FS_4_Management of Capital Issues

7/31/2019 FS_4_Management of Capital Issues

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Rights IssuesBonus Issues

Qualified Institutional PlacementGreen Shoe Option

Sweat EquityESOPS


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Rights Issues Issuing rights to a company's existing shareholders to buy a

proportional number of additional securities at a givenprice (usually at a discount) within a fixed period.

No issuer shall make rights issue of equity if it hasoutstanding fully or partially convertible debt instrumentsat the time of making rights issue

A Rights Issue shall be open for subscription for aminimum period of 15 days and a maximum period of 30days


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Rights Issues: Basic Example An investor: Mr. A had 100 shares of company X at a total

investment of $40,000, assuming that he purchased the shares at$400 per share and that the stock price did not change betweenthe purchase date and the date at which the rights were issued.

Assuming a 1:1 subscription rights issue at an offer price of $200,Mr. A will be notified by a broker dealer that he has the option tosubscribe for an additional 100 shares of common stock of thecompany at the offer price.

Now, if he exercises his option, he would have to pay anadditional $20,000 in order to acquire the shares, thus effectivelybringing his average cost of acquisition for the 200 shares to $300per share


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Bonus Issues An offer of free additional shares to existing shareholders. A

company may decide to distribute further shares as an alternativeto increasing the dividend payout.

New shares are issued to shareholders in proportion to theirholdings. For example, the company may give one bonus sharefor every five shares held.

While the issue of bonus shares increases the total number of

shares issued and owned, it does not increase the value of thecompany.

Although the total number of issued shares increases, the ratioof number of shares held by each shareholder remains constant.


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Bonus Issues: Basic Example Purpose: Usually bonus shares are issued with the intent of

rewarding the investor, although having said that the ex-bonus(post bonus) price of the share is adjusted to bonus ratio.

So for e.g., if the price of a share before bonus is Rs.100 and abonus of 1:1 is issued, then ex-bonus share price would adjust toRs. 50, which means that the total market value will remain thesame. There is generally a case where the price of the shareincreases after bonus effect is incorporated.

Ratios' Impact: The main financial effect of bonus share is that itincreases the number of shares outstanding and reduces theearnings per share (EPS). Basic EPS = (Net Profit after tax / no. ofequity shares outstanding).


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Qualified Institutional Placement

(QIP) Qualified institutional placement (QIP) is a capital-raising tool,

primarily used in India, whereby a listed company can issue equityshares, fully and partly convertible debentures, or any securities otherthan warrants which are convertible to equity shares to a QualifiedInstitutional Buyer (QIB).

a qualified institutional buyer shall mean: public financial institution scheduled commercial bank mutual funds; Foreign institutional investor registered with SEBI;

Venture capital funds registered with SEBI foreign venture capital investors registered with SEBI. state industrial development corporations. Insurance companies registered with the IRDA provident funds with minimum corpus of Rs.25 crores


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Green Shoe Option A provision contained in an underwriting agreement that

gives the underwriter the right to sell investors more sharesthan originally planned by the issuer.

This would normally be done if the demand for a securityissue proves higher than expected. Legally referred to as anover-allotment option.

A greenshoe option can provide additional price stability toa security issue because the underwriter has the ability toincrease supply and smooth out price fluctuations ifdemand surges.


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Green Shoe Option The term "greenshoe" came from the Green Shoe

Manufacturing Company (now called Stride RiteCorporation), founded in 1919. It was the first company toimplement the greenshoe clause into their underwritingagreement.

This type of option is the only means for an underwriter tolegally stabilize the price of a new issue after the offeringprice has been determined.

The SEC introduced this option in order to enhance theefficiency and competitiveness of the fundraising processfor IPOs.


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Green Shoe Option This is how a greenshoe option works:

The underwriter works as a liaison (like a dealer), finding buyersfor the shares that their client is offering.

A price for the shares is determined by the sellers (companyowners and directors) and the buyers (underwriters and clients).

When the price is determined, the shares are ready to publiclytrade. The underwriter has to ensure that these shares do nottrade below the offering price.

If the underwriter finds there is a possibility of the shares tradingbelow the offering price, they can exercise the greenshoe option.

In order to keep the price under control, the underwriteroversells or shorts up to 15% more shares than initially offered bythe company.


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Green Shoe Option For example, if a company decides to publicly sell 1 million shares, the

underwriters can exercise their greenshoe option and sell 1.15 millionshares.

When the shares are priced and can be publicly traded, theunderwriters can buy back 15% of the shares.

If the market price of the shares exceeds the offering price that isoriginally set before trading, the underwriters could not buy back theshares without incurring a loss.

This is where the greenshoe option is useful: it allows the underwritersto buy back the shares at the offering price, thus protecting them fromthe loss.


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Full, Partial and Reverse

Greenshoes The number of shares the underwriter buys back determines if they

will exercise a partial greenshoe or a full greenshoe.

A partial greenshoe is when underwriters are only able to buy back

some shares before the price of the shares increases.

A full greenshoe occurs when they are unable to buy back any sharesbefore the price goes higher

The reverse greenshoe option has the same effect on the price of theshares as the regular greenshoe option, but instead of buying theshares, the underwriter is allowed to sell shares back to the issuer. Ifthe share price falls below the offering price, the underwriter can buyshares in the open market and sell them back to the issuer.


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Sweat Equity Sweat equityis a term that refers to a party's

contribution to a project in the form of effort --- asopposed to financial equity, which is a contribution inthe form of capital.

In a partnership, some partners may contribute to thefirm only capital and others only sweat equity

Sweat equity shares are equity shares issued by acompany to its employees or directors at a discount, oras a consideration for providing know-how or a similarvalue to the company.


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Sweat Equity Unlisted companies: sweat equity shares cannot be issued

before one year of commencement of operations.companies cannot issue more than 15 percent of the paid-up capital in a year or shares with a value of more than Rs 5crores - whichever is higher - except with the prior approvalof the central government.

Section 79A of the Companies Act lays down conditions forthe issue of sweat equity shares. For listed companies, thereare regulations made by the SEBI. The SEBI also prescribes

the accounting treatment of sweat equity shares. Thus,sweat equity is expensed, unless issued in consideration ofa depreciable asset, in which case it is carried to thebalance sheet.


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ESOP Employee Stock Option Plan (ESOP), is a plan through

which a company awards Stock Options to theemployees based on their performance. Under an

ESOP, the employees have right to buy the shares ofthe company on a predetermined date at apredetermined price.

The objective of ESOP is to motivate the employees to

perform better and improve shareholders' value.Apart from giving financial gains to the employees,

ESOP also creates a sense of belonging and ownershipamongst the employees.


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ESOP Different terms used in an ESOP Grant date - The date on which the company grants an option to

its employee. Option price - The price at which such shares in a scheme are

offered. It is also known as the strike price or grant price.Normally such option price would be below the market value/fair value of the shares on the date of grant.

Vesting date - An ESOP would provide for a date on which anoption is vested with employees and time frame over which the

stock option would vest with employees (Vesting period). Exercise period - The employees would be given a time period,

called exercise period, within which they are required to exercisethe option. The date on which employees exercise this option isknown as exercise date.


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Different types of ESOPs Employee Stock Option Scheme (ESOS) - Under this scheme, the company grants an

option to its employees to acquire shares at a future date at a pre-determined price.Eligible employees are free to acquire shares on vesting within the exercise period.Employees are free to dispose of the shares subject to lock-in-period if any. Generallyexercise price is lower than the prevalent market price.

Employee Stock Purchase Plan (ESPP) - This is generally used in listed companies,wherein the employees are given the right to acquire shares of the company immediately,not at a future date as in ESOS, at a price lower than the prevailing market price. Sharesissued by listed companies under ESPP will be subject to lock-in-period, as a result, theemployee cannot sell the shares and/or the employee has to continue with the employerfor a certain number of years.

Share Appreciation Rights (SAR)/ Phantom Shares - Under this scheme, no shares areoffered or allotted to the employee. The employee is given the appreciation in the value ofshares between two specified dates as an incentive or performance bonus, that is linkedto the performance of the company as a whole, as reflected in its share value.


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Juhi Sapra

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FS_4_Management of Capital Issues