Financial Services and Merchant Banking

Financial Services
Investment Banking Credit rating Consumer Finance Factoring Housing Finance Asset Restructuring/Management Company Depository Services Credit cards & Debit cards.

Financial services include the services offered by both types of companies- Asset Management Companies and Liability Management Companies.

Functions Of Financial Services

Financial services firms not only help to raise the required funds but also assure the efficient deployment of funds. 1. They assist in deciding the financing mix. 2. They extend their service up to the stage of servicing of lenders. 3. They provide services like bill discounting, factoring of debtors, parking of short-term funds in the money market, e-commerce, Securitization of debts, etc. in order to ensure an efficient management of funds. 4. Financial services firms provide some specialized services like credit rating, venture capital financing, lease financing, factoring, mutual funds, merchant banking, stock lending, depository, credit cards, housing finance, book building, etc.

Features Of Financial Services

1. It is a customer-intensive industry. 2. Financial services are intangible in nature. 3. Production and supply of financial services must be performed simultaneously. 4. Marketing of financial service is people intensive. 5. Financial services firms should always be proactive in visualizing in advance what the market wants, or reactive to the needs and wants of customers.
Financial Services and Merchant Banking | 1

Problems Of Indian Financial Services

1. Indian financial industry hardly finds suitable personnel to deal with financial services. 2. Expensive physical accommodation is another problem being faced by the financial services firms. 3. The financial services firms lack core competence. 4. They cannot review their performance without a benchmarking. 5. They fully depend on fee-based business. 6. Lack of proper appreciation of the advantages that could be derived by using the advances 7. In computer and telecommunication technology has constrained the growth of the industry.

Investment Banking
An investment bank is a type of financial intermediary that performs a variety of functions such as underwriting, facilitating mergers and acquisitions or brokerage services for institutions. The work of an investment bank begins right from the counseling before the underwriting sessions, and stretches right till the securities are properly handled and distributed. Investment banks play a very crucial role in market transactions on behalf of, or for private and public investors, government and corporations. There are a number of investment banks that also provide highly professional services in assisting their clients with industrial know-how on various parameters. Industries from diverse sectors like media and telecommunications, real estate, industry, finance, health care, consumer products and various such segments are provided assistance by investment banking services. Along with these, an investment bank also deals in the securities, trading services, credit counseling, financial engineering and merchant banking. The primary source of income for investment bankers is the commissions, fees and gain margins on transactions provided for the above mentioned institutions. The role of an investment bank as a mediator is to directly familiarize the nature of the investment and the entity being invested in. In case of conventional banking, people deposit finances in the form of cash, assets and so on with a bank. The bank in turn can lend to a borrower under some standard norms to utilize in his own way. In the case of investment banking, there is a direct familiarization of both the investor and the borrower.

Financial Services and Merchant Banking |

 This means that an individual or institutional investor has an option to choose his type of investment or division of investment into any given entity looking out for funds. An investment bank can also assist investment in the financial market. Investment banks provide companies with expert guidance and formulate strategies on their behalf for disinvestment, and also to merge or acquire new entities. Good investment banking involves procedures to maintain and upgrade the quality of services and keep a close watch on the emerging trends in the market, where their customer's money can be invested. It also incorporates risk management services in order to streamline the flow of capital, check its overuse, and come up with a detailed analysis of credit risks. A big firm should ensure a number of parameters before tying up with an investment bank, in order to make sure a given investment results in sizable profits. The bank should have a long-standing reputation of providing quality and consistent service. It should be accountable for all the transactions done through it. You need to do a thorough market research, compare and contrast the functioning styles of different investment banks, the consistency of their workforce in staying with a particular deal, or the reputation of their previous clients. The investment banking market was increasing leaps and bounds, until the present recession struck. Banks all over the world are trying to recoup the losses. The US is the biggest market for investment banks, followed by Europe, Middle East, Africa and Asia. The global hubs of investment banking are a few economically sound centers like London, New York and Tokyo. However, investment banking is not restricted in its scope to a few regions of the world. It caters to a global community which makes it highly sensitive to global ups and downs, along with innovative fluctuations. A career as an investment advisor is both a challenging and a highly rewarding career option.

Credit Rating
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.

Rating Process
Rating is an interactive process with a prospective approach. It involves series of steps. The main points are described as below: Mandate
Financial Services and Merchant Banking | 3

 Team Information Secondary Data Meetings and Visits Preview/Meeting Committee Meeting Rating Communication Rating Reviews Surveillance Rating Framework These factors can be conceptually classified into business risk and financial risk drivers. Business risk drivers Industry characteristics Market position Operational efficiency Management quality Financial risk drivers Funding policies Financial flexibility New projects

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)

Criticisms
Since issuers are charged for ratings by CRAs, i.e., the issues are pay masters,the independence of ratings becomes questionable. CRAs are not accountable for the ratings given by them. Ratings may lead to herding behaviour thereby increasing the volatility of capital flows. Credit ratings change infrequently since the rating agencies are unable to constantly monitor developments.
Financial Services and Merchant Banking | 4

Regulations
In India, in 1998, SEBI constituted a Committee to look into draft regulation for CRAs that were prepared internally by SEBI. The Committee held the view that in keeping with international practice, SEBI Act 1992 should be amended to bring CRAs outside the purview of SEBI for a variety of reasons. In consultation with Government, in July 1999, SEBI issued a notification bringing the CRAs under its regulatory ambit in exercise of powers conferred on it by Section 30 read with Section 11 of the SEBI Act 1992.

Consumer Finance
Consumer Finance includes all asset-based financing options provided to investors for acquiring consumer durables. In a consumer finance transaction, an individual initially pays a fraction of the cash on purchase while promising to pay the balance with interest over a specified time period. Consumer finance is available for a large number of durables like televisions, refrigerators, air conditioners, washing machines, cars, two-wheelers, personal computers and four-wheelers too.

Consuming

Class

in

India

Financial Services and Merchant Banking |

Characteristics of Consumer Finance

Parties and Structure of the transaction Payment for the transaction Rate of Interest and Repayment Period Security Eligibility Criteria for Borrowers

Importance of Consumer Finance

Increasing Risk of Disintermediation in Corporate Lending Housing Loans Consumer Durables Reduction in Interest Rates Impact of Consumer Finance Growth on Consumer Durables Market Passenger Cars and Two-wheelers Key Issues and Success Factors Innovative Solutions Credit Constraint in Rural India for Consumer Durables Consumer Preferences

Financial Services and Merchant Banking |

 Consumer Finance by GE Countrywide

Consumer Protection
Complaint Procedure Under the Consumer Protection Act, every district has at least one Consumer Redressal Forum, more commonly called a Consumer Court.

FACTORING
Factoring is of recent origin in Indian Context. Kalyana Sundaram Committee recommended introduction of factoring in 1989. Banking Regulation Act, 1949, was amended in 1991 for Banks setting up factoring services. SBI/Canara Bank have set up their Factoring Subsidiaries: SBI Factors Ltd., (April, 1991) CanBank Factors Ltd., (August, 1991). RBI has permitted Banks to undertake factoring services through subsidiaries.

What is Factoring?
Factoring is essentially a financial service designed to help firms manage their trade credit or receivables effectively. Factoring is defined as an asset-based means of financing by which the factor buys up the book debts of a company on a regular basis, paying cash down against receivables, and then collects the amounts from the customers to whom the company has supplied goods. Factoring is the Sale of Book Debts by a firm (Client) to a financial institution (Factor) on the understanding that the Factor will pay for the Book Debts as and when they are collected or on a guaranteed payment date. Normally, the Factor makes a part payment (usually upto 80%) immediately after the debts are purchased thereby providing immediate liquidity to the Client.

So, a Factor is,

Financial Services and Merchant Banking |

1. A Financial Intermediary 2. That buys invoices of a manufacturer or a trader, at a discount, and 3. Takes responsibility for collection of payments. The parties involved in the factoring transaction are:1. Supplier or Seller (Client) 2. Buyer or Debtor (Customer) 3. Financial Intermediary (Factor)

SERVICES OFFERED BY A FACTOR

1. Follow-up and collection of Receivables from Clients. 2. Purchase of Receivables with or without recourse. 3. Help in getting information and credit line on customers (credit protection) 4. Sorting out disputes, if any, due to his relationship with Buyer & Seller.

Reasons to Factor
a. It helps to obtain a source of working capital. b. It increases sales. c. It expands clients business or fills more orders. d. It eliminates the risk of credit losses on clients customers. e. Factor has a professional credit checking and collection payment system f. It has flexible funding programme that increases as seller increases his sales (the goal of factoring). g. It helps to pay suppliers timely or take cash discounts or increase credit limits with suppliers. h. It facilitates to have funds for payroll and taxes. i. Clients can extend credit to customers on large orders without having to ask them pay Cash on Delivery (COD).

Mechanism of Factoring
Financial Services and Merchant Banking | 8

 The Client (Seller) sells goods to the buyer and prepares invoice with a notation that debt due on account of this invoice is assigned to and must be paid to the Factor (Financial Intermediary). The Client (Seller) submits invoice copy only with Delivery Challan showing receipt of goods by buyer, to the Factor. The Factor, after scrutiny of these papers, allows payment (,usually upto 80% of invoice value). The balance is retained as Retention Money (Margin Money). This is also called Factor Reserve. The drawing limit is adjusted on a continuous basis after taking into account the collection of Factored Debts. Once the invoice is honoured by the buyer on due date, the Retention Money credited to the Clients Account. Till the payment of bills, the Factor follows up the payment and sends regular statements to the Client.

CHARGES FOR FACTORING SERVICES

Factor charges Commission (as a flat percentage of value of Debts purchased) (0.50% to 1.50%) Commission is collected up-front. For making immediate part payment, interest charged. Interest is higher than rate of interest charged on Working Capital Finance by Banks. If interest is charged up-front, it is called discount.

Types of Factoring
Financial Services and Merchant Banking | 9

 Recourse Factoring Non-recourse Factoring Advance Factoring Invoice Discounting Full Factoring Bank Participation Factoring Supplier Guarantee Factoring Cross-border Factoring Maturity Factoring

Recourse Factoring
Upto 75% to 85% of the Invoice Receivable is factored. Interest is charged from the date of advance to the date of collection. Factor purchases Receivables on the condition that loss arising on account of nonrecovery will be borne by the Client. Credit Risk is with the Client. Factor does not participate in the credit sanction process. In India, factoring is done with recourse.

Non-Recourse Factoring
Factor purchases Receivables on the condition that the Factor has no recourse to the Client, if the debt turns out to be non-recoverable. Credit risk is with the Factor. Higher commission is charged. Factor participates in credit sanction process and approves credit limit given by the Client to the Customer.

Maturity Factoring
Financial Services and Merchant Banking | 10

 Factor does not make any advance payment to the Client. Pays on guaranteed payment date or on collection of Receivables. Guaranteed payment date is usually fixed taking into account previous collection experience of the Client. Nominal Commission is charged. No risk to Factor.

Cross - Border Factoring

It is similar to domestic factoring except that there are four parties, viz., a) Exporter, b) Export Factor, c) Import Factor, and d) Importer. It is also called two-factor system of factoring. Exporter (Client) enters into factoring arrangement with Export Factor in his country and assigns to him export receivables. Export Factor enters into arrangement with Import Factor and has arrangement for credit evaluation & collection of payment for an agreed fee. Notation is made on the invoice that importer has to make payment to the Import Factor. Import Factor collects payment and remits to Export Factor who passes on the proceeds to the Exporter after adjusting his advance, if any. Where foreign currency is involved, Factor covers exchange risk also.

Financial Aspects of Factoring

Financial Services and Merchant Banking | 11

To use the services of a factor, one should meet two types of expenses. They a. Factoring commission, and b. Interest on funds advances.

Advantages
Factoring offers the following advantages from the firms point of view: (a) There will be no liquidity problem if firms effectively use the factoring services. The factoring improves the cash flow. (b) Factoring is invaluable as it leads to a higher level of activity resulting in profitability. (c) Division of work is effectively carried out if a firm hires a factor. The management has more time for planning, running and improving business. (d) Factoring also helps the firms to explore and exploit opportunities. (e) The improved cash flows and speedy collection will bring down the cost of debt. This will contribute towards cost savings.

Disadvantages
Factoring could prove to be costlier to in-house management of receivables. Large firms having access to similar sources of funds function like factors, themselves as they have large size of business and well-organised credit and receivable management. Therefore, there is no need for factor services separately. Factoring is perceived as an expensive form of financing and also as finance of the last resort. This tends to have a negative effect on the creditworthiness of the company in the market.

Statutes Applicable To Factoring

Factoring transactions in India are governed by the following Acts:a) Indian Contract Act b) Sale of Goods Act
Financial Services and Merchant Banking | 12

c) Transfer of Property Act d) Banking Regulation Act. e) Foreign Exchange Regulation Act.

Why factoring has not become popular in India

Banks reluctance to provide factoring services Banks resistance to issue Letter of Disclaimer (Letter of Disclaimer is mandatory as per RBI Guidelines). Problems in recovery. Factoring requires assignment of debt which attracts Stamp Duty. Cost of transaction becomes high.

Forfaiting
Forfait is derived from French word A Forfait which means surrender of fights. Forefaiting is a mechanism by which the right for export receivables of an exporter (Client) is purchased by a Financial Intermediary (Forfaiter) without recourse to him. It is different from International Factoring in as much as it deals with receivables relating to deferred payment exports, while Factoring deals with short term receivables. Exporter under Forfaiting surrenders his right for claiming payment for services rendered or goods supplied to Importer in favour of Forefaiter. Bank (Forefaiter) assumes default risk possessed by the Importer. Credit Sale gets converted as Cash Sale. Forfaiting is arrangement without recourse to the Exporter (seller) Operated on fixed rate basis (discount) Finance available upto 100% of value (unlike in Factoring) Introduced in the country in 1992. It is a technique of trade finance, which has attracted growing interest in the banking sector and the financial press of export-orientated countries over the last years.
Financial Services and Merchant Banking | 13

 This is certainly due to the fact that in many cases it has proven to be the most efficient instrument when it comes to export finances.

Definition of Forfaiting
Forfaiting is the term generally used to denote the purchase of obligations falling due at some future date, arising from deliveries of goods and servicesmostly export transactions without recourse to any previous holder of the obligation.

Essential Requisites Of Forfaiting Transactions

Exporter to extend credit to Customers for periods above 6 months. Exporter to raise Bill of Exchange covering deferred receivables from 6 months to 5 years. Repayment of debts will have to be avallised or guaranteed by another Bank, unless the Exporter is a Government Agency or a Multi National Company. Co-acceptance acts as the yard stick for the Forefaiter to credit quality and marketability of instruments accepted.

In Forfaiting
Promissory notes are sent for avalling to the Importers Bank. Avalled notes are returned to the Importer. Avalled notes sent to Exporter. Avalled notes sold at a discount to a Forefaiter on a NON-RECOURSE basis. Exporter obtains finance. Forfaiter holds the notes till maturity or securitises these notes and sells the Short Term Paper either to a group of investors or to investors at large in the secondary market.

Characteristics of Forfaiting
Converts Deferred Payment Exports into cash transactions, providing liquidity and cash flow to Exporter. Absolves Exporter from Cross-border political or conversion risk associated with Export Receivables.

Financial Services and Merchant Banking |

14

 Finance available up to 100% (as against 75-80% under conventional credit) without recourse. Acts as additional source of funding and hence does not have impact on Exporters borrowing limits. It does not reflect as debt in Exporters Balance Sheet. Provides Fixed Rate Finance and hence risk of interest rate fluctuation does not arise. Exporter is freed from credit administration. Provides long term credit unlike other forms of bank credit. Saves on cost as ECGC Cover is eliminated. Simple Documentation as finance is available against bills. Forfait financer is responsible for each of the Exporters trade transactions. Hence, no need to commit all of his business or significant part of business. Forfait transactions are confidential.

Advantages of Forfaiting
100 % Risk Cover Country Risk (Political and Transfer Risk) Currency Risk Commercial Risk Interest Rate Risk Instant Cash Flexibility and Simplicity

Stages Involved In Forfaiting

Exporter approaches the Facilitator (Bank) for obtaining Indicative Forfaiting Quote. Facilitator obtains quote from Forfaiting Agencies abroad and communicates to Exporter. Exporter approaches importer for finalising contract duly loading the discount and other charges in the price.

Financial Services and Merchant Banking |

15

 If terms are acceptable, Exporter approaches the Bank (Facilitator) for obtaining quote from Forfaiting Agencies. Exporter has to confirm the Firm Quote. Exporter has to enter into commercial contract. Execution of Forfaiting Agreement with Forefaiting Agency. Export Contract to provide for Importer to furnish avalled BoE/DPN. Forfaiter commits to forefait the BoE/DPN, only against Importer Banks Co-acceptance. Otherwise, LC would be required to be established. Export Documents are submitted to Bank duly assigned in favour of Forfaiter. Bank sends document to Importer's Bank and confirms assignment and copies of documents to Forefaiter. Importers Bank confirms their acceptance of BoE/DPN to Forfaiter. Forfaiter remits the amount after deducting charges. On maturity of BoE/DPN, Forfaiter presents the instrument to the Bank and receives payment. Forfaiter commits to forefait the BoE/DPN only against Importer Banks Co-acceptance. Otherwise, LC would be required to be established. Export Documents are submitted to Bank duly assigned in favour of Forfaiter Importers Bank confirms their acceptance of BoE/DPN to Forfaiter. Forfaiter remits the amount after deducting charges. On maturity of BoE/DPN, Forfaiting Agency presents the instruments to the Bank and receives payment.

Financial Services and Merchant Banking |

16

HOUSING FINANCE Housing Vs Retail Lending

Housing is one of the basic human needs of the society. It is closely linked with the process of overall socio-economic development of a country. The retail lending business is growing at an outstanding rate of over 30% every year. Banks in India have gone a long way since 1990s where the retail portfolio was less than 5% to the current level of around 18%. The proportion of the retail share in the lending portfolio is slated to close in at around 40% by 2005-2006.

Reasons for lending housing loan

Poor credit off take of companies, commercial and other traditionally industrial sector. Growing risk of lending to industry on account of recession. Growing financial disintermediation process enabling many triple A rated companies to access the market directly. Relatively less risk for retail borrowers. Rising disposable income and changing life style aspiration of a sizable section of the Population. Continuous softening of lending rates which has improved the borrowers ability to repay. Increased governmental incentives by way of tax relief or concessions on certain types of Loans. Improved liquidity with banks following a reduction in Cash Reserve Ratio (CRR) and low credit off take in the face of continued accretion of deposits. Availability of better spread to banks. Widespread of risk among large number of borrowers and Developments in technology which have reduced transaction costs on a large number of borrower accounts.

Financial Services and Merchant Banking |

17

Housing Finance organizations

Housing Finance Institutions

The Housing Finance Institutions can be segregated into three categories: o Public Sector Finance o Banks o Private Sector Finance

Public Sector Institutions

HUDCO (Housing and Urban Development Corporation Limited) LICHFL (Life Insurance Corporation Housing Finance Limited) GICHFL (General Insurance Corporation Housing Finance Limited) PNBHFL (Punjab National Bank Housing Finance Limited) SBIHF (State Bank of India Housing Finance) The other major players in the public sector are the Indian Housing, Corp bank Homes, Cent Bank Home Finance Limited, etc.

Financial Services and Merchant Banking |

18

Private Sector Finance

HDFC (Housing Development Finance Corporation) DHFCL (Dewan Housing Finance Corporation Limited) GHFCL (Global Housing Finance Corporation Limited) BHFL (Birla Home Finance Limited) Maharishi Housing Others Other key housing finance providers in the private sector are Sundaram Home Finance, Hometrust Housing, Grihaa Finance, Weizmann Homes, GLFL Housing, etc.

National Housing Bank

The National Housing Bank was setup in 1988 as a subsidiary of Reserve Bank of India. It is a principal agency promoting housing finance institutions both at local and regional levels and provides financial and other support to such institutions.

Types of Home Loans

Home Purchase Loan Home Improvement Loan Home Construction Loan Home Extension Loan Home Conversion Loan Land Purchase Loan Bridge Loan Balance Transfer Loan Refinance Loan Stamp Doty Loan Loans to WRXs

Financial Services and Merchant Banking |

19

Asset Management Company

An Asset Management Company (AMC) is an investment management firm that invests the pooled funds of retail investors in securities in line with the stated investment objectives. For a fee, the investment company provides more diversification, liquidity, and professional management consulting service than is normally available to individual investors. The diversification of portfolio is done by investing in such securities which are inversely correlated to each other. They collect money from investors by way of floating various mutual fund schemes. In general, an investment company is a company that is engaged primarily in the business of investing in, and managing, a portfolio of securities.

Depository Services Introduction

We have pleasure in informing you that the scripts of your company are amongst the first ten securities which have been notified by SEBI to be compulsorily traded in electronic form with effect from 4th January, 1999. We, therefore, feel that we should share with you certain information regarding the Depository System so as to assist you in converting your physical holdings into electronic form.

Need for Depository System

The trading in physical segment is full of inefficiencies due to handling of large volumes of certificates and also involves various other problems like delays in transfer, delay in settlement, loss in transit, forgery certificates, stolen certificates, mutilation of certificates, postal losses, court cases, litigation etc. To overcome these deficiencies, a new system of trading, viz. Depository system was introduced, which facilitates investor to hold securities in electronic form and to trade in these securities. The first depository set up in India is National Securities Depository Limited (NSDL) and is promoted by IDBI, UTI and NSE.

Financial Services and Merchant Banking |

20

What is Depository ?
Depository is an organisation which holds your securities in electronic (also known as book entry) form, in the same manner as a bank holds your money. Further, a depository also transfers your securities without actually handling securities, in the same day as a bank transfers funds without actually handling cash.

Benefits of Depository System

1. No danger of loss of share certificates since the shares are credited to your account. 2. No possibility of bad deliveries. 3. Elimination of all rise associated with physical certificates such as loss, theft, forgery, mutilation etc. 4. No need to affix share transfer stamp as it is a paperless trading. 5. No postal / courier charges. 6. Less brokerage charges. 7. After the settlement, pay in and pay out are on the same day for paperless trading which means you get your securities and cash immediately. 8. Scriptless trading helps allocate corporate benefits faster. 9. Facilitates pledging and hypothecation of your securities. 10. Eliminates the problem of odd lot shares. 11. Facility to lock your account if you are abroad.

Credit Cards
Credit card is a monetary instrument that enables the cardholder to obtain goods and services without actual payment at the time of purchase. It is also popularly known as plastic money. The value of purchases made by the cardholder using the card is recovered at the end of a specified period, usually a month, called the billing cycle.

Financial Services and Merchant Banking |

21

 It can be said that a credit card is basically a Pay Later card that is provided to a customer.

Benefits of Holding Credit Card

(a) Credit can be availed for a period of 30-45 days (Max.52 days). (b) A cardholder need not have the required amount in his account to the extent of the transaction made. (c) The card carries a predetermined limit up to which the holder can spend. (d) At the end of each billing cycle, the cardholder has to pay only 5-10% of the outstanding value and the rest can be paid in installments over the next few months/years. (e) An outstanding balance, a nominal rate of 2-3% per month is charged as interest. (f) Regular use of the credit card by the user earns him additional points that provide the cardholder with discounts on purchases.

Mechanism of a Credit Card Transaction

Every transaction made on a credit card involves three parties: (a) The Card Issuer (b) The Cardholder (c) The Merchant Establishment (ME)

Debit Card
It is the accountholders mobile ATM. Open an account with a bank that offers a debit card, and payments for purchases are deducted from your bank account. The retailer swipes the card over an electronic terminal at this outlet, you enter the personal identification number on a PIN pad and the money is immediately debited at the bank.

Benefits of Debit Cards

Debit cards offer wide range of benefits to the customers. Some of them are: (a) One can plan Budget within the savings instead of going for credit (b) He can access his own money 24 hours a day
Financial Services and Merchant Banking | 22

(c) He saves fee and other service changes on cash withdrawals. (d) He can carry one card to use both at ATMs and at merchant locations

Types of Cards
MasterCard VISA Card Affinity Cards Standard Card Classic Card Gold Card or Executive Card Platinum Card Titanium Card Secured Card Charge Card Rebate Card Co-branded Card Travel Card Laghu Udyarni Credit Card (LUCC) Scheme

New Types of Credit Card

1. Corporate Credit Cards 2. Smart Cards 3. Global Credit Cards

Financial Services and Merchant Banking |

23

Eligibility to get a Card

Place of Residence Telephone Profession Place of Work Age

Costs of Credit Card Payment

Renewal Interest-free period on every bill Purchases on credit Fuel on credit Billing period Cash advance

Choosing The Right Card

Acceptability Eligibility Fees Other Charges Credit Period Cash Advance Insurance Cover

Financial Services and Merchant Banking |

24

Uses of Credit Cards

(a) Personal Accident Insurance., (b) Cash Withdrawal Facility. (c) Increase in Credit. (d) Add-On Facility. (e) Leveraged Investment Facility.

Financial Services and Merchant Banking |

25

MERCHANT BANKING
OBJECTIVE
The objective of this white paper is to introduce the concept of Merchant Banking, Players of Merchant Banking and Merchant Banking services.

INTRODUCTION
Merchant banking, as a commercial activity, took shape in India through the management of Public Issues of capital and Loan Syndication. It was originated in 1969 with the setting up of the Merchant Banking Division by ANZ Grind lays Bank. The main service offered at that time to the corporate enterprises by the merchant banks included the management of public issues and some aspects of financial consultancy.

DEFINITION
A merchant bank is a financial institution conducting money market activities & lending, underwriting & financial advice, and investment services whose organization is characterized by a high proportion of professional staff able to approach problems in an innovative manner and to make and implement decisions rapidly(By Skully). A merchant banker is any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to the securities as manager, consultant, adviser or rendering corporate advisory service in relation to such issue management(Securities & Exchange Board of India (Merchant Bankers) Rules, 1992). A merchant banker may be in the form of a bank, a company, firm or even a proprietary concern. A Merchant Banker understands the requirements of the business concern and arranges finance with the help of financial institutions, banks, stock exchanges and money market. Underwriter 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. Though underwriting is not mandatory after April 1995, its organization is an important element of the primary market. 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.
Financial Services and Merchant Banking | 26

Merchant Bankers in India

Public Sector Merchant Bankers SBI capital markets ltd Punjab national bank Bank of Maharashtra IFCI financial services ltd Karur Vysya bank ltd, State Bank of Bikaner and Jaipur Private Sector Merchant Bankers ICICI Securities Ltd Axis Bank Ltd (Formerly UTI Bank Ltd.) Bajaj Capital Ltd Tata Capital Markets Ltd ICICI Bank Ltd Reliance Securities Limited Kotak Mahindra Capital Company Ltd Yes Bank Ltd.

Foreign Players in Merchant Banking Goldman Sachs (India) Securities Pvt. Ltd. Morgan Stanley India Company Pvt. Ltd Barclays Securities (India) Pvt. Ltd Bank Of America, N.A Deutsche Bank Deutsche Equities India Private Limited Barclays Bank Plc Citigroup Global Markets India Pvt. Ltd.
Financial Services and Merchant Banking | 27

 DSP Merrill Lynch Ltd FEDEX Securities Ltd

SERVICES
Issue management Portfolio and management services Credit syndication Mergers, acquisitions and take overs Off shore finance Non-resident investment Project counseling Capital structure Venture capital Infrastructure financing Real estate financing Lease finance Hire purchase

Issue Management:The management of issues for raising funds through various types of instruments by companies is known as issue management. The function of capital issues management in India is carried out by merchant bankers. The Merchant Bankers have the required skill and competence to carry out capital issues management. The funds are raised by companies to finance new projects, expansion of existing units etc.

Classification of Securities Issue

Public Issue Right Issue Private Placement Public Issue of Securities

Financial Services and Merchant Banking |

28

 When capital funds are raised through the issue of a prospectus, it is called public issue of securities. It is the most common method of raising funds in the capital market. The Prospectus has to disclose all the essential facts about the company to the prospective purchasers of the shares. Further, the prospectus must conform to the formal set out in Schedule II of the Companies Act, 1956. SEBI insists on the adequacy of disclosure of information that should serve as the basis for investors to make a decision about the investment of their money. Rights Issue When shares are issued to the existing shareholders of a company on a privileged basis, it is called as Rights Issue. The existing shareholders have a pre-emptive right to subscribe to the new issue of shares. Rights shares are offered as additional issues by corporate to mop up further capital funds. Such shares are offered in proportion to the capital paid up on the shares held by them at the time of the offer. It is to be noted that the shareholders, although privileged to be offered on the issue, are under no legal obligation to accept the offer. Right shares are usually offered on terms advantageous to the shareholders. Private Placement When the issuing company sells securities directly to the investors, especially institutional investors; it takes the form of private placement. In this case, no prospectus is issued, since it is presumed that the investors have sufficient knowledge and experience and are capable of evaluating the risks of the investment. Private placement covers shares, Preference shares and debentures. The role of the financial intermediary, such as the merchant bankers and lead managers, assures great significance in private placement. They involve themselves in the task of preparing an offer memorandum and negotiating with investors.

PRICING OF PUBLIC ISSUES

A new company set up by entrepreneurs without a track record will be permitted to issue capital to public only at par.

Financial Services and Merchant Banking |

29

 A new company set up by existing companies with a five-year track record of consistent profitability will be free to price its issue provided the participation of the promoting companies is not less than 50 per cent of the equity of the new company and the issue price is made applicable to all new investors uniformly. An existing private/closely held company with a three-year track record of consistent profitability shall be permitted to freely price the issue. An existing listed company can raise fresh capital by freely pricing further issue.

PORTFOLIO AND MANAGEMENT SERVICES

A list of all those services and facilities that are provided by a portfolio manager to its clients, relating to the management and administration of portfolio of securities or the funds of the client, is referred to as portfolio management services. The term portfolio means the total holdings of securities belonging to any person.

Portfolio Manager
According to SEBI, Portfolio Manager means any person who pursuant to a contract or arrangement with a client, advises or directs or undertakes on behalf of the client the management or administration of a portfolio of securities or the funds of the client.

Benefits

Provide long term capital appreciation with lower volatility, compared to the broad equity markets. Takes long positions in the cash market and short positions in the index futures markets. Invests in the model portfolios thus downside the risk by selling index futures in the derivatives market.

Functions:
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. It is an effective way of diversifying the risk in an investment. Simple diversification reduces risk within categories of stocks that all have the same quality rating. Asset Allocation An important function of portfolio management is asset allocation. It deals with attaining the operational proportions of investments from asset categories
Financial Services and Merchant Banking | 30

 Portfolio managers basically aim of stock-bond mix. For this purpose, equally weighted categories of assets are used. Best Estimation Another important function of a portfolio manager is to make an estimate of best coefficient. It measurers and ranks the systematic risk of different assets. Best coefficient is an index of the systematic risk. This is useful in making ultimate selection of securities for investment by a portfolio manager. Rebalancing Portfolios Rebalancing of portfolios involves the process of periodically adjusting the portfolios to maintain the original conditions of the portfolio.

Credit Syndication
It refers to obtaining of loans from single development finance institution or a syndicate or consortium. Merchant Banks help corporate clients to raise syndicated loans from commercials banks. Merchant banks helps in identifying which financial institution should be approached for term loans. The merchant bankers follow certain steps before assisting the clients approach the appropriate financial institutions. Merchant banker first makes an appraisal of the project to satisfy that it is viable He ensures that the project adheres to the guidelines for financing industrial projects. It helps in designing capital structure, determining the promoters contribution and arriving at a figure of approximate amount of term loan to be raised. After verifications of the project, the Merchant Banker arranges for a preliminary meeting with financial institution. If the financial institution agrees to consider the proposal, the application is filled and submitted along with other documents. Financing arranged on behalf of the client for meeting both fixed capital as well as working capital requirements is known as loan syndication service The scope of syndicated loan services provided by merchant bankers includes identifying the sources of finance, applying for the credit, and sanction and disbursal of loans to the clients. While carrying out the activities connected with credit syndication, the merchant banker ensure due compliance with the formalities of the financial institution, banks and regulatory authority.

Financial Services and Merchant Banking |

31

They are: 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 project. 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. 3. Company information: The merchant banker has to furnish the following information as regard the company for loan syndication arrangements to be made: Brief history of the concern Schemes already executed in the case of existing company Expansion/diversification plans in the case of an existing company Nature, size and status of the project to assess the funds requirement in the case of a new company Changes in names, business, management, etc. and mergers, reorganizations, etc. that have taken place in the past. 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. 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 financing information :
Financial Services and Merchant Banking | 32

 Details regarding the mode of financing used for the project should be stated. This includes information on the extent of debt and equity capital funding source. Besides, details of rupee loans, foreign currency loans, debentures, internal cash accruals, promoters contribution. The security offered for he loan/bank guarantee, etc. should also be specified. Data should also be provided on the extent of loan arrangements already applied for and the limit of financial arrangements. 7. 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. 8. Cash flow information : The merchant banker has to furnish details as to profitability and expected stream of cash flows and cost of the proposed project for this purpose, it is essential that working results of operations, cash flow statements and projected balance sheet are given in prescribed form along with the basis of the calculations.

Mergers & Acquisitions

A form of business combination is increasingly being used for undertaking restructuring of corporate enterprises all over the world. Mergers happen in all the sectors of the economy, the prime driving force being the accomplishment of synergetic effect for both the acquiring and the acquirer companies. 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. Steps In M & A Following are the steps involved in M&A:
1. Review of Objectives
Financial Services and Merchant Banking | 33

 The first and foremost step in M&A is that the merging companies must undertake the review of the purpose for which the proposal to merge is to be considered. 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. In addition, the need for elimination of inefficient operations, cost reduction and productivity improvement, etc. should also be considered. Such a move would help the acquiring company to decide as to the kind of business units that must be acquired. 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, case 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 data 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 to determine the earnings and cash flows, areas 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. In such a case, the firm would pay an offer price which is higher than the target firms premerger market value.
Financial Services and Merchant Banking | 34

 This would happen where the acquiring firm is of the firm opinion that such an option would augment operational results of the target firm owing to synergic effect.

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 subtracted to arrive at the figure of net economic advantage of merger. This advantage is shared between the shareholders of the merging firms. TAKEOVERS 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. For instance, the Monopolies and Restrictive Trade Practices (MRTP) Act prescribes that a minimum of 25 percent voting power must be acquired as to constitute a takeover. Similarly, section 372 of the Companies Act defines the limit of a companys investment in the shares of another company as anything more than 10 percent of the subscribed capital so as to constitute a takeover. ACQUISITION It happens at the instance and the willingness of the company management and the shareholders. It is for this reason that acquisition is generally referred to as friendly takeover. e.g. An example of acquisition is Mahindra and Mahindra Ltd., a leading manufacturer of jeeps and tractors, acquiring equity stake of Allwyn Nissan Ltd.

OFF SHORE FINANCE

The merchant bankers help their clients in the following areas involving foreign currency. Joint Ventures abroad Long term foreign currency loans Financing exports and imports Financial Services and Merchant Banking | 35

 Foreign collaboration arrangements

NON-RESIDENT INVESTMENT
The services of merchant banker includes investment advisory services to NRI in terms of classification of investment opportunities, selection of securities, investment management, and operational services like purchase and sale of securities.

SEBI
SEBI is a body corporate with head office at Bombay. The Chairman and the board members are appointed by the Central government. SEBI has brought about a effective regulative measures for the purpose of disciplining the functioning of the merchant bankers in India. The objective is to ensure an era of regulated financial markets and thus streamline the development of the capital market 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 discussed below.

Registration of Merchant Bankers 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 any one of the following categories of the merchant banker namely: 1. Category I- to act as adviser, consultant, manager, 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
Financial Services and Merchant Banking | 36

 Subject to the provisions of the regulations, any application, which not complete in all respects and does not conform to the instructions specified in the form, shall be rejected. However, before rejecting any such application, the applicant will be given an opportunity to remove within the time specified such objections and may be indicated by the board. Furnishing of Information The Board may require the applicant to furnish further information or clarification regarding matter relevant to the activity of a merchant banker for the purpose of disposal of the application. The applicant or its principal officer shall, if so required, appear before the Board for personal representation. Consideration of Application The Board shall take into account for considering the grant of a certificate, all matters, which are relevant to the activities relating to merchant banker and in particular whether the applicant complies with the following requirements; 1. That the applicant shall be a body corporate other than a non-banking financial company as defined by the Reserve Bank of India Act, 1934. 2. That the merchant banker who has been granted registration by the Reserve Bank of India to act as Primary or Satellite Dealer may carry on such activity subject to the condition that it shall not accept or hold public deposit. 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 a person (any person being an associate, subsidiary, inter-connected or group Company of the applicant in case of the applicant being a body corporate) directly or indirectly connected with the applicant has not been granted registration by the Board. 6. That the applicant fulfils the capital adequacy as specified.
Financial Services and Merchant Banking | 37

7. That the applicant, his partner, director or principal officer is not involved in any litigation connected with the securities market which has an adverse bearing on the business of the applicant. 8. That the applicant, his director, partner or principal officer has not at any time been convicted for any offence involving moral turpitude or has been found guilt of any economic offence. 9. That the applicant has the professional qualification from an institution recognized by the Government in finance, law or business management. 10. That the applicant is a fit and proper person. 11. 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. For this purpose, the net wroth shall be as follows: Category Minimum Amount Category - I Rs.5,00,00,000 Category - II - Rs.50,00,000 Category - III Rs.20,00,000 Category - IV Nil Procedure for Registration- The Board on being satisfied that the applicant is eligible shall grant a certificate in Form B. On the grant of a 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 desired, make an application for renewal in Form A. 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 of being heard. The refusal to grant registration shall be
Financial Services and Merchant Banking | 38

communicated by the Board within thirty days of such refusal to the applicant stating therein the grounds on which the application has been rejected. Any applicant may, being aggrieved by the decision of the Board, under sub-regulation(1), apply within a period of thirty days from the date of receipt of such intimation to the Board for reconsideration for its decision. The Board shall reconsider an application made under subregulation (3) and communicate its decision as soon as possible in writing to the applicant. Effect of Refusal to Grant Certificate Any merchant banker whose application for a certificate has been refused by the Board shall on and from the date of the receipt of the communication under sub-regulation (2) of regulation 10 cease to carry on any activity as merchant banker.

GENERAL OBLIGATIONS
The 1992 regulations have enunciated the following general obligations and responsibilities for the merchant bankers.

Sole Function
Every merchant banker shall abide by the Code of Conduct as specified in Schedule III. They are as follows 1. Merchant Banker not to associate with any business other that that of the securities market. 2. No merchant banker, other than a bank or a public financial institution, who has been granted certificate of registration under these regulations, shall after June 30th, 1998 carry on any business other than that in the securities market..

Maintenance of Books
Every merchant banker shall keep and maintain the following books of accounts, records and documents: 1. A copy of balance sheet as at the end of each accounting period; 2. A copy of profit and loss account for that period; 3. A copy of the auditors report on the accounts for that period; and 4. A statement of financial position.

Financial Services and Merchant Banking |

39

 Submission of Half-yearly Results Preservation of Books of Account, Records, etc., Report on Steps taken on Auditors Report Appointment of Lead Merchant Bankers Restriction on Appointment of Lead Managers Responsibilities of Lead Managers

Size of Issue Number of Merchant Bankers

Less than Rs. 50 Crores Two Above Rs. 50 Crores but less than Rs.100 Crores Three Above Rs. 100 Crores but less that Rs.200 Crores Four Above Rs.200 Crores but less that Rs.400 Crores Five Above Rs.400 Crores Five or more as agreed by SEBI

Appointment of Compliance Officer

Every merchant banker shall appoint a compliance officer who shall be responsible for monitoring the compliance of the Act, rules and regulations notifications, guidelines, instructions etc., issued by the board or the Central Government and for redressed of investors grievances.

Boards Right to inspect

The Board may appoint one or more persons as inspecting authority to undertake inspection of the books of accounts, records and documents of the merchant banker for any of the purposes specified 1. To ensure that the books of account are being maintained in the manner required; 2. To ensure that the provisions of the Act, rules, regulations are being complied with;

Financial Services and Merchant Banking |

40

3. To investigate into the complaints received from investors, other merchant bankers or any other person on any matter having a bearing on the activities of the merchant banker; and 4. To investigate suo-moto in the interest of securities business or investors interest in the affairs of the merchant banker.

Notice before inspection

Before undertaking an inspection under regulation 29 the Board shall give a reasonable notice to the merchant banker for that purpose Submission of Report to the Board Action on Inspection or Investigation Report

Appointment of Auditor
The Board may appoint a qualified auditor to investigate into the books of account or the affairs of the merchant banker.

CODE OF CONDUCT FOR MERCHANT BANKERS

The SEBI regulations have outlined the following code of conduct for the merchant bankers operation in India
A merchant banker shall make all efforts 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. A Merchant Banker shall Endeavour to ensure that enquiries from the investors are adequately dealt with, grievances of investors are redressed in a timely and appropriate manner, where a complaint is not remedied promptly, the investor is advised of any further steps which may be available to the investor under the regulatory system.

Financial Services and Merchant Banking |

41

 A Merchant Banker shall ensure that adequate disclosures are made to the investors in a timely manner in accordance with the applicable regulations and guidelines so as to enable them to make a balanced and informed decision. A Merchant Banker shall endeavour to ensure that the investors are provided with true and adequate information without making any misleading or exaggerated claims or any misrepresentation and are made aware of the attendant risks before taking any investment decision. A Merchant Banker shall endeavour to ensure that copies of the prospectus, offer document, letter of offer or any other related literature is made available to the investors at the time of issue of the offer.

Operational Guidelines
SEBI has pronounced the following guidelines for merchant bankers Submission of offer document Dispatch of issue material Underwriting Compliance obligations The merchant banker shall ensure compliance with the following post-issue obligations a. Association of resource personnel b. Redressal of investor grievances c. Submission of post issue monitoring reports d. Issue of No objection Certificate (NOC) e. Registration of merchant bankers f. Reporting requirements g. Impositions of penalty points

Financial Services and Merchant Banking |

42

Guidelines on Advertisement
Following are the guidelines applicable le to the lead merchant banker who shall ensure due compliance by the issuer company: 1. Factual and truthful 2. Clear and concise 3. Promise or profits 4. Mode of advertising 5. Financial data 6. Risk factors 7. Issue date 8. Product advertisement 9. Subscription 10. Issue closure 11. Incentives 12. Reservation 13. Undertaking 14. Availability of copies

OTHER FUNCTIONS Project counseling

Project counseling is a part of corporate counseling and relates to project finance. It broadly covers the study of the project, offering advisory assistance on the viability and procedural steps for its implementation. a. Identification of potential investment avenues. b. A general view of the project ideas or project profiles. c. Advising on procedural aspects of project implementation
Financial Services and Merchant Banking | 43

d. Reviewing the technical feasibility of the project e. Assisting in the selection of TCOs (Technical Consultancy Organizations) for preparing project reports f. Assisting in the preparation of project report g. Assisting in obtaining approvals , licenses, grants, foreign collaboration etc., from government h. Capital structuring i. Arranging and negotiating foreign collaborations, amalgamations, mergers and takeovers. j. Assisting clients in preparing applications for financial assistance to various national and state level institutions banks etc., k. Providing assistance to entrepreneurs coming to India in seeking approvals from the Government of India.

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.,

Other Functions
Treasury Management- Management of short term fund requirements by clientcompanies. Stock broking- helping the investors through a network of service units Servicing of issues- servicing the shareholders and debenture holders in distributing dividends, debenture interest. Small Scale industry counseling- counseling SSI units on marketing and finance Equity research and investment counseling merchant banker plays an important role in providing equity research and investment counseling because the investor is not in a position to take appropriate investment decision. Assistance to NRI investors - the NRI investors are brought to the notice of the various investment opportunities in the country.
Financial Services and Merchant Banking | 44

 Foreign Collaboration: Foreign collaboration arrangements are made by the Merchant bankers

VENTURE CAPITAL
An entrepreneur, with a good technical knowledge, raising of capital in the conventional method will be very difficult. So, by a new technique of financing, long term capital is provided to small and medium sector through an institutional mechanism So capital assistance against high growth oriented along with managerial assistance was felt necessary. This gave to the birth of Venture Capital Assistance. Venture Capital is a long term capital invested in companies which involves high risk. The financing involves high risk but is compensated by high return.

FEATURES OF VENTURE CAPITAL

The following are the features of venture capital 1. It is the financing of capital for new companies. 2. This finance can also be loan-based or in convertible debentures 3. Providers of venture capital aim at capital gain due to the success achieved by the borrowing concern. 4. Venture capital is always a long-term investment and made in companies which have high growth potential. 5. The venture capital provider take part in the business of borrowing concern simultaneously provides managerial skill. 6. Venture capital financing contains risks. But the risk is compensated with a higher return. 7. It involves financing mainly small and medium size firms, which are in their early stages. When the assistance of venture capital, these firms will stabilize and later can go in for traditional finance.

Objectives
To finance new companies who find it difficult to go to capital market
Financial Services and Merchant Banking | 45

 To provide long term finance to small and medium scale industries To provide managerial assistance To bring in rapid growth in the business

Financing By Venture Capital Institutions

Before going in for venture capital finance, the venture capital institution will have to assess the potentiality of the borrowing concern by a proper appraisal. This appraisal will be similar to the project appraisal undertaken by commercial banks. The stages involved in the venture capital finance. 1. Seed capital It is the capital provided for testing the product and examining the commercial viability of the product. It enables the venture capital institution to find out the technical skill of the borrowing concern and its market potentially. So, we can say seed capital is more of a product development and all the finance required at this stage is provided by the venture capital institution. 2. Start up Start up of the product refers to the is tested in the market and after being satisfied with its acceptability by the market, financing will be provided for further development of the product and marketing of the product. 3. Second round finance It is the second round of finance after the initial stage after being commercially successful for want of some more finance.

Financial Services and Merchant Banking |

46

4. Later stage financing It is the financing after second round finance. The business concern which has borrowed venture capital has now become a well established business. But still, it is not able to go in for public issue of shares. At this stage, the venture capital institution will provide finance. 5. Messanine capital 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. 6. 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. 7. Management Buy-outs (MBO) It is the capital used for acquiring all the shares and the voting rights to remove external control. Example : An Indian companys shares may be purchased by NRIs at the initial stage and after sometime these shares are bought back by the company with the help of profits and finance by venture capital institutions. 8. Management buy-in (MBI) Management buy in is the case where the funds are provided for an outside group to buy an on going company.

Financial Services and Merchant Banking |

47

9. Turn Arounds Turn around may be Financial Turn around : When the company is able to improve its conditions financially, it is called financial turn around, which is due to the financial assistance by venture capital institution. Management Turn around : Similarly, when the management of the company makes a turn around by becoming self dependent and is able to face the challenges of business, it is called management turn around.

Infrastructure financing
Incubators : Incubators are non profit entities providing consultancy services in promoting venture capital. To encourage venture capital industry, it is necessary to develop proper infrastructure for venture capital, as being done in foreign countries. There are two successful incubator models. 1. Small Business Investment Company Programme (SBIC), administrated by Small Business Administrator (SBA) 2. Bilateral Industrial Research and Development Foundation (BIRD).

Venture Capital in India

The venture capital institutions (VCIs) in India can be broadly classified into 5 types. 1.Venture Capital companies promoted by Development Banks a) IDBI VFC (Venture Fund Company) b) TDICI - Technology Development and Information company of India Ltd. c) RCTC Risk Capital and Technology Finance Corporation Ltd. 2. State level Venture capital companies

Financial Services and Merchant Banking |

48

There are two state-level venture fund companies in India. They are 1. Gujarat Venture Finance Ltd. 2. Andhra Pradesh Venture Capital Limited (AVCL). 3. Commercial banks promoted Venture capital companies 4. Private sector Venture capital companies 5. Foreign venture Capital funds.

Guidelines For Providing Venture Capital

The venture capital companies have been given certain guidelines for providing venture capital. Accordingly, the venture capital companies must obtain a detailed report from the borrowing company. The report should contain the following details 1. History of the borrowing company 2. Available facility for the borrowing company 3. Description of the products manufactured by the company 4. Market trend of the products 5. Cash flow position of the concern 6. Operating profit 7. key personnel. It takes about 6 months for a venture capital company to process the application during which period, aspects such as the organizational structure, competition for the companys product, etc., are studied. Investment Pattern In Venture Capital The investment plan will consist of 3 stages

Financial Services and Merchant Banking |

49

 Basic stage involves the study and evaluation of the project. Operating stage deals with monitoring the functioning of the management of the borrowing concerns and advice for providing new round of finance. In the course of studying the managerial skill, the following aspects will be taken a) Product quality b) Market size c) Rate of return d) Venture location e) Growth potential f) State of entrepreneur Exit stage The borrowing company may be sold to a third party or the company may be left to look after itself. While studying the managerial skill, he following aspects will be taken: a) Product quality b) Market size c) Rate of return d) Venture location e) Growth potential f) State of entrepreneur

Financial Services and Merchant Banking |

50

Benefits of Venture Capital

(a) Venture backed companies have been shown to grow faster than other types of companies. This is made possible by the provision of a combination of capital and experienced personal input from venture capital executives, which sets it apart from other forms of finance.

(b) Venture capital can help you achieve your ambitions for your company and provide a stable base for strategic decision making. (c) The venture capital firms will seek to increase a companys value to its owners, without taking day-to-day management control. Although you may have a smaller slice of cake, within a few years your slice should be worth considerably more than the whole cake was to you before.

(d) Venture capital firms often work in conjunction with other providers of finance and may be able to help you to put a tats funding package together for your business.

Real Estate financing

The Real Estate financing has become so popular, that the procedure for obtaining a loan has become so simplified that housing loans are easily available. This may be attributed to the change in the housing policy of both the Central and State Governments. A redeeming feature of Indian real estate finance is the recent entry of real estate commercial banks in a big way. It is financing for the purchase of real property, where real property refers to land or buildings. Its a set of all financial arrangements that are made available by housing finance institutions to meet the requirements of housing. Housing finance institutions include banks, housing finance companies, special lousing finance institutions, etc.

Factors Determining the Real Estate Finance Assistance

Real estate finance companies consider the following factors before making any financial assistance for housing:

Financial Services and Merchant Banking |

51

1. Loan Amount 2. Tenure 3. Administrative and processing costs, etc. 4. Pre-payment charges 5. Services 6. Value Addition 7. Sources of finance like HFCs and Banks 8. EMI calculation methods

LEASE FINANCE
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.

Classification of Lease
Finance Lease and Operating Lease Sale and Lease Back and Direct Lease. Single Investor Lease and Leveraged Lease. Domestic Lease and International Lease.

Finance lease
A finance lease or capital lease is a type of lease. It is a commercial arrangement where: The lessee (customer or borrower) will select an asset (equipment, vehicle, software); The lessor (finance company) will purchase that asset; The lessee will have use of that asset during the lease; The lessee will pay a series of rentals or installments for the use of that asset;

Financial Services and Merchant Banking |

52

 The lessor will recover a large part or all of the cost of the asset plus earn interest from the rentals paid by the lessee; The lessee has the option to acquire ownership of the asset (e.g. paying the last rental, or bargain option purchase price)

Operating Lease
An operating lease is a lease whose term is short compared to the useful life of the asset or piece of equipment (an airliner, a ship, etc.) being leased.

Conveyance-type lease
It is a very long tenure lease applicable to immovable properties

ADVANTAGES
Flexibility Leased With User Oriented Variants Tax-Based Benefits Convenience Less Paper Work and Quick Disbursement Financing for the Total Requirements Scope for Better Use of Own Funds

HIRE PURCHASE
A hire purchase can be defined: as a contractual arrangement under which the owner lets his goods on hire to the hirer and offers an option to the hirer for purchasing the goods in accordance with the terms of the contract.

Features of Hire Purchase

The hire-vendor (the counterpart of lessor) gives the asset on hire to the hirer (the counterpart of lessee).

Financial Services and Merchant Banking |

53

 The hirer is required to make a down payment of around 20 per cent of the cost of the equipment and repay the balance in regular hire purchase installments over a specified period of time. When the hirer pays the last installment, the title of the asset is transferred from the hire vendor to the hirer. The hire-vendor charges interest on a flat basis. This means that a certain rate of interest (usually around 10%) is charged on the initial investment (made by the hire-vendor) and not on the diminishing balance. Theoretically the hirer can exercise the cancelable option and cancel the contract after giving due notice to the finance company.

Hire Purchase And Lease Compared

Ownership of the vehicle is with the owner in HP but it is with the lessor in leasing. After the repayment vehicle is transferred to the owner but in leasing after the lease period the vehicle may not be transferred to the user. Risk is very high in HP due to technological Obsolescence. But it is less in leasing. Cancellation of lease is possible, which is not in HP.

Problems
Taxation Shortage of Low-cost Funds Slow Market Growth

Financial Services and Merchant Banking |

54