(continued from previous module)
BC: It is clear that each ‘part’ (henceforth referred to as share) will be worth Rs.10. Out of these 100 shares, the initial 70 belong to you (Raj) and the balance 30 needs to be funded by (yet to be identified) share holders.
Raj: You mean to say somebody will give me this 300 rupees?
BC: Yes. One or more person will give you the amount and thus become a share holder in your business.
Raj: When do I return them their money?
BC: You never have to !
Raj: And what is the % of interest I have to pay them?
BC: None. You will pay them proportional value of the profit. And if your business continues to be in loss, you pay them nothing. That’s it!
Raj was very much excited once he got introduced to the possibilities of equity financing compared to the complexities of debt financing . He wanted to take a plunge straight away and expressed his willingness to go public.
The business consultant took him to Manager, Corporate Banking division of his bank(henceforth referred to as Merchant Banker). He took down the details of his business and promised to meet Raj within two weeks after studying various aspects of his business.
During the next couple of weeks ,while Raj was dreaming about expanding his business to new and higher levels, the merchant bank was doing its home work. It had a thorough examination of all the past and current accounts related to his business. It also studied
- General health of his business
- Expertise and experience of those managing the business
- Price / availability of raw materials
- Demand for the product in neighbouring geographic locations
- Possibility of expansion of market in farther locations
- Overall mood in stock markets
- Availability and ease with which cash flows in present day economy (liquidity)
- Overall sentiment in the poultry and dairy industry
- Existing tax benefits accorded to the specific industry by local and central Governments
- Possibility of future reduction in taxes.
and several other factors directly and remotely connected to Raj and his business.
After two weeks, Raj reached the bank early morning to collect his 300 Rupees. In the bank, he was a bit dissapointed to know that there are other formalities to be completed before he could get his hands on the additional 300 Rupees.
The manager gave his part of the lecture to Raj:
“We have done a thorough study of the prevailing investment climate in general and your business in particular. As was discussed in our previous meeting, we are about to announce to the general public an Initial Public Offering (IPO) of 30 shares each with a face value of Rs. 10. This should fetch you Rs.300 as public investment in your business.
But we understand that there will be good demand for these 30 shares , since the investors feel that your business is poised for better profit and thus higher yields for their investment. Hence , we might use this demand in our favour by selling these 30 shares at a higher price, instead of the Rs. 10 we have as face value.
There are two types of pricing of IPOs.
1. Fixed price
2. Book building
In the Fixed price method, based on the data available with us, we fix the premium amount.
In the book building method, instead of a fixed price ,we announce a price band (eg Rs. 15 to Rs 32) and the indivdual investors bid the price themselves. Once all the bids are evaluated, we can arrive at the final price.
In your case, we propose to go for the book building method. We fix a price band of Rs. 12 to Rs. 18.
The offer to general public will start on July 1st and will close on July 4th. The bids will be evaluated and price fixed on July 6th.”
Raj was happy. He went home and dug into the past to see how some of the more recent IPOs fared in the market.