PRIVATE PLACEMENT

1.1 Concept and background of private placement:

According to the Dictionary of Banking and Finance, 'Private placement is the act of placing a new issue of shares with a group of selected financial institutions' . Bloomberg defines a private placement as the transferring of securities to a small group of investors. The sale of a bond or other security directly to a limited number of investors an institutional investor likes an insurance company antithesis of public offering. Private placement is the method of fund raising from the capital market, when public issue is not feasible option. It can be made both by companies that have already gone public in the past (listed companies) and by those that have not (unlisted companies). In the Indian capital market, private placements do not require issue of a prospectus and regulatory clearances for the issue of securities. However, if such securities are subsequently proposed to be listed in a stock exchange (NSE or BSE), they would need to be compliant with the Listing regulations of the respective stock exchange. Though the intention behind a private placement is fund raising, sometimes they are also made not with a. fund raising intention but to accommodate certain strategic objectives. These could be, (a) Consolidation of stakes of promoters, (b) Induct a strategic investor or a joint venture partner, (c) Provide management stakes to working directors and senior management, (d) Implement an employee stock option plan, (e) Reward shareholders with bonus issues and such other objectives.

1.2. Types of private placement:

Private placement

B.

Private Placements Made

A.

Private Issues Made with a

with a Fund Raising Objective Early Stage Venture Capital Later Stage Private Equity Other Institutional Investors Non-institutional investors International Capital Markets

Strategic Objective Promoters and Promoter Group Employees Management Bonus Issues Introduction of Strategic Investor and Senior

1.3. Assessment of Private Placement:

From an issuer's perspective, private placement provides faster access to funds, less market uncertainties and a more cost effective way of raising funds as compared to public offers. The effectiveness of private placement would however, depend on the maturity of this market in respective countries. Floatation costs would also depend on the type of investors being targeted, size of the offer and the desirable distribution of securities. Private placements are therefore more cost efficient for larger floatation if a widespread distribution is required. There is also lesser paperwork and administrative pressure on the issuer company in satisfying process requirements. Even under the debt category, private placements offer an efficient mechanism for raising capital. The lack of illiquidity is seemingly compensated by higher levels of accessibility for the investors to the issuer company. In addition most privately placed debt is rated and only instruments with investment grade rating get placed eventually

with institutional investors. Therefore, it can be stated that private placement of debt is as efficient as a public issue of similar instruments from an issuer's perspective. From an investor's perspective, private placement provides lesser transparency and is therefore suitable more for informed institutional and HNI investors than retail investors. A balancing factor though is the opportunity for investors to interact with the issuer company's management on a one-to-one basis and assess investment prospects in the proposal. If private placed securities are also listed on the stock exchange, they would combine the advantages of publicly offered securities as well by providing liquidity and price validation on a continuous basis to investors.

1.4. Market Segments for Privately Placed Debt:

Private placement of debt securities

PSU bonds

Bonds from banks and institutions

Corporate debt securities

A)

The PSU bond market consists of debt securities issued by public sector corporations set up under separate statutes, government companies incorporated under the Companies Act, local authorities and municipal bodies that float debt securities for raising funds. Many well-known names such as the NTPC, Power Finance Corporation, Konkan Railway Corporation, Sardar Sarovar Narmada Nigam, Rural Electrification Corporation and other Central and State Government undertakings had raised funds through private placement route.

The essential difference between PSU bonds and other corporate debt is the constitution of the PSUs. In many of them, the government being the main shareholder provides credit enhancements including a financial guarantee. For example, the bond issue made by Krishna Bhagya Jala Nigam Ltd was guaranteed by the State Government of Karnataka. This kind of a structure not only helps the PSU to raise funds but raise them at competitive rates as well.
B) The institutional bond segment consists of all India and state level financial

institutions and commercial banks that raise funds through issue of SLR and non-SLR bonds. SLR bonds are called so since they fulfill the requirements of the statutory liquidity ratio. SLR bonds constitute an inter-bank offering whereby the bonds issued by a financial institution or a bank are subscribed to by other banks. Financial institutions do not subscribe to SLR bonds since they do not have to maintain any statutory liquidity ratio. The non-SLR bonds are issued to other investors mainly to augment the fund base of the financial institutions and banks. They serve as an alternative to raising funds from deposits.
C) The corporate debt securities market consists of private sector companies

that issue privately placed debentures to financial institutions, banks and other investors to raise funds through the debt route as a substitute for long-term borrowings through term loans. These debentures offer better advantages to corporate, since these are easy to float and if these are rated, they become an easier option to raise funds than through term loans that go through long drawn appraisals. Since many of these debentures, are placed with select investors, suitable credit enhancements can be made to get a good rating for the structured obligation and thereby place them at finer coupon rates.

1.5. Market Segments for Privately Placed Equity:

Private placement of equity

Venture capital

Institutional private equity

Placement to others QIBs and non institutional investors

The main investors in the private market are qualified institutional buyers such as banks, insurance companies, mutual funds, registered venture capital funds, foreign institutional investors and others. Unregistered foreign private equity investors also from a significant part of the investing community in privately placed equity. In the privately placed debt market, the dominant investors are mutual funds, banks and insurance companies. To lesser extent foreign institutional investors, HUFs, private trusts etc comprise the bottom layer of the investment community.

A) VENTURE CAPITAL:

Concept and introduction:

'Venture Capital' is an important source of finance for those small and medium-sized firms, which have very few avenues for raising funds. Although such a business firm may possess a huge potential for earning large profits in the future and establish itself into a larger enterprise. But the common investors are generally unwilling to invest their funds in them due to risk involved in these types of investments. In order to provide financial support to such entrepreneurial talent and business skills, the concept of venture capital emerged. In a way, venture capital is a commitment of

capital, or shareholdings, for the formation and setting up of small scale enterprises at the early stages of their life cycle. Bloomberg defines it as 'An investment in a start-up business that is perceived to have excellent growth prospects but does not have access to capital markets. Type of financing sought by early-stage companies seeking to grow rapidly'. Some of the famous companies of today such as Netscape Communications, Apple Computer, Cisco Systems, Compaq (since merged with HP), Network General, Yahoo, e-Bay etc were all start-up companies financed through venture capital. The Indian examples of successful venture backed companies include Biocon, i-Flex Solutions,Sasken, Geometric Software, Mastek Global etc. Venture financing involves significant risk-taking on the part of the venture capitalist since young businesses are subject to high rates of mortality and the venture investor could stand to lose the investment made in the company. The venture capital recognizes different stages of financing, namely: 1. Early stage financing - This is the first stage financing when the firm is undertaking production and need additional funds for selling its products. It involves seed/ initial finance for supporting a concept or idea of an entrepreneur. The capital is provided for product development, R&D and initial marketing. 2. Expansion financing - This is the second stage financing for working capital and expansion of a business. It involves development financing so as to facilitate the public issue. 3. Acquisition/ buyout financing - This later stage involves: Acquisition financing in order to acquire another firm for further growth. Management buyout financing so as to enable the operating groups/ investors for acquiring an existing product line or business and Turnaround financing in order to revitalize and revive the sick enterprises.

Venture capital is not meant for any type of start up business. A venture capital backed business requires certain characteristics in the business model and financing structure of the company. Some of the usual features are furnished in below: Structure of a venture capital backed start up business Business structure: 1. Generally associated with a technology venture or a knowledge intensive or innovation driven business model. 2. Venture to be backed by technology that has been created or is to be created. 3. Requires product development / technology and / or market validation. 4.Product has to be successful at lab scale / prototype level (beta version) before it is commercially launched. 5. Test marketing or phased marketing is required since concept selling is involved. 6. Cash flow model requires to be established. 7. Business to be ramped up in phase. 8.Business risks are taken in phases. Investment monitoring by the VC is more of mentoring, with the VC appointing its nominees on the board of the company to bring in significant value addition apart from protecting its interests. Financial structure: 1.Starts up firms go through rounds of financing starting from the seed stage to preIPO stage. Financing is generally linked to pre set milestone either in terms of financial projections or strategic achievements.

2.Financial risk is taken in phases. The highest risk reward relationship is at the seed stage and the risks and rewards go down progressively as the business gets derisked in each subsequent round of financing. 3.Promoters may or may not have sufficient financial resources. Their technology is valued and allowed to be capitalized as stock. Alternatively, investors are prepared to pay a high premium on their stock. Promoters equity is more in intellectual capital and stock options than in hard cash. 4.More suitable for financing through equity since the business model may not be able to support debt financing. Some part of the financing could be a convertible or a soft loan to prevent excessive dilution of promoters equity. 5.Tangible asset creation would be less there is a high component of intellectual property valuation. VCs are open to financing soft costs in the business plan that does not result in creating tangible assets. In other words they are not security oriented in the financing structuring. No collateral security needs to be created for VC financing unlike in bank borrowing. 6.Involves significant amount of cash burn in terms of product development and validation expenditure and seed marketing expenses. No restriction is placed on allocation of funds for working capital. 7.The business model should have the potential for very high returns to investors since the risk level is also very high. The risks are clearly understood through a due diligence process and assumed by the investors.

A venture capitalist normally looks for some of the following type of attributes in a business plan before deciding to invest:
An industry or space that is currently a sunrise sector that promises to be creating a

paradigm shift.
An exciting concept that has the potential for an uninhibited market.

 A concept that significantly improves existing processes or applications and therefore

find a vast replacement market.

A business or idea that has potential for spin off businesses or revenue streams or

significant possibilities for future scale up.

A start-up business that has the potential to become an attractive proposition for

strategic acquisition in future by a market leader.

A firm that has the caliber to become an industry leader in due course with the right

inputs.
A business that is in a cutting edge technology that could become an industry

benchmark.
A company that has sufficient technology and management bandwidth to reach and

sustain the leadership position that it promises to attain.

A business or technology that has a first mover advantage which can be harnessed

adequately before competition catches up.

A business that has significant entry barriers for the competition either in technology

or in business variables that can largely be sustained.

A firm that has an unfair advantage to begin with which could remain long enough

before it is diluted by competition or regulation.

A firm that offers possibilities for multiple exit options.

There are many other types of start up firms that do not qualify for venture capital as they do satisfy the investment criteria of VC investors. These could be more of commercial ventures in manufacturing, trading and services that either address a commodity or a mass market, small scale market, or engaged in the business of volumes with thin value addition or in a generic product or service market with little technology or innovation. Such businesses do not find favour with VC investors and would therefore need to be financed differently.

Regulatory framework of Venture Capital in India:

Venture Capital in India governs by the SEBI Act, 1992 and SEBI (Venture Capital Fund) Regulations, 1996. According to which, any company or trust proposing to carry on activity of a Venture Capital Fund shall get a grant of certificate from SEBI. However, registration of Foreign Venture Capital Investors (FVCI) is not obligatory under the FVCI regulations. Venture Capital funds and Foreign Venture Capital Investors are also covered by Securities Contract (Regulation) Act, 1956, SEBI (Substantial Acquisition of Shares & Takeover) Regulations, 1997, SEBI (Disclosure of Investor Protection) Guidelines, 2000. Guidelines for the Venture Capital Funds: For the Venture Capital Funds, it is required that Memorandum of Association or Trust Deed must have main objective to carry on action of Venture Capital Fund including prohibition by Memorandum of Association & Article of Association for making an invitation to the public to subscribe to its securities. Further, it is required that Director or Principal Officer or Employee or Trustee is not caught up in any litigation connected with the securities market and has not at any time been convicted of any offence involving moral turpitude or any economic offence. Also, in case of, body corporate, it must have been set up under Central or State legislations and applicant has not been refused certificate by SEBI. A Venture Capital Funds may generate investment from any investor (Indian, Foreign or Non-resident Indian) by means of issue of units and no Venture Capital Fund shall admit any investment from any investor which is less than five Lakhs. Employees or principal officer or directors or trustee of the VCF or the employees of the fund manager or Asset Management Company (AMC) are only exempted. It is also mandatory that VCF shall have firm commitment of at least five Crores from the Investors before the

start of functions by the VCF. Disclosure of investment strategy to SEBI before registration, no investment in associated companies and duration of the life cycle of the fund is compulsorily being done. It shall not invest more than twenty five percent of the funds in one Venture Capital Undertaking. Also, minimum 66.67% of the investible funds shall be utilized in unlisted equity shares or equity linked instruments of Venture Capital Undertaking.

It is also mandatory that not more than 33.33% of the investible funds may be invested by way of following as stated below: 1.Subscription way one sick possible industrial company whose shares are to IPO of a Venture of Capital Undertaking (VCU). equity. year. listed. investment.

2. Debt or debt instrument of a VCU in which VCF has already made an investment by 3. Preferential allotment of equity shares of a listed company subject to lock in period of 4. The equity shares or equity linked instruments of a monetarily weak company or a 5. SPV (special purpose vehicles) which are created by VCF for the purpose of making

RBI and Investment Criteria:

A foreign venture capital investor proposing to carry on venture capital activity in India may register with the Securities and Exchange Board of India (SEBI), subject to fulfilling the eligibility criteria and other requirements contained in the SEBI Foreign Venture Capital Investor Regulations. The SEBI Foreign Venture Capital Investor Regulations prescribe the following investment guidelines, which can impact overall financing plans of foreign venture capital funds.

a) The foreign venture capital investor must disclose its investment strategy and life

cycle to SEBI, and it must achieve the investment conditions by the end of its life cycle. b) At least 66.67 per cent of the investible funds must be invested in unlisted equity shares or equity linked instruments.

c) Not more than 33.33 per cent of the investible funds may be invested by way of: Subscription to initial public offer of a venture capital undertaking, whose shares are proposed to be listed. Debt or debt instrument of a venture capital undertaking in which the foreign venture capital investor has already made an investment, by way of equity. Preferential allotment of equity shares of a listed company, subject to a lock-in period of one year. The equity shares or equity linked instruments of a financially weak or a sick industrial company (as explained in the SEBI FVCI Regulations) whose shares are listed. A foreign venture capital investor may invest its total corpus into one venture capital fund.

Tax Matters related to Venture Capital Funds: Indian Venture Capital Funds are allowed to tax payback under Section 10(23FB) of the Income Tax Act, 1961. Any income earned by an SEBI registered Venture Capital Fund (established either in the form of a trust or a company) set up to raise funds for investment in a Venture Capital Undertaking is exempt from tax[16]. It will also be extensive to domestic VCFs and VCCs which draw overseas venture capital investments provided these VCFs/VCCs be conventional to the guidelines pertinent for domestic VCFs/VCCs. On the other hand, if the Venture Capital Fund is prepared to

forego the tax exemptions available under Section 10(23F) of the Income Tax Act, it would be within its rights to invest in any sector

B) INSTITUTIONAL PRIVATE EQUITY The private placement market for equity is quite large and consists of several types of institutional and non-institutional investors. The term 'private equity' is commonly associated with the institutional investors that cater to the requirement of equity capital by companies otherwise than through public offers. Venture capital is all about identifying early stage investment opportunities, while private equity is large and as companies grow and mature, they require more of equity capital through private sources. Thus, private equity is associated with those companies that have crossed the venture stage in their life cycle. Thus, Private equity can be termed as 'later stage financing' as compared to venture capital, which is all about early stage financing. Private equity financing is thus a distinct model of making direct equity investments wherein investors identify good investment opportunities in well performing companies, some of them even listed, either for financing their growth or for acquisitions and buyouts. Private equity funds cater to larger deal sizes and do not normally look at transaction values less than a minimum threshold. This is quite in contrast to venture capital wherein, since the risk is significantly higher, the venture capitalist looks to gradual infusion of capital to minimize risk. Private equity investors also have a relatively moderate return expectation as compared to venture capitalists who have exponential return expectations. Therefore, it may be

said that private equity market is all about investors who invest later, invest more, prefer reasonable stakes and moderate risk entailed returns. Private equity investors showed interest even in project financing, an area dominated by large banks and specialized financial institutions. Private equity investments extend over later stage unlisted companies and many a time, in listed companies as well, a phenomenon known as PIPE in the US markets.

Private investment in Public Equity (PIPE):

According to Bloomberg, 'Private Investment in Public Equity (PIPE) occurs when private investors take a sizable investment in publicly traded corporations. This usually occurs when equity valuations have fallen and the company is looking for new sources of capital'. From the above definition, it is clear that when private equity is infused into a listed company it would be classified as a PIPE investment. Character of PIPE:
A) Private- A PIPE is a private placement transaction between a limited group of

investors and a listed company. The private placement of securities is made possible only to the extent permitted by regulations governing issue of securities by listed companies, such as the SEBI regulations in India and the SEC regulations in USA.
B)

Investment- A PIPE is a direct investment in a company. Unlike securities of a

listed company purchased from other investors in the secondary market, a PIPE involves the purchase of securities in the primary market. In a PIPE, securities are issued directly by an issuer company, and the proceeds from such investment go to that company.
C)

Public- A PIPE is used by a listed company to raise capital. These have to be

differentiated from private equity raised by unlisted companies due to the fact that there are several regulatory restrictions on PIPE financings as compared to private investments in private companies. The way, in which these regulations and laws are

interpreted, make PIPEs a discrete financing alternative, distinct from other forms of private and public investments.
D)

Equity- A PIPE is an equity or equity-linked investment, i.e. securities that

involve an equity component, and securities that are convertible or exchangeable into equity.

C)

PRIVATE PLACEMENTS WITH OTHER DOMESTIC INVESTORS

Apart from institutional equity in the nature of venture capital or private equity that is raised from dedicated equity funds, there are other sources to raise equity in the private placement route. The QIB sources for private placements are mutual funds, foreign institutional investors, insurance and pension funds, banks and financial institutions. The non-institutional sources for private placements include family sources or associates of promoters, private high net worth investors (called HNIs), early stage investors (also called angel' investors), financial and investment companies, other corporate investors, stock broking companies, portfolio funds and non-residents. If equity is raised from any of the above sources without a public offer, it is simply referred to as a private placement as distinguished from venture capital or private equity. Private placements to non-institutional investors are more informal processes than to institutional investors and normally do not entail elaborate disclosures and due diligence.

 Regulatory aspect of private placement:

Point Special Resolution 2003 Rules 2011 Rules The issue of shares can be onlyThe Additional made, if authorizes to do so and A special resolution is meeting authorizing the allotment. to act upon within a includes: disclosures in the offer

Requirements

The AOA of the company The company has to make

document as prescribed. approved by way of a special resolution. resolution the ROC. and the offer

passed at the general The offer document has to be

The special resolution has Both the copy of the special

period of 12 months.

document has to be filed with

Condition issue of Placement

for

the Does not prescribe any suchThe

following

conditions

are

Private condition.

prescribed:
Not more than 30 day gap

between opening and closing of the issue.

 Minimum

60

days

gap

between two issues.

Any financial instrument which

is

convertible

into

equity

shares at a later date and resulting into a cumulative amount of Rs. 5 Crores or more will require the prior approval of the central government.
After the issue, the company

has to file a return of allotment Dematerialization of No such requirement Securities All with the ROC within 30 days. securities issued under

preferential allotment or private placement has to be kept in a demate form. A Similar audit certificate wasThe compliance certificate has to only required to be placed beforebe filed with the ROC. HoweverThe 2003 rules only prescribed

Compliance Certificate

the shareholders. Disclosures in the Not applicable. offer document

disclosures are to be made inthat the object of the issue had to the explanatory statement to thebe disclosed. The 2011 rules notice for the general meeting. require disclosures with regard to the object of the issue, brief detail of the project and statutory clearances required and obtained for the project. Apart from this the two rules are more or less the same in this regard.

1.7. Guidelines of the private placement:

1. All placements of securities must be done through an independent placement agent (a merchant bank or a stock broking company), except where,
The securities are to be issued to the directors or substantial shareholders of the

issuing company; 2. Time Frame for Placements Securities must be placed out to places within a period of 5 market days from the pricefixing date of the placement.