Financing options at the time of Recession

Category: International Finance Sub-category: International Banking
Document type: article


The vicious circle of investment operating at low levels and a dearth of money in the worldwide economy have forced management to put on their thinking caps and explore new avenues to raise capital or funds. The conventional methods have not produced fruitful results and management has to leap the walls of traditional financing options to innovate and attract investors to raise funds. Expansions, new projects and repayment of old debts, all plans linger on paper as managers fail to find a secure and inexpensive way to raise funds.

Let us first evaluate the conventional methods to raise funds and how they can be still used to raise funds though not exactly as the management would like.

Private Equity (PE): Private Equities are equity securities which do not carry the privilege of being traded in the stock market like other equities. Such equities are usually of the nature of introduction of capital or acquisition or like. Such funds are raised from private and select sources. There are often specialised firms who invest in PE but due to liquidity crisis and low business sentiment such investments have been drastically reduced and hence not the most appropriate source to raise funds. India Inc struck PE deals worth $872 million in May, the highest since September 2008.

Venture Capital: Venture capital is a special type of Private Equity capital or fund that is invested in new and emerging companies with little or no operating history and hence do not enjoy any goodwill in the commercial market. Hence such companies often fail to raise the required funds in form of loans from banks and institutions or through IPO. This is where Venture Capital plays a vital role for new companies where they can raise funds and float. A pool of fund or say capital is accumulated by investment institutions who gather these funds from net worthy institutions and individuals and invest in new companies as venture capital in return getting significant control over management of new company. The new company also benefits as the receive expertise from these venture capitalists. This however has not been able to be a successful tool in times of recession where the purchasing power and risk bearing capacity of institutes and individuals are at a low. Recently, due to similar reasons, Aavishkaar India Micro Venture Capital Fund failed to reach its set target of $15 million.

Initial Public Offering (IPO): IPOs, the most common way to raise funds, are offers made to, the individual and institutional investors along with the general masses at large, to purchase equity shares, a tool to raise funds. IPO are issued before listing of company in the stock market to institutional as well as individual investors in ratio as prescribed by the governing body. A company usually levies a premium, the amount of which is monitored by the governing body. During recession two major concerns prevail over IPOs, firstly the premium has to be reasonably low and secondly whether all issued shares are subscribed for during recession. This has been seen as the market price of most of the recently listed IPO has been below the issue price. The only listed IPO in India in 2009 so far has been Edserv Softsystems which was issued at Rs. 60 and trading at Rs. 28.95(as on 18-06-2009).Such performances has made it difficult for the companies to raise funds through IPOs.

Loans: Loans are debt instruments where companies raise funds from institutions and banks, repayable after or over a specified period of time with the agreed interest on the principal loan amount. The high rate of commercial interest is a key feature against loan being used an instrument to raise fund. Loans also lead to more involvement of banks in management and often companies do not have enough collateral to raise required amount. However inspite of the demerits loans have been an effective tool during recession as the investments from public and institutions have been low and this safe investment is preferred by finance institutes and banks.

Angel Fund: Angel Funds are given by business angels (very affluent people) to newer business expecting little or no return out of them. They wish to promote new industries which may seek benefit to them in future. Lack of money supply in the economy has removed such business angels from the market and hence not a successful mode to raise funds during recession.

High cost and insecurity and the current market scenario during recession have brought in a lot of new ways to raise funds which suite the needs of the companies.

Warrants: Warrants are securities issued by companies, holders of which becomes entitled to purchase the stock of the company during a specified period of time, at that specific price at which the warrant has been issued (which is usually over the prevailing marker price of the date of issue), irrespective of what the market price is on the day of purchase. In simpler words warrants are issued at a price (say Rs. X) higher than the market price that day (say Rs. Y, X>Y) carrying an expiry date (say N years).Now , during the period (within N years) the holder is entitled to purchase the stock of the company at the price of issue of warrant (Rs. X) irrespective of market price, so if the market price over time has risen(say Rs. Z , Z>X), the holder can still purchase at issue price of warrant i.e. at price lower than market prevailing value and can trade or hold those stocks like other stocks. The future prospects of the company are the key factor in issue and pricing of issue of warrant. The brighter the future the more the company can levy as premium from issue of warrants and the general perception of recovery of world markets and economy over a period of years have motivated the investors to invest in warrants than the conventional measures to raise funds and hence successful during worldwide recession. Aditya Birla Nuvo plans to raise Rs. 1000 crores using 18.5 million warrants to lower its Rs. 4500 crore debt burden and KS oils have raised Rs.157 crore through 280 million warrants.

Qualified Institutional Placements (QIPs): QIPs, a mode to raise capital has proven to be an effective tool in turbulent times, in particular to the real estate sector. QIPs can be issued by listed companies in form of equity or any form of securities other than warrants, which can be partly or fully converted or exchanged with equity shares. This mode involves few legal procedures and does not require any pre-issue filings and hence is a hassle free and rapid method to raise capital. These features of QIP have made them a popular and quick way to raise funds highly used during sudden dearth of funds. These shares are issued to qualified institutional buyers (QIBs),i.e. investors, generally institutional who expertise to evaluate and also the resources to invest in capital markets, namely public financial institution, Scheduled commercial banks, Mutual Funds , FIIs, Multilateral and bilateral  development financial institutions, Venture Capital, Insurance Companies, Provident Funds and Pension Funds (with minimum corpus of Rs.25 crores).QIPs may be issued at sole discretion of the company to select buyers with only a 10% reservation for Mutual Funds and requiring a minimum of 2 QIBs if allotment is below 250 crores and 5 QIBs for any amount above that. QIP guidelines were introduced alongside by SEBI in 2006 to foster investments by domestic institutions. Since the introduction of QIP the capital market has seen some effective QIP issues to raise funds. In April 2009, Unitech raised Rs. 1625 crores through QIP and DLF raised Rs 2656 crores where HDIL raised Rs. 2880 crore to offset its debt burden.

Non-Convertible Debentures (NCDs): NCDs are a form of debenture