All you need to know about fund raising tools

Here is the transcript of the exclusive interview on CNBC-TV18. Also watch the accompanying video.

Q: What exactly does one mean when one talks about instruments of fund raising?

Nayar: I think as a company looks at its growth plans and capital expenditure requirements, they obviously take care of it through internal resources first. Over and above that they have options of raising either debt or equity. Within equity also there can be pure equity or convertibles, which are equity like instruments which get converted to equity or can stay as debt.

Q: Is this always done in order to do capital raising or sometimes it is also done in order to get in a strategic investor etc. In that, are there different layers to why a company chooses to do fund raising or is it just as simple as the capex issue?

Chatterjee: From a pure corporate finance point of view, there would be several angles to look at it. If one looks at fund raising for capex, which is the most obvious, whether it is in capex or growth, one first one needs to ensure that the company's long-term strategy is aligned to growth. And, within growth then to use fund raising as the enabler to make it happen.

Sometimes one looks at the capital structure and the need to balance capital structure either ways, whether it is towards debt or equity, it depends on where that structure is, if it is over capitalized in terms of equity and you are paying too much taxes, you would certainly want to get some tax shield to ensure that there is a rebalancing and it can be vice-versa.

The third thing is the instrument selection or the financing strategy. One looks at what instruments work for that particular company, given its track record of cash flows and earnings.

And, finally one looks at the market and sees what is the right time to access the market and in which form.

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Q: From a minority shareholders point of view, how should one read these fund raising exercises by a company? Do they have an impact on the company's core business or performance as a stock as well?

Sharma: Yes, certainly. Depending on what kind of fund raising it is, whether it is equity or debt and also from perspective of which investor base it is raising. The existing minority shareholders if they do not participate in that equity offering will get diluted. So to that extent they will be impacted. As long as it is debt, they also need to look at how it impacts the capital structure and the future growth of the company.

Q: On the equity side, one can raise money via an initial public offering (IPO) which is step one, but how beneficial is it going down the equity route whether it is an IPO or a preferential share issue from a company's point of view?

Chatterjee: Equity is obviously a form of capital raising where one has to be very careful in the context of two to three things. One is in the earnings per share (EPS) implications of raising equity. Whether one goes through an IPO or a private placement or bring in strategic investors, is functional of again where the capital structure wants to be. And, if one wants to have an equity-biased capital structure we need to look at raising equity.

A listed company would perhaps go in for a follow-on public offer (FPO) or a private placement or induction of a strategic partner or even a preferential allotment to the existing shareholders.

For an unlisted company, it could be in the form of an IPO or simple private placement by a financial or strategic partner. So, the key consideration is whether that equity which is effectively costlier than debt can be serviced and can be value accretive going forward for the shareholders.

Q: What exactly should a retail investor or any shareholder actually look at when a company announces equity offering because there is a) potential dilution that will happen b) potential dilution on the earnings itself. I guess if it's preferential you will have to wonder about which kind of parties are coming into the company.

Sharma: I think from the perspective of any investors, categorized into two'one who is an existing shareholder and two is somebody who is coming in new. What they need to look at is going top down in terms of what the industry dynamics are. How the company is doing in that industry and finally what the backing of the promoters or other strategic investors is. Also they need to look at what is the planned fund raising going to be used for. That is also important consideration because it would have an impact on future growth of the company.

Q: You have participated and run many follow-on offers for companies, how does one marry this mismatch that starts happening between the listed price and the way it starts reacting to news of a follow-on because immediately for many stocks especially from the public sector there is a deceleration in the price performance expecting the FPO to be at a much lower price point?

Nayar: Usually follow-on have little more flexibility on pricing. Also, since it's a more intensive an effort in terms of distribution and there is whole host of cost that go along with it, the feeling is that one will try and price it in such a way that the follow-on goes through and doesn't lead to an overhang.

Any retail investor would not like to pay a premium because they can buy that stock in the market at market related prices. So, most follow-ons always happen at a discount of about 5%. So usually in that sense investors start expecting 3-5% discount and start playing on that arbitrage.

Q: How elegant an option is it when you look at equity fund raising instruments because you have to consider the retail minority shareholder, you have to consider some kind of discount and you also have to take into account the kind of pressure your stock may face because of that impending follow-on offer?

Chatterjee: In India the route to access the capital markets especially in the secondary side, for a listed company, depends on how the stock performs post the announcement. The period to close fund raising is very critical to ensure that there is a balance between what the company wants and what the investor wants. I still believe that rights and FPO should be done in a shorter period of time and that would be a great benefit both to the issuer as well as the investor.