
Provisions Related to Indemnity and Guarantee: The provisions contained in the
Indian Contract Act, 1872 related to indemnity and guarantees are related to lease
agreements. Main provisions are as under
Indemnity: A contract of indemnity is one whereby a person promises to make good the
loss caused to him by the conduct of the promisor himself or any third person.
Guarantee: A contract of guarantee is a contract, whether oral or written, to perform the
promise or discharge the liability or a third person in case of his default.
Liabilities of Lessee: A lessee is responsible to take reasonable care of the leased assets.
He should not make unauthorized use of the assets. He should return the goods after
purpose is accomplished. He should pay the lease rental when due and must insure &
repair the goods.
Liabilities of Lessor: A lessor is responsible for delivery of goods to lessee. He should
take back the possession of goods when due. He must disclose all defects in the assets
before leasing. He must ensure the fitness of goods for proper use.
What are the tax benefits derived by the lessor and lessee in a lease finance
transaction?
The lessor claims depreciation on the asset, as he is the owner of the asset during the
lease finance period and even after its termination. Depreciation can be claimed on the
actual cost incurred by the lessor for the asset at such rates as are prescribed under the
Income Tax Act. The lessee, on the other hand, is entitled to claim deductions on the rent
paid by him for the asset under the Income Tax Act.
HIRE PURCHASE
A hire purchase agreement is defined in the Hire Purchase Act, 1972 as peculiar kind of
transaction in which the goods are let on hire with an option to the hirer to purchase
them, with the following stipulations:
a. Payments to be made in installments over a specified period.
b. The possession is delivered to the hirer at the time of entering into the contract.
c. The property in goods passes to the hirer on payment of the last installment.
d. Each installment is treated as hire charges so that if default is made in payment of any
installment, the seller becomes entitled to take away the goods, and
e. The hirer/ purchase is free to return the goods without being required to pay any
further installments falling due after the return.

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Lease financing v/s Hire Purchase Financing
The two modes of financing differ in the following respect:

Legal Framework
There is no exclusive legislation dealing with hire purchase transaction in India. The Hire
purchase Act was passed in 1972. An Amendment bill was introduced in 1989 to amend
some of the provisions of the act. However, the act has been enforced so far. The
provisions of are not inconsistent with the general law and can be followed as a guideline
particularly where no provisions exist in the general laws which, in the absence of any
specific law, govern the hire purchase transactions. The act contains provisions for
regulating:
1. The format / contents of the hire-purchase agreement
2. Warrants and the conditions underlying the hire-purchase agreement,
3. Ceiling on hire-purchase charges,
4. Rights and obligations of the hirer and the owner.
In absence of any specific law, the hire purchase transactions are governed by the
provisions of the Indian Contract Act and the Sale of Goods Act.
Hire Purchase Agreement
A hire purchase agreement is in many ways similar to a lease agreement, in so far as the
terms and conditions are concerned.
The important clauses in a hire purchase agreement are:
1. Nature of Agreement: Stating the nature, term and commencement of the agreement.

59
2. Delivery of Equipment: The place and time of delivery and the hirers liability to bear
delivery charges.
3. Location: The place where the equipment shall be kept during the period of hire.
4. Inspection: That the hirer has examined the equipment and is satisfied with it.
5. Repairs: The hirer to obtain at his cost, insurance on the equipment and to hand over
the insurance policies to the owner.
6. Alteration: The hirer not to make any alterations, additions and so on to the
equipment, without prior consent of the owner.
7. Termination: The events or acts of hirer that would constitute a default eligible to
terminate the agreement.
8. Risk: of loss and damages to be borne by the hirer.
9. Registration and fees: The hirer to comply with the relevant laws, obtain registration
and bear all requisite fees.
10. Indemnity clause: The clause as per Contract Act, to indemnify the lender.
11. Stamp duty: Clause specifying the stamp duty liability to be borne by the hirer.
12. Schedule: Schedule of equipments forming subject matter of agreement.
13. Schedule of hire charges: The agreement is usually accompanied by a promissory
note signed by the hirer for the full amount payable under the agreement including the
interest and finance charges.
TAXATION ASPECTS
The taxation aspects of hire purchase transaction can be divided into three parts (a)
Income Tax, (b) Sales Tax and (c) Interest Tax.
Income Tax Aspect
Hire purchase, as a financing alternative, offers tax benefits both to the hire-vendor (hire
purchase finance company) and the hirer.
Income tax assessment of the Hire purchase or hirer: The hirer is entitled to (i) The tax
shield on depreciation calculated with reference to the cash purchase price and (ii) the tax
shield on the finance charges. Even though the hirer is not the owner he gets the benefit
of depreciation on the cash price of the asset/equipment.
Income tax assessment of the Owner or financer: The consideration for hire/hire
charges / income received by the hire vendor / financer is liable to tax under the head
profits and gains of business and profession where hire purchase constitute the business
(mainstream activity) of the assessee, otherwise as income from other sources.
Sales Tax Aspect
The salient features of sales tax pertaining to hire purchase transactions after the
Constitution (Forty Sixth Amendment) Act, 1982, are as discussed in following points:
a. Hire purchase as Sale: Hire purchase, though not sale in the true sense, is deemed to
be sale. Such transactions as per are liable to sales tax. Full tax is payable irrespective of
whether the owner gets the full price of the goods or not.
b. Delivery v/s Transfer of property: A hire purchase deal is regarded as a sale
immediately the goods are delivered and not on the transfer of the title to the goods. The

60
quantum of sales tax is the sales price, thus the sales tax is charged on the whole
amount payable by the hirer to the owner.
c. Rate of tax: The rate of sales tax on hire purchase deals vary from state to state. There
is, as a matter of fact, no uniformity even regarding the goods to be taxed.
Interest Tax
The hire purchase finance companies, like other credit / finance companies, have to pay
interest tax under the Interest Tax Act, 1974. According to this Act, interest tax is payable
on the total amount of interest earned less bad debts in the previous year at a rate of 2
percent. The tax is treated as a tax deductible expense for the purpose of computing the
taxable income under the Income Tax.
PARTIES TO THE HIRE PURCHASE CONTRACT
There are two parties in a hire purchase contract
1. The intending seller
2. The intending purchaser or the hirer.
Tripartite agreement
1. Seller
2. Financier
3. Hirer/Purchaser
FINANCIAL EVALUATION
It is an evaluation by the hirer of the desirability for lease and hire purchase. The hirer
makes decision based on the Present Value of Net Cash Outflow. The decision is
considered favorable when the PV of Net Cash Outflow under Hire Purchase is less than
the PV of
Net cash Outflow under leasing. Following are the steps involved.
Step 1 Calculate annual interest amount
Step 2 Find the principal amount outstanding at the beginning of the each year
= Total outstanding principal principal paid in the previous year.
Step 3 Find principal paid in the previous year
= Annual installment amount Annual Interest
Step 4 Find Annual ITS
= Annual Interest x Tax rate
Step 5 Find Annual Depreciation
Step 6 Find Annual DTS = Annual depreciation x Tax rate
Step 7 Find Total TS
= Step 4 + Step 6
Step 8 Find Annual installment amount
= Total HP amount + (HP amount x flat rate of interest) / No. of HP years
Step 9 Find PV of salvage value of assets = SV x PVF
Step 10 Find Net Cash Outflow of HP
= Step 8 Step 7

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Step 11 Find PV of net cash outflow of HP at the appropriate discount rate
Step 12 Find Total PV net cash outflow of HP
= Step 11 Step 9
Step 13 Find Tax shield on annual ease rentals
= Annual Lease rental x Tax rate
Step 14 Find Net cash outflow of Leasing
= Annual lease rental Step 13
Step 15 Find Total PV of net cash outflow of Leasing at the approp. discount rate
= Net cash outflow of Leasing x PVAF
Step 16 Make a decision: HP is desirable if total PV of net cash flow of HP is
Less than that of leasing

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 UNIT V OTHER FUND BASED FINANCIAL SERVICES
Consumer Credit Credit Cards Real Estate Financing Bills Discounting Factoring
and Forfaiting Venture Capital.

BILLS DISCOUNTING
The bill of exchange is an instrument in writing containing an unconditional order,
signed by the maker, directing a certain person to pay a certain sum of money only to, or
to the order of, a certain person, or to the bearer of that instrument.
Types of Bills
There are various types of bills. They can be classified on the basis of when they are due
for payment, whether the documents of title of goods accompany such bills or not, the
type of activity they finance, etc. Some of these bills are:
Demand Bill: This is payable immediately at sight or on presentment to the drawee. A
bill on which no time of payment or due date is specified is also termed as a demand
bill.
Usance Bill: This is also called time bill. The term usance refers to the time period
recognized by custom or usage for payment of bills.
Documentary Bills: These are the B/Es that are accompanied by documents that
confirm that a trade has taken place between the buyer and the seller of goods. These
documents include the invoices and other documents of title such as railway receipts,
lorry receipts and bills of lading issued by custom officials.
Documentary bills can be further classified as: (i) Documents against acceptance (D/A)
bills and (ii) Documents against payment (DIP) bills.
D/A Bills: In this case, the documentary evidence accompanying the bill of exchange is
deliverable against acceptance by the drawee. This means the documentary bill becomes a
clean bill after delivery of the documents.
DIP Bills: In case a bill is a documents against payment bill and has been accepted by
the drawee, the documents of title will be held by the bank Dr the finance company till
the maturity of the B/E.
Clean Bills: These bills are not accompanied by any documents that show that a trade
has taken place between the buyer and the seller. Because of this, the interest rate
charged on such bills is higher than the rate charged on documentary bills.
Advantages : The advantages of bill discounting to investors and banks and finance
companies are as follows:
To Investors
1. Short-term sources of finance;
2. Bills discounting being in the nature of a transaction is outside the purview of Section
370 of the Indian Companies Act 1956, that restricts the amount of loans that can be
given by group companies;
3. Since it is not a lending, no tax at source is deducted while making the payment
charges which is very convenient, not only from cash flow point of view, but also from the
point of view of companies that do not envisage tax liabilities;
4. Rates of discount are better than those available on ICDs; and

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5. Flexibility, not only in the quantum of investments but also in the duration of
investments.
To Banks
1. Safety of Funds The greatest security for a banker is that a B/E is a negotiable
instrument bearing signatures of two parties considered good for the amount of bill; so he
can enforce his claim easily.
2. Certainty of Payment A B/E is a self-liquidating asset with the banker knowing in
advance the date of its maturity. Thus, bill finance obviates the need for maintaining
large, unutilised, ideal cash balances as under the cash credit system. It also provides
banks greater control over their drawls.
3. Profitability Since the discount on a bill is front-ended, the yield is much higher than in
other loans and advances, where interest is paid quarterly or half yearly.
4. Evens out Inter-Bank Liquidity Problems The development of healthy parallel bill
discounting market would have stabilized the violent fluctuations in the call money
market as banks could buy and sell bills to even out their liquidity mismatches.
Features
Following are the salient features of bill discounting financing:
1. Discount charge : The margin between advance granted by the bank and face value of
the bill is called the discount, and is calculated on the maturity value at rate a certain
percentage per annum.
2. Maturity : Maturity date of a bill is defined as the date on which payment will fall due.
Normal maturity periods are 30, 60,90 or 120 days. However, bills maturing within 90
days are the most popular.
3. Ready finance : Banks discount and purchase the bills of their customers so that the
customers get immediate finance from the bank. They need not wait till the bank collects
the payment of the bill.
4. Discounting and purchasing : The term discounting of bills is used for demand bills,
where the term purchasing of bills is used for usance bills. In both cases, the bank
immediately credits the account of the customer with the amount of the bill, less its
charges.
Steps In Discounting And Purchasing
Following steps are involved in the discounting and purchas8isng of commercial bills of
exchange :
1. Examination of Bill : The banker verifies the nature of the bill and the transaction.
The banker then ensures that the customer has supplied all required documents along
with the bill.
2. Crediting Customer Account After examining the genuineness of the bill, the banker
grants a credit limit, either on a regular or on an adhoc basis. The customers account is
credited with the net amount of the bill i.e. value of bill minus discount charges. The
amount of discount is the income earned by the bank on discounting / purchasing. The
amount of the bill is taken as advance by the bank
3. Control over Accounts : To ensure that no customer borrows more than the
sanctioned limit, a separate register is maintained for determining the amount availed by

64
each customer. Separate columns are allotted to show the names of customers, limits
sanctioned, bills discounted, bills collected, loans granted and loans repaid. Thus, at any
given point in time the extent of limit utilized by the customer can be readily known.
4. Sending Bill for collection : The bill, together with documents duly stamped by the
banker, is sent to the bankers branch (or some other banks branch if the banker does
not have a branch of its own) for presenting the bill for acceptance or payment, in
accordance with the instructions accompanying the bill.
5. Action by the Branch : On receipt of payment, the collecting bank remits the payment
to the banker which has sent the bill for collection.
6. Dishonor : In the event of dishonor, the dishonor advice is sent to the drawer of the
bill. It would be appropriate for the collecting banker to get the protested for dishonor. For
this purpose, the collecting banker or branch of the bank maintains a separate register in
which details such as date on which the bills are to be presented, the party to whom it is
to be presented, etc. are recorded.
BILL SYSTEMS
There are essentially two systems of bills, the drawer bill system and the drawee bill
system, which are explained blow :
Drawer Bills System
Drawer Bills System is characterized by:
1. Bills being drawn by the sellers of goods on the buyer of the goods
2. Bills being discounted or purchased at the instance of the drawer of the bills
3. The banker primarily taking into consideration the credit of the drawer of bill, while
discounting or purchasing these bills
This system of financing goods is quite popular in our country.
Drawee Bills System
Drawee Bills System is characterized by :
a. The banker accepting the bill drawn by the seller at the instance of the buyer (the
drawee)
b. The banker providing assistance, primarily on the strength of the creditworthiness of
the buyer.
The two types of the drawee bills system are as follows :
1. Acceptance credit system: Under this system, the buyers banker accepts the bill of
exchange for the goods purchased by the drawee. Such a bill may either be drawn on the
buyer or the banker. The banker also requires the borrower to show separately, the goods
purchased under acceptance credit in periodical stock statements submitted to the
banker.
2. Bills discounting system: Under this system, the seller directly draws the bill on the
buyers bank. The buyers bank discounts the bill and sends the proceeds to the seller.
The buyers banker will show the bill as bill discounted.
Under both the systems, the banker keeps a record of the bills, both accepted and still
outstanding. This is to ensure that the advance sanctioned does not exceed the credit
limit.

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The main advantages of the Drawee bill scheme are as follows :
1. Assured payment: Since the banker has accepted the bill, the seller is assured of
payment. Moreover, if the seller decides to get it discounted, the discount rate will be
lower because the drawee is the banker itself.
2. Buying advantage: Due to the surety and standing of the banker, it is possible for the
buyer to obtain goods at competitive rates.
3. Safety of funds: There is hardly any risk for the buyers bank because the bill is
accepted or discounted against the security of the goods purchased by the buyer.
Moreover, the goods are under the control of the banker. It is equally advantageous for the
sellers bank, since the discounted bill may be rediscounted with any other financial
institution. This is because; a banker has accepted the bill.
FACTORING
Meaning and Definition
Factoring may broadly be defined as the relationship, created by an agreement, between
the seller of goods/services and a financial institution called .the factor, whereby the later
purchases the receivables of the former and also controls and administers the receivables
of the former.
A domestic factoring means an arrangement between a Factor and his client, which
includes at least two of the following services to be provided by the Factor.
a. Finance
b. Maintenance of accounts
c. Collection of debts
d. Protection against credit risk.
Features of Factoring
The characteristics of Factoring are as follows :
1. The Nature: The nature of the Factoring contract is similar to that of a bailment
contract. Factoring is a specialized activity whereby a firm converts its receivables into
cash by selling them to a factoring organization.
2. The Form: Factoring takes the form of a typical Invoice Factoring since it covers only
those receivables which are not supported by negotiable instruments, such as bills of
exchange, etc.
3. The Assignment: Under factoring, there is an assignment of debt in favor of the Factor.
This is the basic requirement for the working of a factoring service.
4. Fiduciary Position: The position of the Factor is fiduciary in nature, since it arises
from the relationship with the client firm. The factor is mainly responsible for fulfilling the
terms of the contract between the parties.
5. Professionalism: Factoring firms are professionally competent, with skilled persons to
handle credit sales realizations for different clients in different trades, for better credit
management.
6. Credit Realizations: Factors assist in realization of credit sales. They help in avoiding
the risk of bad debt loss, which might arise otherwise.

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7. Less Dependence: Factors help in reducing the dependence on bank finance towards
working capital. This greatly relieves the firm of the burden of finding financial facility.
8. Recourse Factoring: Factoring may be non-recourse, in which case the Factor will
have no recourse to the supplier on non-payment from the customer. Factoring may also
be with recourse, in which case the Factor will have recourse to the seller in the event of
non-payment by the buyers.
9. Compensation: A Factor works in return for a service charge calculated on the
turnover. Actor pays the net amount after deducing the necessary charges, some of which
may be special terms to handle the accounts of certain customers.
Mechanism of Factoring:
Factoring business is generated by credit sales in the normal course business. The main
function of factor is realisation of sales. Once the transaction takes place, the role of
factor step in to realise the sales/collect receivables. Thus, factor act as a intermediary
between the seller and till and sometimes along with the sellers bank together.
The mechanism of factoring is summed up as below:
i. An agreement is entered into between the selling firm and the firm. The agreement
provides the basis and the scope understanding reached between the two for rendering
factor service.
ii. The sales documents should contain the instructions to make payment directly to the
factor who is assigned the job of collection of receivables.
iii. When the payment is received by the factor, the account of the firm is credited by the
factor after deducting its fees, charges, interest etc. as agreed.
iv. The factor may provide advance finance to the selling firm conditions of the agreement
so require.
Parties to the Factoring
There are basically three parties involved in a factoring transaction.
1. The buyer of the goods.
2. The seller of the goods
3. The factor i.e. financial institution.
The three parties interact with each other during the purchase/ sale of goods. The
possible procedure that may be followed is summarised below.
The Buyer
1. The buyer enters into an agreement with the seller and negotiates the terms and
conditions for the purchase of goods on credit.
2. He takes the delivery of goods along with the invoice bill and instructions from the
seller to make payment to the factor on due date.
3. Buyer will make the payment to the factor in time or ask for extension of time. In case
of default in payment on due date, he faces legal action at the hands of factor.
The Seller
1. The seller enters into contract for the sale of goods on credit as per the purchase order
sent by the buyer stating various terms and conditions.
2. Sells goods to the buyer as per the contract.

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3. Sends copies of invoice, delivery challan along with the goods to the buyer and gives
instructions to the buyer to make payment on due date.
4. The seller sells the receivables received from the buyer to a factor and receives 80% or
more payment in advance.
5. The seller receives the balance payment from the factor after paying the service
charges.
The Factor
1. The factor enters into an agreement with the seller for rendering factor services i.e.
collection of receivables/debts.
2. The factor pays 80% or more of the amount of receivables copies of sale documents.
3. The factor receives payments from the buyer on due dates and pays the balance money
to the seller after deducting the service charges.
Types of Factoring
Factors take different forms, depending upon the type of specials features attached to
them. Following are the important forms of factoring arrangements:
1. Domestic Factoring: Factoring that arises from transactions relating to domestic sales
is known as Domestic Factoring. Domestic Factoring may be of three types, as described
below.
2. Disclosed factoring: In the case of disclosed factoring the name of the proposed actor
is mentioned on the face of the invoice made out by the seller of goods. In this type of
factoring, the payment has to be made by the buyer directly to the Factor named in the
invoice.
3. Undisclosed factoring: Under undisclosed factoring, the name of the proposed Factor
finds no mention on the invoice made out by the seller of goods. Although the control of
all monies remain with the Factory, the entire realization of the sales transaction is done
in the name of the seller.
4. Discount factoring: Discount Factoring is a process where the Factor discounts the
invoices of the seller at a pre-agreed credit limit with the institutions providing finance.
Book debts and receivables serve as securities for obtaining financial accommodation.
5. Export Factoring: When the claims of an exporter are assigned to a banker or any
financial institution, and financial assistance is obtained on the strength of export
documents and guaranteed payments, it is called export factoring.
6. Cross-border Factoring: Cross-border Factoring involves the claims of an exporter
which are assigned to a banker or any financial institution in the importers country and
financial assistance is obtained on the strength of the export documents and guaranteed
payments. International factoring essentially works on a non-recourse factoring model.
7. Full-service Factoring: Full-service factoring, also known as Old-line factoring, is a
type of factoring whereby the Factor has no recourse to the seller in the event of the
failure of the buyers to make prompt payment of their dues to the Factor, which might
result from financial inability/ insolvency/bankruptcy of the buy.
8. With Recourse Factoring: The salient features of the type of factoring arrangement
are as follows

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1. The Factor has recourse to the client firm in the event of the book debts purchased
becoming irrecoverable
2. The Factor assumes no credit risks associated with the receivables.
3. If the consumer defaults in payment, the resulting bad debts loss shall be met by the
firm
4. The Factor becomes entitled to recover dues from the amount paid in advance if the
customer commits a default on maturity
5. The Factor charges the client for services rendered to the client, such as maintaining
sales ledger, collecting customers debt, etc.
9. Without Recourse Factoring: The salient features of this type of factoring are as
follows :
1. No right with the Factor to have recourse to the client
2. The Factor bears the loss arising out of irrecoverable receivables
3. The Factor charges higher commission called del credere commission as a
compensation for the said loss
4. The Factor actively involves in the process of grant of credit and the extension of line of
credit to the customers of the client
10. Advance and Maturity Factoring
The essential features of this type of factoring are as follows :
1. The Factor makes an advance payment in the range of 70 to 80 percent of the
receivables factored and approved from the client, the balance amount being payable after
collecting from customers
2. The Factor collects interest on the advance payment from the client
3. The Factor considers such conditions as the prevailing short-term rate, the financial
standing of the client and the volume of turnover while determining the rate of interest
11. Bank Participation Factoring: It is variation of advance and maturity factoring.
Under this type of factoring, the Factor arranges a part of the advance to the clients
through the banker.
The net Factor advance will be calculated as follows :
(Factor Advance Percent x Bank Advance Percent)
12. Collection / Maturing Factoring: Under this type of factoring, the Factor makes no
advancement of finance to the client. The Factor makes payment either on the guaranteed
payment date or on the date of collection, the guaranteed payment date being fixed after
taking into account the previous ledger experience of the client and the date of collection
being reckoned after the due date of the invoice.
Functions of a Factor
The purchase of book debts or receivables is central to the function of factoring permitting
the factor to provide basic services such as :
1. Administration of sellers sales ledger.
2. Collection of receivables purchased.
3. Provision of finance.
4. Protection against risk of bad debts/credit control and credit protection.

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5. Rendering advisory services by virtue of their experience in financial dealings with
customers.
1. Administration of Sales Ledger: The factor assumes the entire responsibility of
administering sales ledger. The factor maintains sales ledger in respect of each client.
When the sales transaction takes place, an invoice is prepared in duplicate by the client,
one copy is given to customer and second copy is sent to the factor. Entries are made in
the ledger on open-item method. Each receipt is matched against the specific invoice.
2. Collection of Receivables: The factor helps the client in adopting better credit control
policy. The main functions of a factor is to collect the receivables on behalf of the client
and to relieve him from all the botherations/ problems associated with the collection.
3. Provision of Finance: Finance, which is the lifeblood of a business, is made available
easily by the factor to the client. A factor purchases the book debts of his client and debts
are assigned in favor of the factor. 75% to 80 percent of the assigned debts is given as an
advance to the client by the factor.
4. Protection Against Risk: This service is provided where the debts are factored without
recourse. The factor fixes the credit limits (i.e. the limit up to which the client can sell
goods to customers) in respect of approved customers. Within these limits the factor
undertakes to purchase all trade debts and assumes risk of default in payment by the
customers.
5. Advisory Services: These services arise out of the close relationship between a factor
and a client. Since the factors have better knowledge and wide experience in field of
finance, and possess extensive credit information about customers standing, they provide
various advisory services.
Cost of Services
The factor provides various services at some charge in the form of a commission
expressed as a value of debt purchased. It is collected in advance. The commission is in
the form of interest charged for the period between the date of advance payment and date
of collection/guarantee payment date for short term financing as advance part payment.
It is also known as discount charge.
The cost of factoring services primarily comprises of the following two components:
1. Administrative charges /factoring fees: This is charged towards providing various
services to the clients namely (a) sales ledger administration (b) credit control including
processing, operational overheads and collection of debts (c) providing, protection against
bad debts. This charge is usually some percent of the projected sales turnover of the
client for the next twelve months. It varies between 1 to 2.5 percent of the projected
turnover.
2. Discount charges: This is levied towards providing instant credit to the client by way
of prepayment. This is normally linked with the base rate of the parent company or the
bank from which the factoring institution is borrowing money, say, 1 to 2.5 percent above
the said rate.

Advantages of Factoring

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1. The factors provides specialised services with regard to sales ledger administration and
credit control and relieves the client from the botheration of debt collection.
2. The advance payments made by the factor to the client in respect of the bills purchased
increase his liquid resources.
3. It provides flexibility to the company to decide about extending better terms to their
customers.
4. The company itself is in a better position to meet its commitments more promptly due
to improved cash flows.
5. Enables the company to meet seasonal demands for cash whenever required.
6. Better purchase planning is possible. Availability of cash helps the company to avail
cash discounts on its purchases.
7. As it is an off balance sheet finance, thus it does not affect the financial structure. This
would help in boosting the efficiency ratios such as return on asset etc.
8. Saves the management time and effort in collecting the receivables and in sales ledger
management.
9. Where credit information is also provided by the factor, it helps the company to avoid
bad debts.
10. It ensures better management of receivables as factor firm is specialised agency for
the same. The factor carries out assessment of the client with regard to his financial,
operational and managerial capabilities whether his debts are collectable and viability of
his operations.
Limitations
The above listed advantages do not mean that the factoring operations are totally free
from any limitation. The attendant risk itself is of very high degree. Some of the main
limitations of such transactions are listed below:
1. It may lead to over-confidence in the behavior of the client resulting in over-trading or
mismanagement.
2 The risk element in factoring gets accentuated due to possible fraudulent acts by the
client in furnishing the main instrument invoice to the factor. Invoicing against
nonexistent goods, pre-invoicing (i.e. invoicing before physical dispatch of goods),
duplicate-invoicing (i.e. making more than one invoice in respect of single transaction) are
some commonly found frauds in such operations, which had put many factors into
difficulty in late 50s all over the world.
3. Lack of professionalism and competence, underdeveloped expertise, resistance to
change etc. are some of the problems which have made factoring services unpopular.
4. Rights of the factor resulting from purchase of trade debts are uncertain, not as strong
as that in bills of exchange and are subject to settlement of discounts, returns and
allowances.
5. Small companies with lesser turnover, companies having high concentration on a few
debtors, companies with speculative business, companies selling a large number of
products of various types to general public or companies having large number of debtors
for small amounts etc. may not be suitable for entering into factoring contracts.
Dissimilarities/Differences

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The two services differ from each other in the following respects:

Forfaiting
The forfaiting owes its origin to a French term a forfait which means to forfeit (or
surrender) ones rights on something to someone else. Forfaiting is a mechanism of
financing exports:
a. by discounting export receivables
b. evidenced by bills of exchanges or promissory notes
c. without recourse to the seller (viz; exporter)
d. carrying medium to long-term maturities
e. on a fixed rate basis upto 100% of the contract value.
Parties to Forfaiting

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There are five parties in a transaction of forfaiting. These are
i. Exporter
ii. Importer
iii. Exporters bank
iv. Importers bank
v. The forfaiter.
Mechanism
1. The exporter and importer negotiate the proposed export sale contract. Then the
exporter approaches the forfaiter to ascertain the terms of forfaiting.
2. The forfaiter collects details about the importer, supply and credit terms,
documentation etc.
3. Forfaiter ascertains the country risk and credit risk involved.
4. The forfaiter quotes the discount rate.
5. The exporter then quotes a contract price to the overseas buyer by loading the discount
rate, commitment fee etc. on the sale price of the goods to be exported.
6. The exporter and forfaiter sign a contract.
7. Export takes place against documents guaranteed by the importers bank.
8. The exporter discounts the bill with the forfaiter and the latter presents the same to the
importer for payment on due date or even sell it in secondary market.

Documentation
1. Forfaiting transaction is usually covered either by a promissory note or bills of
exchange.
2. Transactions are guaranteed by a bank.
3. Bills of exchange may be availed by the importers bank. Aval is an endorsement made
on bills of exchange or promissory note by the guaranteeing bank by writing per aval on
these documents under proper authentication.
Costs of forfaiting
The forfaiting transaction has typically three cost elements:
1. Commitment fee, payable by the exporter to the forfeiter for latters commitment to
execute a specific forfaiting transaction at a firm discount rate with in a specified time.
2. Discount fee, interest payable by the exporter for the entire period of credit involved
and deducted by the forfaiter from the amount paid to the exporter against the availised
promissory notes or bills of exchange.
3. Documentation fee.
Benefits of forfaiting
Forfaiting helps the exporter in the following ways:
1. It frees the exporter from political or commercial risks from abroad.
2. Forfaiting offers without recourse finance to an exporter. It does not effect the
exporters borrowing limits/capacity.

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3. Forfaiting relieves the exporter from botheration of credit administration and collection
problems.
4. Forfaiting is specific to a transaction. It does not require long term banking relationship
with forfaiter.
5. Exporter saves money on insurance costs because forfaiting eliminates the need for
export credit insurance.
Problem areas in forfaiting and factoring where legislation is required.
1. There is, presently, no legal framework to protect the banker or forfaiter except the
existing covers for the risks involved in any foreign transactions.
2. Data available on credit rating agencies or importer or foreign country is not sufficient.
Even exim bank does not cover high-risk countries like Nigeria.
3. High country and political risks dissuade the services of factoring and banking to
many clients.
4. Government agencies and public sector undertakings (PSUs) neither promptly make
payments nor pay interest on delayed payments.
5. The assignment of book debts attracts heavy stamp duty and this has to be waived.
6. Legislation is required to make assignment under factoring have priority over other
assignments.
7. There should be some provisions in law to exempt factoring organization from the
provisions of money lending legislations.
8. The order 37 of Civil procedure code should be amended to clarify that factor debts can
be recovered by resorting to summary procedures.

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Difference Between Factoring And Forfaiting
The following are differences between factoring and forfeiting

VENTURE CAPITAL
The term venture capital represents financial investment in a highly risky project with
the objective of earning a high rate of return. While the concept of venture capital is very
old the recent liberalisation policy of the government appears to have given a fillip to the
venture capital movement in India.

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Features of Venture Capital follows:
i. High Degrees of Risk Venture capital represents financial investment in a highly risky
project with the objective of earning a high rate of return.
ii. Equity Participation Venture capital financing. is, invariably, an actual or potential
equity participation wherein the objective of venture capitalist is to make capital gain by
selling the shares once the firm becomes profitable. .
iii. Long Term Investment Venture capital financing is a long term investment. It
generally takes a long period to encash the investment in securities made by the venture
capitalists.
iv. Participation in Management In addition to providing capital, venture capital funds
take an active interest in the management of the assisted firms. Thus, the approach of
venture capital firms is different from that of a traditional lender or banker.
v. Achieve Social Objectives It is different from the development capital provided by
several central and state level government bodies in that the profit objective is the motive
behind the financing. But venture capital projects generate employment, and balanced
regional growth indirectly due to setting up of successful new business.
vi. Investment is liquid A venture capital is not subject to repayment on demand as with
an overdraft or following a loan repayment schedule. The investment is realised only when
the company is sold or achieves a stock market listing.
Stages of Investment Financing
Venture capital firms finance both early and later stage investments to maintain a
balance between risk and profitability.
Venture capital firms usually recognise the following two main stages when the
investment could be made in a venture namely:
A. Early Stage Financing
i. Seed Capital & Research and Development Projects.
ii. Start Ups
ii. Second Round Finance
B. Later Stage Financing
i. Development Capital
ii. Expansion Finance
iii. Replacement Capital
iv. Turn Arounds
v. Buy Outs
A. Early Stage Financing This stage includes the following:
I. Seed Capital and R & D Projects: Venture capitalists are more often interested in
providing seed finance i. e. making provision of very small amounts for finance needed to
turn into a business.
Research and development activities are required to be undertaken before a product is to
be launched. External finance is often required by the entrepreneur during the
development of the product.

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II. Start Ups: Start-ups may include new industries / businesses set up by the
experienced persons in the area in which they have knowledge. Others may result from
the research bodies or large corporations, where a venture capitalist joins with an
industrially experienced or corporate partner. Still other start-ups occur when a new
company with inadequate financial resources to commercialise new technology is
promoted by an existing company.
III. Second Round Financing: It refers to the stage when product has already been
launched in the market but has not earned enough profits to attract new investors.
Additional funds are needed at this stage to meet the growing needs of business.
B. Later Stage Financing
Those established businesses which require additional financial support but cannot raise
capital through public issue approach venture capital funds for financing expansion,
buyouts and turnarounds or for development capital.
I. Development Capital: It refers to the financing of an enterprise which has overcome
the highly risky stage and has recorded profits but cannot go public, thus needs financial
support. Funds are needed for the purchase of new equipment/ plant, expansion of
marketing and distributing facilities, launching of product into new regions and so on.
II. Expansion Finance: Venture capitalists perceive low risk in ventures requiring
finance for expansion purposes either by growth implying bigger factory, large warehouse,
new factories, new products or new markets or through purchase of exiting businesses.
The time frame of investment is usually from one to three years. It represents the last
round of financing before a planned exit.
III. Buy Outs: It refers to the transfer of management control by creating a separate
business by separating it from their existing owners. It may be of two types.
i. Management Buyouts (MBOs): In Management Buyouts (MBOs) venture capital
institutions provide funds to enable the current operating management/ investors to
acquire an existing product line/business. They represent an important part of the
activity of VCIs.
ii. Management Buyins (MBIs): Management Buy-ins are funds provided to enable an
outside group of manager(s) to buy an existing company. It involves three parties: a
management team, a target company and an investor (i.e. Venture capital institution).
MBIs are more risky than MBOs and hence are less popular because it is difficult for new
management to assess the actual potential of the target company. Usually, MBIs are able
to target the weaker or under-performing companies.
IV. Replacement Capital: V CIs another aspect of financing is to provide funds for the
purchase of existing shares of owners. This may be due to a variety of reasons including
personal need of finance, conflict in the family, or need for association of a well-known
name.
V. Turnarounds: It involves buying the control of a sick company which requires very
specialized skills. It may require rescheduling of all the companys borrowings, change in
management or even a change in ownership.
VI. Messanine capital

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This is a stage where the borrowing company is not only well established but has
overcome the risks and has started earning profits. But they have to go for some more
year before reaching the stage of self-sustenance. This finance is used by the borrowing
company for purchase of plant and machinery, repayment of past debts, and entering new
areas.
VII. Bridge capital
A capital of medium term finance ranging from one to three years and used for extending
a business Example : bridge loan for acquiring other firms.

Factors Affecting Investment Decisions

The venture capitalists usually take into account the following factors while making
investments:
1. Strong Management Team: Venture capital firms ascertain the strength of the
management team in terms of adequacy of level of skills, commitment and motivation that
creates a balance between members in area such as marketing, finance and operations.
2. A Viable Idea: Before taking investment decision, venture capital firms consider the
viability of project or the idea. Because a viable idea establishes the market for the
product or service
3. Business Plan: The business plan should concisely describe the nature of the
business, the qualifications of the members of the management team, how well; the
business has performed, and business projections and forecasts.
4. Project Cost and Returns: VCI would like to undertake investment in a venture only if
future cash inflows are likely to be more than the present cash outflows. While calculating
the Internal Rate of Return (IRR) the risk associated with the business proposal, the
length of time his money will be tied up are taken into consideration.
5. Future Market Prospects: The marketing policies adopted, marketing strategies in
relation to the competitors, market research undertaken, market size, share and future
market prospects are some of the considerations that affect the decision.
6. Existing Technology: Existing technology used and any technical collaboration
agreements entered into by the promoters also to a large extent affect the investment
decision.
7. Miscellaneous Factors: Others factors which indirectly affect the investment
decisions include availability of raw material and labor, pollution control measures
undertaken, government policies, rules and regulations applicable to the
business/industry, location of the industry etc.
Selection of Venture Capitalists
Following factors must be taken into consideration:
(1) Approach adopted by VCs - Selection of VCs to a large extent depends upon the
approach adopted by VCs.
a. Hands on approach of VCs aims at providing value added services in an advisory role
or active involvement in marketing, recruitment and funding technical collaborators.

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b. Hands off approach refers to passive participation by the venture capitalists in
management affairs. VCs just receive periodic financial statements. VCs enjoy the right to
appoint a director but this right is seldom exercised by them.
(2) Flexibility in deals - The entrepreneurs would like to strike a deal with such venture
capitalists who are flexible and generous in their approach. They provide them a package
which best meet the needs of the entrepreneurs. VCs having rigid attitude may not be
preferred.
(3) Exit policy - The entrepreneurs should ask clearly the venture capitalists as to their
exit policies whether it is buy back or quotation or trade sale. To avoid conflicts,
clarifications should be sought in the beginning; the policy should not be against the
interests of the business. Depending upon the exit policy of the VCs, selection would be
made by the entrepreneurs.
(4) Fund viability and liquidity - The entrepreneurs must make sure that the VCs has
adequate liquid resources and can provide later stage financing if the need arises, also,
the VC has committed backers and is not just interested in making quick financial gains.
(5) Track record of the VC & its team - The scrutiny of the past performance, time since
operational, list of successful projects financed earlier etc. should be made by the
entrepreneur. The teams of VCs, their experience, commitment, guidance during bad
times are the .other consideration affecting the selection of VCs.

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