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Underwriting of shares & Debenture...

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Underwriting of Shares and Debentures Introduction Underwriting is an agreement, with or without conditions, to subscribe to the securities of a body corporate when existing shareholders of the corporate or the public do not subscribe to the securities offered to them. When a company goes in for an initial public offer (IPO), it may face certain uncertainty about whether its offer of shares or other securities will be subscribed in full or not. If the public issue does not get fully subscribed, the project for which the funds are being raised cannot be implemented. As per law, it is required that if the company is not able to collect 90% of the offer amount, then it needs to compulsorily return the money to those who have subscribed to the shares. To avoid the risk of under-subscription companies may seek the help of a specialised group of risk-redeemers ---- called Underwriters. The function of the Underwriters is to arrange subscription of floated shares. If the whole or a certain portion of the shares or debentures of the company is not applied for by the public, the underwriters themselves apply or persuade others to apply for those shares or debentures. The underwriters, as risk-takers, are entitled to get commission at prescribed rates. It can be easily comprehended that when the floated shares are likely to be under-subscribed, the underwriters come to the forefront. In other cases they remain in the background, acting as catalysts ---- arrangers of sale to the investing public. Before entering into an agreement with the company, the underwriters assess the following : (a) worth of the public issue; (b) market response to the issue; and (c) their own ability to get the issue fully subscribed. Depending upon the risk assessment of the issue, the underwriters decide on their amount of commission. Owing to under-subscription, if the issue devalues upon them, the underwriters pay up the required amount and deduct their commission from that.

10.2 Underwriting of Shares and Debentures From the viewpoint of the issuer company, the following are generally observed : (a) While selecting underwriters and finalising underwriting arrangements, lead merchant bankers shall ensure that the underwriters do not overexpose themselves so that it may become difficult to fulfill underwriting commitments. (b) 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. (c) The lead merchant banker shall satisfy themselves about the ability of the underwriters to discharge their underwriting obligations. (d) The lead merchant banker shall : (i) incorporate a statement in the offer document to the effect that in the opinion of the lead merchant banker, the underwriters’ assets are adequate to meet their underwriting obligations; (ii) obtain underwriters’ written consent before including their names as underwriters in the final offer document. (e) In respect of every underwritten issue, the lead merchant banker(s) shall undertake a minimum underwriting obligation of 5% of the total underwriting commitment or ~ 25 lacs whichever is less. (f) The outstanding underwriting commitments of a merchant banker shall not exceed 20 times its networth any point of time. (g) In respect of an underwritten issue, the lead merchant banker shall ensure that the relevant details of underwriters are included in the offer document. It should be noted that as per the latest SEBI Guidelines underwriting is not mandatory. Under the SEBI rules, no person other than a share broker or merchant banker can act as underwrite unless he holds a certificate granted by SEBI. Regarding underwriting, the following disclosures should be made in the Offer Document : (a) Names and addresses of the underwriters and the amount underwritten by them. (b) Declaration by board of directors of the issuer company that the underwriters have sufficient resources to discharge their respective obligations.

Real Life Focus EDELWEISS CAPITAL LIMITED

Our Company was incorporated on November 21, 1995 as a public limited company under the provisions of the Companies Act, 1956. Our Company received its certificate for commencement of business on January 16, 1996. Registered and Corporate office: 14th Floor, Express Towers, Nariman Point, Mumbai 400 021, Maharashtra, India The registered office of our Company was changed from 413, Dalamal Towers, Nariman Point, Mumbai 400 021 to 1st floor Shalaka Sangh Co-operative Housing Society, 9 M. K. Road, Queen Barracks Area, Mumbai 400 021 by a resolution of our Board dated September 18, 2000. The registered office was further changed to 14th Floor, Express Towers, Nariman Point, Mumbai 400 021, Maharashtra, India by a resolution of our Board dated July 2, 2004. Tel: +91 22 2286 4400; Fax: +91 22 2286 4278; Website: www.edelcap.com; Contact person and Compliance Officer: Ms. Shilpa Soti, Email: [email protected]

PUBLIC ISSUE BY EDELWEISS CAPITAL LIMITED (‘‘COMPANY’’) OF 8,386,147 EQUITY SHARES OF ~. 5 EACH (‘‘EQUITY SHARES’’) FOR CASH AT A PRICE OF RS. 825 PER EQUITY SHARE (INCLUDING A SHARE PREMIUM OF RS. 820 PER EQUITY SHARE) AGGREGATING RS. 6,918.57 MILLION (THE ‘‘ISSUE’’). THE ISSUE COMPRISES A NET ISSUE TO THE PUBLIC OF 8,181,607 EQUITY SHARES OF RS. 5 EACH (THE ‘‘NET ISSUE’’) AND A RESERVATION OF 204,540 EQUITY SHARES OF RS. 5 EACH FOR ELIGIBLE EMPLOYEES OF THE COMPANY (THE ‘‘EMPLOYEES RESERVATION PORTION’’). THE ISSUE WOULD CONSTITUTE 11.19% OF THE POST ISSUE PAID-UP CAPITAL OF THE COMPANY. THE NET ISSUE WOULD CONSTITUTE 10.92% OF THE POST ISSUE PAID-UP CAPITAL OF THE COMPANY.

Financial Accounting Vol. II 10.3 ISSUE PRICE IS ~. 825 PER EQUITY SHARE OF FACE VALUE ~. 5. THE FACE VALUE OF EQUITY SHARES IS RS. 5 THE ISSUE PRICE IS 165 TIMES THE FACE VALUE BID/ISSUE PROGRAMME BIDDING/ISSUE OPENED ON NOVEMBER 15, 2007 BIDDING/ISSUE CLOSED ON NOVEMBER 20, 2007

Underwriting Agreement After the determination of the Issue Price and allocation of our Equity Shares but prior to filing of the Prospectus with RoC, our Company will entered into an Underwriting Agreement with the Underwriters for the Equity Shares proposed to be offered through this Issue. It is proposed that pursuant to the terms of the Underwriting Agreement, the BRLMs shall be responsible for bringing in the amount devolved in the event that the Syndicate Members (other than ESL) do not fulfill their underwriting obligations. Pursuant to the terms of the Underwriting Agreement, the obligations of the Underwriters are several and are subject to certain conditions precedent to closing, as specified therein. The Underwriters have indicated their intention to underwrite the following number of Equity Shares: (This portion has been intentionally left blank and will be filled in before filing of the Prospectus with RoC) Name and Address of the Underwriters Book Running Lead Managers Kotak Mahindra Capital Company Limited 3rd Floor, Bakhtawar, 229, Nariman Point, Mumbai 400 021, India Citigroup Global Markets India Private Limited 12th Floor, Bakhtawar, Nariman Point, Mumbai 400 021 Lehman Brothers Securities Private Limited Ceejay House, 11th Level, Plot F, Shivsagar Estate, Dr. Annie Besant Road, Worli, Mumbai 400 018, India

Indicative number of Equity Shares to be underwritten

Amount underwritten (~. million)

2,795,283

2,306.1

2,795,382

2,306.2

2,795,382

2,306.2

Sub-Underwriters In order to spread the risk of under-subscription, the principal underwriters may enter into subsidiary agreements with sub-underwriters. Such agreements are made between the underwriters alone, with the company not being a party thereto. As per agreement, the company pays commission at a prescribed rate to the principal underwriters, who in turn, disburse commission to the sub-underwriters. Sometimes an additional commission is paid to the principal underwriters to encourage sub-underwriting. This is known as over-riding commission. The payment of an over-riding commission enables the company to deal with one or two underwriters instead of a number of them.

Underwriting Commission It may be paid in cash or in fully paid-up shares or debentures or a combination of all these. It is paid on the issue price of the shares or debentures so underwritten. As per the provision of Section 76 of the Companies Act, 1956, commission is payable if the following conditions are satisfied: (i) The payment of the commission is authorised by the articles; (ii) The commission paid or agreed to be paid does not exceed in the case of shares, five per cent of the price at which the shares are issued or the amount or rate authorised by the articles, whichever is less, and in the case of debentures, two and a half per cent of the price at which the debentures are issued or the amount or rate authorised by the articles, whichever is less; (iii) The amount or rate per cent of the commission paid or agreed to be paid is ---in the case of shares or debentures offered to the public for subscription, disclosed in the prospectus, and in the case of shares or debentures not offered to the public for subscription, disclosed in the statement in lieu of prospectus, or in a statement in the prescribed form signed in like manner as a statement in lieu of prospectus and filled in before the payment of the commission with the Registrar and, where a circular or notices not being a prospectus inviting subscription for the shares or debentures, is issued, also disclosed in that circular or notice;

10.4 Underwriting of Shares and Debentures

(iv) The number of shares or debentures which persons have agreed for a commission to subscribe absolutely or conditionally is disclosed in the manner aforesaid; and (v) A copy of the contract for the payment of the commission is delivered to the Registrar at the time of In this regard, the following points are to be noted: (1) No underwriting commission is payable on the shares taken up by the promoters, employees, directors, business associates, etc. (2) Commission is payable on the whole issue underwritten irrespective of the fact that whole of the issue may be takenover by the public. However, as per Guidelines issued by the Stock Exchange division of the Department of Economic Affairs, Ministry of Finance vide their reference No. F-14/1/SE/85, dated 7th May, 1985, the following rates for payment of underwriting commission are in force :

(A) Equity Shares (B) Preference Shares / Convertible and Non-convertible Debentures (a) For amounts upto ~ 5 lakhs (b) For amounts in excess of ~ 5 lakhs

(i) (ii)

On amounts devolving on the underwriters (per cent) 2.5

On amounts subscribed by the public (per cent) 2.5

2.5 2

1.5 1

The rates of underwriting of commission mentioned above are maximum ceiling rates, within which any company will be free to negotiate the same with the underwriters. Underwriting commission will not be payable on amounts taken up by the promoters group, employees, directors, their friends and business associates.

The company while fixing the underwriting commission should ensure that the commission is within the limits specified by the Central Government as stated in the above table.

delivery of the prospectus or the statement in lieu of prospectus for registration. Underwriting Agreement There are two types of underwriting agreement : (a) conditional; and (b) firm. Conditional underwriting : Under this type of agreement, the underwriter agrees to take up agreed proportion of shares, not taken up by the public. If the shares are fully subscribed by the public, the underwriter does not take up any share. Firm underwriting : Under this type of agreement, the underwriter agrees to take up a specified number of shares irrespective of the number of shares subscribed for by the public. Unless it has otherwise agreed, the underwriters’ liability is determined without considering the number of shares taken up ’firm’ by him.. Marked and Unmarked Applications ‘Marked’ applications are those applications which bear the stamp of an underwriter. If the issue is not fully subscribed, ‘marked’ applications shall be applied in reduction of underwriter’s liability. The ‘unmarked’ applications are those applications which bear no stamp of an underwriter. These applications are received by the company directly from the public. The distinction between marked and unmarked applications becomes immaterial when the whole issue is subscribed by only one underwriter. When there are more than one underwriters, the unmarked applications are divided amongst Underwriters in the ratio of their gross liability. When the issue is fully subscribed, the distinction between marked and unmarked applications becomes immaterial. Full and Partial Underwriting When the whole issue is underwritten by the underwriter(s) it is called full underwriting. When a part (say 75%) of the whole issue is underwritten by the underwriter(s) it is called partial underwriting. In this case the company is treated as having underwritten the balance of shares.

Financial Accounting Vol. II 10.5 Accounting Entries 1. For Commission/brokerage due Commission/Brokerage Account To Underwriter Account To Broker Account 2. For payment of Commission/brokerage Underwriter Account Broker Account To Bank Account To Share Capital Account To Debentures Account

Dr.

Dr. Dr. [Cheque] [Shares] [Debentures]

Determination of Liability in respect of Underwriting Contract The nature of underwriting contract determines the liability of the underwriter. The different types of underwriting contract with their subdivisions can be shown with the help of the following diagram: Underwritten

1. Fully Underwritten

(a) Without Firm Underwriting

(b) With Firm Underwriting

2. Partially Underwritten

(a) Without Firm Underwriting

(b) With Firm Underwriting

1(a) When the Issue is Fully Underwritten [without Firm Underwriting] If the entire issue has been underwritten by one underwriter, the determination of his liability is very simple. The total number of applications (both marked and unmarked) are deducted from the number of shares underwritten and the resultant figure is treated as a liability of the Underwriter. For example, X Ltd. issued 1,00,000 equity shares of ~ 10 each. The issue was fully underwritten by A. However, the company received applications for 80,000 shares which includes marked applications for 60,000 shares. Here, A’s liability will be 1,00,000 -- 60,000 -- 20,000 = 20,000 shares. A would get full credit for the unmarked 20,000 applications. If the entire issue has been underwritten by a number of underwriters, certain difficulties may arise in respect of division of unmarked applications. The unmarked applications can be divided between the underwriters in the following two ways. Method 1 Under this method, all unmarked applications are divided between the underwriters in the ratio of gross liability of individual underwriter. For determining the liability of individual underwriter, the following steps are followed: Step 1 Compute gross liability (if it has not been given) of individual underwriter on the basis of agreed ratio. For example, X Ltd. issued 1,00,000 Equity shares of ~ 10 each. The issue was underwritten as follows: A ---- 30%; B ---- 40% and C ---- 30%. Here, the gross liability will be : A ---- 30% of 1,00,000 = 30,000 shares; B ---- 40% of 1,00,000 = 40,000 shares and C 30% of 1,00,000 = 30,000 shares.

10.6 Underwriting of Shares and Debentures Step 2 Subtract marked applications from gross liability of respective underwriters. Step 3 Determine the number of unmarked applications. (Unmarked application = Total applications received less marked applications). Divide unmarked applications between different underwriters in the ratio of gross liability, as per our example, in the ratio of 3:4:3. If the resultant figures are all positive or zero, then stop here. Now these figures represents the net liability of each underwriter. If some of the resultant figures are negative, then continue to Step 4. Step 4 Add all negative figures and divide the resultant between the underwriters having positive figures in the ratio of gross liability inter se (for details see Illustration 3). Repeat Step 4 unless all figures are non-negative. Now these figures represent the net liability of each underwriter. Method 2 Under this method, all unmarked applications are divided between the underwriters in the ratio of gross liability less marked applications. For determining the liability of individual underwriter, following steps are followed: Step 1 Compute gross liability in the usual manner (if it has not been given). Step 2 Subtract marked applications from gross liability of respective underwriters. If some of the resultant figures are negative, then add all negative figures and divide their sum in the ratio of gross liability inter se (for details, See Illustration 3 alternative solution). Step 3 Determine the number of unmarked applications. Divide unmarked applications between different underwriters in the ratio of gross liability less marked applications, i.e., the resultant figures of Step 2. If the resultant figures of Step 3 are all positive or zero, then stop here. Now these figures represent the net liability of each underwriter. If some of the resultant figures are negative, then continue to Step 4. Step 4 Add all negative figures and divide their sum between the underwriters having positive figures in the same ratio of Step 3. Repeat Step 4 unless all figures are non-negative. Now these figures represents the net liability of each underwriter. Illustration 1 A Ltd. issued 1,00,000 equity shares. The whole of the issue was underwritten as:

X ---- 40%; Y ---- 30%; and Z ----30%. Applications for 80,000 shares were received in all, out of which applications for 20,000 shares had the stamp of X; those for 10,000 shares had that of Y; and 20,000 shares had that of Z. The remaining applications for 30,000 shares did not bear any stamp. Show the liability of the Underwriters. [C.S. (Inter) ---- Adapted] Solution Statement Showing the Liability of Underwriters [Figures ---- No. of shares] Underwriters Gross liability (X -- 40%; Y -- 30%; and Z -- 30%) Less: Marked applications Less: Unmarked applications (Note 1) Net liability

X 40,000 20,000 20,000 12,000 8,000

Y 30,000 10,000 20,000 9,000 11,000

Z 30,000 20,000 10,000 9,000 1,000

Working Notes: (1) Total number of applications received = 80,000. Out of 80,000 only 50,000 applications are marked (X ---- 20,000; Y ---- 10,000; and Z ---- 20,000). Therefore, unmarked applications = 80,000 -- 50,000 = 30,000. Unmarked applications are distributed amongst the underwriters in the ratio of their gross liability i.e. 4:3:3. Alternatively, the unmarked applications can be allocated in the ratio of liability after credit of marked applications. The solution in that case will be as follows:

Statement Showing the Liability of Underwriters Underwriters Gross liability (X -- 40%; Y -- 30%; and Z -- 30%) Less: Marked applications Gross Liability less marked applications Less: Unmarked applications (2:2:1) Net Liability

[Figures ---- No. of shares] X Y Z 40,000 30,000 30,000 20,000 10,000 20,000 20,000 20,000 10,000 12,000 12,000 6,000 8,000 8,000 4,000

Financial Accounting Vol. II 10.7 The liability of each underwriter may vary widely according to the choice of the method adopted. Generally, the underwriting contract contains a provision in this respect. In the examination if nothing is mentioned, the position should be clarified by way of a note.

Illustration 2 On 1st January, 2005, Moon Ltd. issued a prospectus inviting applications for subscription in 10,00,000 equity shares of ~ 10 each. The whole issue was fully underwritten by A, B, C and D as : A ---- 30%; B ---- 25%.; C ---- 35%; a...