CORPORATE FINANCE

MODULE–1: INTRODUCTION TO CORPORATE FINANCE.

1.1 Law in Corporate Finance – Scope, Relevance, Function.

Corporate finance is the discipline focused on managing a
company's finances to maximize its value, particularly for
shareholders. The primary aim is to make strategic decisions about
acquiring, financing, and deploying financial resources in a way
that boosts profitability, growth, and long-term success.

Scope of Corporate Finance:

1. Identifying Opportunities: Corporate finance professionals
seek opportunities that can increase a company's financial
growth and market value. This includes evaluating new
projects, business expansions, or acquisitions.
2. Creating Value for Shareholders: The primary goal of
corporate finance is to enhance the company's worth to its
shareholders. This is achieved by making smart investment
decisions that yield positive returns.
3. Managing Corporate Risk: Effective corporate finance
involves managing risks associated with the company's
capital structure. Decisions about the mix of debt and equity,
and how much leverage (borrowing) to use, are crucial for
managing risk.
4. Using Financial Leverage: Financial leverage refers to using
borrowed funds to increase the return on equity. While
leverage can enhance profits, it also increases the risk, so
decisions must be carefully assessed.
5. Efficient Internal Funding Structure: Corporate finance
focuses on ensuring that the company's internal financial
 structure is efficient. This means determining the right
sources of funding (debt vs. equity) and ensuring that
resources are allocated where they are most needed for
growth.

Functions of Corporate Finance:

1. Capital Budgeting: Corporate finance helps businesses
manage expenses effectively by using capital budgeting. This
process involves evaluating potential projects or investments
to determine which ones are worth pursuing. The goal is to
allocate funds to the most profitable ventures while
controlling unnecessary costs.
2. Market Research: To stay competitive in rapidly evolving
markets, corporate finance integrates market research. By
studying market trends and comparing similar practices,
businesses can make informed financial decisions and adapt
to changes more effectively.
3. Raising Capital: Corporate finance plays a crucial role in
decisions related to raising capital. Businesses must carefully
assess capital market options and select the most reliable
and practical sources of funding. This ensures they can
secure the necessary capital with minimal risk and optimal
conditions.
4. Advisory in Mergers, Acquisitions, and Takeovers: Corporate
finance professionals often advise businesses on mergers,
acquisitions, and takeovers. They provide expertise in
evaluating potential deals, negotiating terms, and guiding
the legal and financial processes to ensure successful
transactions.
5. Investment Analysis: Through corporate finance principles,
businesses conduct thorough analysis of various investment
 opportunities. This helps them identify the optimal financing
instruments, ensuring they achieve the most efficient mix of
debt and equity for growth and sustainability.
6. Diversification and Expansion: As a business grows,
corporate finance guides decisions related to diversification
and expansion. By analysing the financial implications of
entering new markets or product lines, companies can
strategically allocate resources to maximize growth while
minimizing risks.

Relevance of Corporate Finance:

 Investor Protection: It protects investors by ensuring that

corporations disclose accurate information and adhere to fair

market practices.
 Market Stability: It helps maintain market stability by

preventing fraudulent activities and ensuring transparency in

financial reporting.
 Economic Growth: By promoting efficient capital allocation

and corporate governance, corporate finance law can

contribute to economic growth and development.
 Corporate Accountability: It holds corporations accountable

for their financial actions and ensures that they act in the
best interests of their shareholders.

1.2 Investment, Financing and Dividend Decision–

Interrelationship and Factors.
Corporate finance operates under three foundational
principles:
1. Investment Principle
o This principle guides businesses in allocating
 resources to projects or assets that are expected to
generate returns above a predetermined minimum
rate (hurdle rate).
o Riskier projects require a higher hurdle rate. The

analysis of investment decisions considers the cash

flows generated by the project, their timing, and
potential side effects.
2. Financing Principle
o This principle addresses how businesses raise funds

to finance their investments. Companies can opt for

a mix of debt (borrowed funds) and equity (owner’s
funds).
o The goal is to determine the optimal financing mix

that maximizes the value of the firm while matching

the financing type to the nature of the assets.
3. Dividend Principle
o This principle outlines how businesses manage

excess cash. When cash flows exceed the

investment needs, companies must decide how to
return this surplus to owners.
o Publicly traded companies may distribute cash via

dividends or stock buybacks, influenced by

shareholder preferences and the company’s past
performance in managing funds.

1. Investment Decisions: Investment decisions, also known as

capital budgeting decisions, involve determining where to
allocate the firm’s limited resources to maximize returns.
Factors Affecting Investment Decisions:
 Cash Flow of the Venture: A company must ensure that it

generates sufficient cash flow to cover its operational

 expenses after investing capital in a project. A regular cash
flow is vital for sustainability.
 Profits: The primary goal of investment is to generate
income and profits. Decision-makers evaluate potential
projects based on their expected return rates to choose
the most profitable options (e.g., preferring a 15% return
over a 10% return).
 Investment Criteria: Various capital budgeting techniques
(like Net Present Value, Internal Rate of Return) help
assess the viability of investment proposals, taking into
account cash flows, interest rates, and investment
amounts.

2. Financing Decisions: Financing decisions are fundamental to

a company’s existence as they determine how a business
acquires funds to operate and grow. Without money, a business
cannot survive; without decisions on how to utilize that money,
it cannot thrive. Financing decisions focus on determining how
a company will raise the funds necessary for investment
projects, including the optimal mix of debt and equity.
Factors Affecting Financing Decisions:
 Cost: Different financing sources come with varying costs.

The goal is to choose the most cost-effective source of

funding, which maximizes profits.
 Risk: Borrowing money (debt financing) usually carries

higher risk than equity financing, as it obligates the

company to make regular interest payments. Assessing
the risk involved is crucial in financing decisions.
 Cash Flow Position: A company's cash flow health

influences its ability to attract investors. Strong cash flow

signals stability and encourages investment.
  Control: Existing shareholders may prefer to avoid diluting
their control over the company. Borrowing might be
favored if they want to maintain control, while issuing
equity might be acceptable if they are willing to share
ownership.
 Market Conditions: The state of the financial market can
affect financing decisions. For example, firms might prefer
issuing equity in a booming market and rely on debt
during economic downturns.

3. Dividend Decisions: Dividend decisions involve determining

how much profit to distribute to shareholders as dividends
versus how much to retain for reinvestment in the business.
Factors Affecting Dividend Decisions:
 Earnings: A company's current and historical earnings are

crucial in determining dividend payouts. Higher profits

typically lead to higher dividends.
 Dependability in Earnings: Companies with stable and

predictable earnings are more likely to offer higher

dividends compared to those with fluctuating incomes.
 Balancing Dividends: Companies strive to maintain a

stable dividend per share, adjusting only when there are

significant changes in profitability.
 Growth Opportunities: Firms with strong growth
prospects may choose to retain earnings for reinvestment
rather than distributing them as dividends, leading to
lower dividend payouts.
 Cash Flow: Adequate cash flow is necessary to sustain

dividend payments. If cash flow is insufficient, a company

may need to cut dividends.
 Shareholders’ Preferences: Management must consider
 shareholder preferences regarding dividend payouts.
Some investors may prioritize receiving dividends.
 Tax Considerations: Differences in tax treatment between
dividends and capital gains can influence dividend policy.
A lower tax rate on dividends may lead shareholders to
prefer higher dividends.
 Market Reaction: Dividend changes can significantly
impact a company's stock price. An increase in dividends
may boost the stock market, while a decrease can have
the opposite effect.
 Access to Capital Markets: Larger companies with better
market reputations often have easier access to capital
markets and can rely less on retained earnings for growth,
allowing them to pay higher dividends.
 Contractual and Legal Constraints: Certain loan
agreements may impose restrictions on dividend
payments, and compliance with legal regulations (like
those outlined in company laws) must be considered.

Interrelation of Decisions
1. Investment Requires Financing: When a company
identifies a profitable investment opportunity, it needs to
secure the necessary funds through financing. Without
adequate financing, the investment cannot proceed.
2. Financing Affects Dividends: The method of financing can
impact a company’s ability to pay dividends. For instance,
if a company takes on significant debt, its cash flow may
be diverted to servicing that debt, potentially limiting
dividend payouts.
3. Dividends Impact Investment Capacity: A company that
pays out a large portion of its profits as dividends may
 have less capital available for new investments. This can
affect future growth prospects, especially if the company
encounters opportunities that require significant
investment.
Conclusion
The interconnected nature of these decisions means that a
change in one area can lead to ripple effects in the others.
Companies need to adopt a holistic approach when making
financial decisions. For instance:
 If an investment is deemed critical for growth, a company

may prioritize financing options that ensure adequate

capital while balancing dividend payouts to maintain
shareholder confidence.
 Conversely, if profitability is declining, the company may

choose to reduce dividends to preserve cash for

investment or debt servicing.

1.3 Objectives of Corporate Finance – Profit Maximization and

Wealth Maximization.
When it comes to financial management strategies, businesses
generally focus on two primary goals: profit maximisation and
wealth maximisation.
Profit Maximisation
Profit maximisation refers to strategies aimed at increasing a
business's returns while minimising costs. This involves
optimizing operations and reducing production costs to
maximize net income after expenses.
Objectives:
 Increase the company’s overall profitability.

 Deliver profitable returns to shareholders and investors.

Pros:
 Financial Sustainability: It helps in building a sustainable
business model.
 Earnings Growth: Promotes consistent earnings growth,

thereby enhancing shareholder value.

 Resource Allocation: Encourages effective use of
resources, leading to improved operational efficiency.
 Foundation for Growth: Establishes a strong financial

base necessary for survival in competitive markets.

Cons:
 Ethical Concerns: May lead to unethical practices as

companies prioritize profit over social responsibility.

 Short-term Focus: Often emphasizes short-term gains at

the expense of long-term strategies such as customer

satisfaction and employee training.
 Risky Ventures: Companies may engage in high-risk

projects to maximise profits, which can result in

significant losses.

Wealth Maximisation
Wealth maximisation focuses on enhancing the long-term value
of the company’s stock in the market. It prioritizes quality,
customer satisfaction, and overall business performance to
maximize shareholder wealth.
Objectives:
 Improve the market value of the company’s shares over

time.
 Enhance the long-term returns for shareholders.

Pros:
 Long-term Sustainability: Encourages a focus on long-

term strategies that ensure business sustainability.

  Focus on Cash Flow: Prioritizes cash flows over mere
profits, reducing ambiguity in financial planning.
 Time Value of Money: Considers the time value of money,

allowing for more accurate valuation of future cash flows.

 Risk Assessment: Incorporates risk and uncertainty into

decision-making processes, improving strategic outcomes.

Cons:
 Dependence on Profits: Wealth maximisation strategies

still require a solid profit base to be effective.

 Ambiguity: May lack clear, descriptive guidelines
compared to profit-focused strategies.
 Potential Conflict: The focus on long-term wealth can

sometimes overshadow other business goals.

1.4 Concept of Corporate Finance.

A. Capital Investment:
Capital investment involves allocating funds into a business
to generate future profits. This type of long-term investment
encompasses purchasing assets, upgrading technology,
expanding production capabilities, or building infrastructure.
The expectation is that these investments will yield returns
over time.
Importance of Capital Investment
Capital investment is vital for business growth and success. It
helps:
 Increase Productivity: Enhancements in technology

and infrastructure can lead to more efficient

operations.
 Improve Efficiency: Investing in new tools and

processes can streamline operations and reduce costs.

  Enhance Competitiveness: Staying current with market
trends and technological advancements is essential to
outperform competitors.
 Generate Employment: Capital investments can lead to
business expansion, which often results in new job
opportunities.
 Boost Economic Growth: Increased business activity
contributes to the overall economy.

Types of Capital Investment

1. Financial Capital Investment:
o Investment in financial assets such as stocks,

bonds, and mutual funds.

o Types:

 Equity Investments: Purchasing shares for

ownership in a company.
 Debt Investments: Buying bonds or lending

money for interest.

o How it Works: Investors aim for returns through

dividends, interest, or capital gains, typically

creating a diversified portfolio to mitigate risk.
o Examples: Bonds, stocks, mutual funds, ETFs.

2. Physical Capital Investment:

o Investment in tangible assets like property, plant,

and equipment.
o Types:

 Land and Buildings: Purchasing land or

constructing new facilities.

 Equipment and Machinery: Acquiring tools

or machinery necessary for production.

 o How it Works: These investments often require
significant upfront costs but can appreciate in
value, contributing to long-term growth.
o Examples: Purchasing land, equipment, vehicles.

B. Needs and Factors affecting Capital Investment:

Factors to Consider Before Making a Capital Investment
1. Return on Investment (ROI):
o A measure of profitability relative to the

investment cost.
o Calculation: ROI=Total Profit/Total Cost×100

2. Risk:
o The likelihood of loss or failure associated with

the investment.
o Mitigation Strategies: Diversify investments,
conduct thorough research, and prepare
contingency plans.
3. Time Horizon:
o The duration for which the investment is held

before liquidation.
o Importance: Longer time horizons may yield

higher returns but come with increased risks;

shorter horizons may provide stability but lower
returns.

Capital Investment Formula

The capital investment formula helps assess the profitability
of an investment opportunity:
CIP= CIP = (Earnings – Costs) / Costs
Where:
  CIP: Capital Investment Profitability
 Earnings: Net cash inflows generated by the investment

 Costs: Initial investment

Capital Investment Examples

 Building a new manufacturing facility.

 Upgrading technology.

 Expanding product lines.

 Acquiring a competitor.

How to Evaluate a Capital Investment Opportunity

1. Payback Period: Time required for the investment to
pay for itself.
2. Net Present Value (NPV): Difference between the
initial investment and the present value of future cash
flows.
3. Internal Rate of Return (IRR): The rate at which the
NPV equals zero.
Advantages and Disadvantages of Capital Investment
Advantages:
 Increased revenue and profits.

 Improved productivity and efficiency.

 Enhanced competitiveness and market share.

 Job creation and economic growth.

 Long-term financial stability.

Disadvantages:
 High initial costs and risks.

 Potential project delays or failures.

 Market uncertainty and volatility.

 Possible increased debt and interest payments.

Opportunity costs of not pursuing other investments.

C. Risk and Return–Correlation:

The relationship between risk and return is a cornerstone of
financial investment strategy, and understanding this
relationship is essential for making informed investment
decisions. In finance, there is a direct correlation between
risk and return; typically, the potential for higher returns
comes with a higher level of risk. Investors expect to be
compensated for taking on additional risk.
1. Definitions:
o Risk: This refers to the uncertainty and variability

associated with an investment. It encompasses

the possibility of losing some or all of the capital
invested.
o Return: This is the profit or loss generated from

an investment, expressed as a percentage of the

original investment.
2. Influencing Factors:
o An investor's level of acceptable risk is influenced

by several factors, including:

 Investment Goals: What the investor hopes

to achieve with their investment.

 Time Horizon: The length of time the

investor plans to hold the investment.

Longer time horizons can sometimes allow
investors to take on more risk.
 Risk Tolerance: An individual’s capacity and

willingness to endure fluctuations in

investment value.

Understanding Risk
1. Inherent Nature of Risk:
o Risk is a natural aspect of investing. There is
 always a possibility of loss, which varies
depending on the type of investment.
2. Types of Investments and Risk Levels:
o High-Risk Investments: For example, stocks are

often considered high-risk due to their volatility.

Their values can fluctuate significantly, which can
lead to substantial gains or losses.
o Low-Risk Investments: Investments such as

government bonds are generally viewed as safer

options, offering more stable and predictable
returns, albeit usually at lower rates than riskier
assets.
3. Assessing Risk:
o Before investing, it's important for individuals to

evaluate and quantify the risks associated with

different investment choices.
4. Risk Tolerance:
o Each investor has a different level of risk

tolerance, which dictates their comfort with

fluctuations in the value of their investments:
 High-Risk Tolerance: Some investors are

willing to endure significant volatility for the

chance of greater returns.
 Low-Risk Tolerance: Others prefer stability

and may choose investments with lower

returns to avoid potential losses.

Fundamental concept of the relationship between risk and

return in finance and investment:
1. Basic Principle of Risk and Return
 The relationship is straightforward: higher risk typically
 means higher potential returns, while lower risk
usually corresponds to lower potential returns.
 High-risk investments (e.g., stocks) can yield high

returns but are also subject to market volatility.

Conversely, low-risk investments (e.g., government
bonds) offer more stable but generally lower returns.
2. Understanding Risk
 Risk is an inherent aspect of investing and can take

various forms, including:

o Market Risk: Fluctuations in the market affecting

investment value.
o Credit Risk: The possibility of a borrower

defaulting on a loan.
o Liquidity Risk: Difficulty in converting an
investment to cash without a loss in value.
o Operational Risk: Risks arising from internal

processes or systems.
 Investors must evaluate their risk tolerance, which

reflects their comfort with uncertainty and potential

losses.
3. Diversification as a Strategy
 Diversification is a key strategy to balance risk and

return.
 By investing across various asset classes, sectors, and

geographic regions, investors can mitigate the impact

of poor performance in any single investment.
 While diversification does not eliminate risk, it helps

reduce overall portfolio volatility, leading to a more

stable investment experience.
4. Risk-Return Trade-Off in Portfolio Management
 In portfolio management, investors strive to maximize
 returns for a given level of risk or minimize risk for a
targeted return.
 Tools such as the Capital Asset Pricing Model (CAPM)

and the Efficient Frontier aid investors in

understanding and optimizing this trade-off.
5. Real-World Implications
 The risk-return relationship affects decision-making in

areas like personal finance, retirement planning, and

overall investment strategies.
 For example:

o A young investor with a high-risk tolerance may

favor stocks for growth.

o An investor nearing retirement might opt for

bonds to preserve capital and reduce risk.

Hurdle Rate
 The hurdle rate is the minimum rate of return on an

investment that an investor requires before considering

it worthwhile. It is often used in capital budgeting to
assess the feasibility of an investment project.
 The hurdle rate typically reflects:

o The risk-free rate (e.g., the return on government

bonds).
o A risk premium for the specific investment, based

on its risk profile.

Marginal Investor Perspective

 Marginal Investor: This concept refers to the investor

who is most likely to trade a stock at any given time.

Understanding risk from this perspective is crucial
because:
 o It determines how the stock is valued in the
market based on supply and demand dynamics.
o The marginal investor’s expectations influence
stock prices, as they are more sensitive to
changes in risk and return conditions.

6. Conclusion
 Understanding the risk-return relationship is vital for

informed investment decisions, helping investors set

realistic expectations and manage their portfolios
effectively.
 While high returns are appealing, assessing associated

risks and aligning them with personal financial goals is

crucial. Balancing risk and return enables investors to
pursue their financial objectives while minimizing
setbacks.

Framework for understanding and measuring investment

risk and how it relates to returns
1. Risk and Return Relationship:
 Risk in an investment is measured by the variance in

actual returns compared to expected returns. In simple

terms, it shows how much the actual returns fluctuate
around what was anticipated.
 Investments can be classified based on risk:

o Riskless Investment: No variance in returns; the

actual return is always the expected return.

o Low-Risk Investment: Returns have low variability

around the expected return.

o High-Risk Investment: Returns show significant

variability around the expected return.

2. Rewarded vs. Unrewarded Risk:
 Firm-Specific Risk: This is the risk unique to a particular

company or investment. It can be diversified away by

holding a wide variety of investments (a diversified
portfolio).
 Market Risk: This is the risk that affects all investments

in the market (e.g., economic downturns). It cannot be

diversified away because it impacts most or all assets.
 Key Concept: Investors are only rewarded for taking on

market risk, not firm-specific risk, since firm-specific

risk can be eliminated through diversification.
3. Measuring Market Risk:
 There are several ways to measure market risk, which is

the risk added by an investment to the overall market

portfolio:
o The CAPM (Capital Asset Pricing Model):
Assumes that in a perfect market (no private
information or transaction costs), everyone holds
the same market portfolio that includes every
traded asset. The market risk of an asset is
measured by how much risk it adds to this
portfolio.
o The APM (Arbitrage Pricing Model): Suggests

that market risk is captured by factors that affect

all investments (e.g., interest rates, inflation).
Each asset's risk is related to these factors.
o Multi-Factor Models: These models suggest that

market risk comes from macroeconomic factors,

and the risk of an asset is determined by how
much it is exposed to these factors.
o Proxy Models: In efficient markets, long-term
 differences in returns are due to market risk.
Proxy variables (like size or price-to-earnings
ratio) are used to estimate this risk.
4. Beta:
 CAPM Beta: Measures an asset's sensitivity to

movements in the overall market portfolio.

 Factor Model Beta: Measures an asset’s sensitivity to

unspecified factors that affect the market.

 Macroeconomic Beta: Measures an asset's sensitivity

to specified macroeconomic factors.

 Proxy Model Beta: Measures the relationship between

returns and proxy variables that reflect market risk.

In Behavioral Finance, risk assessment diverges from the

traditional mean-variance school’s view of risk in three key
aspects:
1. Loss Aversion: Behavioral finance highlights that
people often fear losses more than they value
equivalent gains. This is a central concept in prospect
theory, which suggests that individuals are more
sensitive to potential losses than to gains of the same
magnitude, leading them to make risk-averse choices
even when it is irrational from a mean-variance
perspective.
2. Familiarity Bias: Investors tend to prefer assets or
investments they are familiar with, even if such choices
may not provide the best risk-return tradeoff. This bias
can lead them to under-diversify their portfolios and
take on higher risk, contrary to the mean-variance
approach, which advocates for diversification based on
optimal return-to-risk ratios.
 3. Emotional Factors: Emotions play a significant role in
financial decision-making. Behavioral finance suggests
that emotions such as fear, overconfidence, or anxiety
can lead to irrational decisions. This stands in contrast
to the rational, objective calculations emphasized by
the mean-variance school, where risk is evaluated
without emotional interference.

Components of risk that a firm faces when making

investments and explains how diversification helps reduce
firm-specific risk.
The Components of Risk
1. Project-Specific Risk: This is the risk tied to the
cashflows of a particular project. A firm might
overestimate or underestimate the costs or revenues of
a project due to errors or unforeseen circumstances.
However, when firms engage in multiple projects, the
risk specific to each project can be diversified and
managed better, as errors in one project might be
offset by successes in others.
2. Competitive Risk: This type of risk arises from how
competitors behave, which can impact the profitability
of a project. Firms try to predict competitors' actions,
but actual outcomes can differ. Unlike project-specific
risks, competitive risk affects multiple projects and is
harder to eliminate.
3. Industry-Specific Risk: This risk affects an entire
industry and stems from factors like technology
changes, legal regulations, or commodity price
fluctuations. Firms cannot diversify this risk unless they
operate in different industries, but investors can
 manage it by holding stocks in diverse sectors.
4. International Risk: When a firm operates
internationally, exchange rate fluctuations and political
developments can impact its earnings. Firms can
mitigate this by operating in multiple countries or
borrowing in local currencies. Investors can reduce
international risk by holding global portfolios.
5. Market Risk: This is the broadest type of risk, affecting
all firms due to macroeconomic factors like changes in
interest rates, inflation, and economic growth. No
amount of diversification can eliminate market risk, as
it impacts all investments.

Why Diversification Reduces or Eliminates Firm-Specific

Risk
Diversification helps reduce firm-specific risk (such as
project-specific, competitive, and industry-specific risks)
because:
1. Smaller Portfolio Impact: In a diversified portfolio,
individual investments represent a smaller portion of
the overall portfolio, so any adverse impact on one
investment has a limited effect on the entire portfolio.
2. Offsetting Effects: The negative impacts on some
investments are often balanced out by positive impacts
on others, reducing overall volatility.
However, risks that affect the entire market, like changes in
interest rates or inflation, cannot be eliminated through
diversification because they impact all investments.
Statistical Explanation of Diversification
Diversification's benefits are seen mathematically when
combining assets in a portfolio. When the returns of two
assets do not move together, the combined portfolio's risk
(measured by standard deviation) is lower than that of the
individual assets. The formula to calculate the portfolio's risk
accounts for the correlation between the two assets' returns.

Types of Risks:
The concept of risk categories in project management is
used to classify different types of risks that can impact a
project. These classifications help in identifying, assessing,
and mitigating risks.
Main Risk Categories
1. Project-Level Risks: These risks directly affect the
specific project being undertaken. They include issues
related to budget, schedule, resources, and scope.
These risks can slow down or derail a project but
typically do not impact the broader business unless
they are severe.
Examples include:
o Budget overruns

o Resource shortages

o Missed deadlines

2. Business-Level Risks: These risks are broader and

impact the entire organization. They affect overall
operations and strategy, which may influence how
projects are prioritized, governed, and executed. Risks
in this category include customer satisfaction issues,
workforce challenges, and governance problems.
Examples include:
o Poor project governance

o Workforce instability

o Failure to prioritize critical projects

Subcategories of Risks
Both project-level and business-level risks can be divided into
the following types:
1. Financial Risks: These risks pertain to financial issues
such as escalating costs, insufficient funding, and
unrealistic budgeting. They can occur due to poor
financial planning or unexpected cost increases.
2. Strategic Risks: These risks are associated with the
strategies used to manage and execute the project.
Choosing the wrong project management
methodology, having poor planning techniques, or
lacking investment in necessary technology can lead to
strategic risks.
3. Performance Risks: These risks involve how well the
project is performing. Factors like unclear expectations,
undefined key performance indicators (KPIs), and
outdated research contribute to performance risks.
4. External Risks: These risks arise from factors outside
the project or organization, such as natural disasters,
legal issues, market changes, or supply chain
disruptions. They are less predictable and can have
widespread effects.

Major Risks in Project Management

Project management is fraught with various risks that can
significantly impact a project’s success. Among these risks,
certain ones are more severe and can stall or even halt a
project altogether. Some of the major risks include major
budget overages, workforce volatility, production and
procurement problems, scheduling and resource
mismanagement, and organizational changes.
1. Major Budget Overages
Budget constraints are one of the most critical factors in
project planning. If a project exceeds its budget, it could
threaten the financial health of the organization. Budget
overages can occur due to various reasons, including:
 Insufficient Planning: If project teams overlook

emergency expenses or miscalculate project costs, they

can quickly exceed their budgets. For example, if a
project team fails to account for potential rework due
to measurement errors, they may run out of funds to
cover the additional costs.
 Unexpected Costs: If unforeseen issues arise, such as

equipment failures or the need for additional

resources, the project can become financially unviable.
To manage budget risks effectively, project managers should
conduct thorough research, create detailed budgets, include
contingencies for emergencies, and continuously update
budgets throughout the project.
2. Retention of Skilled Employees
Employee turnover is a significant risk for project success.
High turnover rates can disrupt project timelines and erode
team cohesion, leading to:
 Knowledge Gaps: When experienced employees leave,

they take valuable skills and institutional knowledge

with them. For example, if a senior engineer leaves
without proper training programs in place, the
company may find itself unable to fulfill project
requirements effectively.
 Reduced Morale: A constantly changing workforce can

lead to low morale among remaining employees,

further exacerbating turnover rates.
To mitigate this risk, companies should prioritize employee
satisfaction through competitive compensation, training
opportunities, and a supportive work environment. Satisfied
employees are more likely to stay, maintaining the skill level
necessary for successful project execution.
3. Procurement and Production Complications
For projects involving physical products, sourcing materials is
essential. Supply chain disruptions can halt project progress,
such as:
 Material Shortages: Natural disasters or market

fluctuations can impact material availability and costs.

For instance, if a furniture company relies on a specific
type of wood that becomes scarce due to wildfires,
they may face delays and increased costs, ultimately
affecting customer satisfaction.
To reduce procurement risks, companies should diversify
suppliers, maintain inventory reserves, and be transparent
with customers about potential delays.
4. Resource Mismanagement
Effective management of resources—financial, human, and
material—is crucial for project success. Mismanagement can
lead to:
 Overutilization of Resources: If resources are stretched

too thin, it can result in burnout among employees and

delays in project timelines. For example, if a coffee
chain opens a new store without adequately staffing it,
existing stores may struggle to maintain operations,
leading to high turnover rates among employees.
Implementing resource management processes, such as
regular assessments of resource allocation and maintaining
emergency reserves, can help avoid these issues.
5. Organizational Changes
Changes in company leadership or priorities can significantly
impact project funding and direction. Projects may be
deprioritized, shelved, or canceled altogether if a new CEO
re-evaluates the budget and resource allocation. For
instance, a company sponsoring a marathon event may find
that the new CEO views it as an unnecessary expense,
leading to the cancellation of the sponsorship.
While organizational changes can lead to beneficial
outcomes, they can also result in lost momentum for
ongoing projects. It’s crucial for companies to evaluate the
impact of such changes on existing initiatives.
Common Project Risks
In addition to the major risks, there are several common
project risks that, while not always project-ending, require
attention:
 Scope Creep: This occurs when project requirements

increase without corresponding adjustments to budget

or timeline, often due to poor communication. For
example, if a project to update an app's checkout page
expands to include additional features midway through
development, it can lead to delays and increased costs.
 Low Sales Performance: A project may be at risk if

sales do not meet expectations, potentially leading to

project cancellation or shifts in focus. Conducting
thorough market research can help mitigate this risk by
aligning project offerings with customer demand.
 External Hazards: Unforeseen events such as natural

disasters can disrupt project timelines. Having

contingency plans in place, including emergency funds
and insurance, can help mitigate these risks.
  IT Risks: Data management and security are critical
components of project management. Implementing
regular data backups and employee training can help
prevent IT-related crises.
 Construction Risks: Construction projects are complex
and can face numerous risks if not managed properly.
Effective communication, real-time updates to budgets
and schedules, and adherence to legal requirements
are essential for success.

Project Risk Categories (PMBOK)

The Project Management Body of Knowledge (PMBOK)
classifies project risks into three categories:
 Operational Risks: These risks relate to the execution

and results of the project, becoming more prevalent in

the later stages.
 Short-Term Strategic Risks: These risks affect the

project during its execution and may influence

immediate stakeholders.
 Long-Term Strategic Risks: These risks pertain to the

overarching goals and objectives of the project and

may have lasting implications for users and the
organization.

Best Practices for Managing Project Risk

To ensure successful project completion, project managers
should adopt best practices for risk management, including:
1. Be Proactive: Identify potential risks early in the
project lifecycle. Incorporate risk assessment into
project planning and educate the team about common
risks.
 2. Adopt an Agile Approach: Utilize project management
methodologies like Scrum to manage risks effectively.
Agile practices allow teams to focus on specific tasks
and address issues as they arise.
3. Operate Within Your Means: Avoid risky behaviors by
understanding resource limitations and not
overcommitting.

Concept of the Risk-Free Rate (rf) in finance, which is crucial

for understanding investment returns and risk assessment.
1. Risk-Free Rate (rf):
o The Risk-Free Rate is the return on an investment

that is considered to have no risk of financial loss.

It's a theoretical concept that represents the
minimum return investors expect for any
investment, given that they could opt for a zero-
risk investment.
2. Role in Investment Decisions:
o The Risk-Free Rate serves as a benchmark for

evaluating riskier investments. Investors expect to

earn a return above this rate to compensate for
the additional risk they are taking on with more
volatile assets. In other words, the higher the risk
associated with an investment, the higher the
expected return should be relative to the risk-free
rate.
3. Yield to Maturity (YTM):
o The Risk-Free Rate should ideally reflect the Yield

to Maturity (YTM) on government bonds that are

considered default-free. YTM is the total return
anticipated on a bond if it is held until it matures,
 and it incorporates both the bond's current
market price and its interest payments.
o Government bonds, particularly those issued by

stable governments (like U.S. Treasury bonds), are

typically viewed as default-free because they are
backed by the government, which can raise taxes
or print money to meet its obligations.
4. Equivalence in Maturity:
o When assessing the Risk-Free Rate, it’s important

to match the duration of the bonds to the

duration of the cash flows being analysed. For
example, if an investor is evaluating a project with
cash flows expected over ten years, they should
consider the yield on a ten-year government bond
as their risk-free rate. This ensures that the rate
reflects the same timeframe as the investment
being assessed.

The risk-free rate of return is a crucial concept in finance,

representing the theoretical return on an investment that
carries no risk. This rate acts as a baseline for investors,
helping them gauge whether the potential returns of riskier
investments justify the added risks involved.
Definition and Importance
1. What It Is:
o The risk-free rate of return is the return expected

from an investment with zero risk over a specific

period.
o It is often used as a benchmark to compare

against other investments with varying risk levels.

2. Real Risk-Free Rate:
 o The "real" risk-free rate can be calculated by
subtracting the current inflation rate from the
yield of a Treasury bond that matches the
investment's duration.
Key Takeaways
 Theoretical Minimum Return: It serves as the

minimum return an investor should expect for taking

on any investment.
 Investor Behaviour: Investors will only accept risks if

the potential returns exceed the risk-free rate.

 Practical Limitations: A truly risk-free rate does not

exist, as all investments entail some degree of risk.

Calculation
 The real risk-free rate is calculated as:

Real Risk-Free Rate=Yield on Treasury Bond−Inflation

Common Proxies for Risk-Free Rate

1. U.S. Treasury Bills (T-Bills):
o The interest rate on a three-month U.S. T-bill is

frequently used as the risk-free rate in the U.S.

because the U.S. government is considered highly
unlikely to default.
o T-bills are short-term government securities sold

at a discount and don’t pay traditional interest.

2. Other Government Securities:
o In other countries, similar short-term government

bonds (like German Bunds or Swiss Bonds) are

used as proxies.
Factors Influencing the Risk-Free Rate
1. Monetary Policy:
o Central banks influence the risk-free rate through
 interest rate adjustments to manage economic
growth and inflation.
2. Economic Conditions:
o Economic growth, inflation, and employment

levels impact the risk-free rate. Strong growth

may lead to higher rates.
3. Inflation Expectations:
o Investors seek compensation for inflation to

maintain purchasing power, affecting the risk-free

rate.
4. Supply and Demand:
o The demand for government securities influences

yields. High demand can lower yields and the risk-

free rate.
5. Market Sentiment:
o During uncertainty, demand for risk-free assets

may increase, affecting the risk-free rate.

Limitations of the Risk-Free Rate
 Assumption of Zero Risk: The concept assumes risk

neutrality, which is not practical, as all investments

involve some risk.
 Market Fluctuations: The risk-free rate can change due

to various market factors, making it an unstable long-

term benchmark.
 Variability Across Countries: The risk-free rate differs

by country due to varying economic conditions and

policies.
 Liquidity Risk: Proxies for the risk-free rate may not

account for liquidity risk, particularly during market

stress.
Financial Applications
  Valuation Models: The risk-free rate is crucial in
models like the Capital Asset Pricing Model (CAPM),
where it serves as a base for determining expected
returns on risky assets.
 Bond Pricing: It influences bond yields, as bond prices
are calculated using the prevailing risk-free rate for
discounting future cash flows.
 Investment Strategy: Investors compare the expected
return of investments to the risk-free rate to assess risk
versus reward.

Estimating the cost of equity involves determining the

return that equity investors require for holding a company's
stock, given the risk associated with that investment. Two
common models used for this purpose are the Capital Asset
Pricing Model (CAPM) and the Arbitrage Pricing Model
(APM) or multifactor model.
1. Capital Asset Pricing Model (CAPM)
The CAPM is a widely-used model that establishes a linear
relationship between the expected return on an asset and its
systematic risk (beta). The formula is:
Expected Return = Risk-Free Rate + Beta × Expected Risk
Premium
 Risk-Free Rate: This is the return on an investment with

zero risk, typically represented by government bonds

(e.g., U.S. Treasury bonds). It serves as a baseline for
expected returns.
 Beta (β): Beta measures the sensitivity of the stock's

returns relative to the overall market returns. A beta

greater than 1 indicates that the stock is more volatile
than the market, while a beta less than 1 indicates it is
 less volatile.
 Expected Risk Premium: This represents the additional

return investors expect for taking on the risk of

investing in the stock market compared to risk-free
assets. It is typically calculated as the difference
between the expected market return and the risk-free
rate.
2. Arbitrage Pricing Model (APM) and Multifactor Model
The APM and multifactor models extend the CAPM by
incorporating multiple factors that may affect expected
returns. The formula can be expressed as:
Expected Return = Risk-Free Rate + n Σ(Beta x j) = 1 (Beta x
j) × Risk Premium x j)
Where:
 n: Represents the number of factors considered in the

model.
 Beta_j (β_j): The sensitivity of the stock’s returns to the

j-th factor. Each beta corresponds to a different risk

factor.
 Risk Premium_j: The expected return associated with

the j-th risk factor. This captures the return investors

expect for taking on risk related to that specific factor.

Equity Risk Premium (ERP)

The Equity Risk Premium (ERP) is the additional return that
investors expect to earn from investing in the stock market
over a risk-free rate, typically represented by government
bonds. It reflects the extra compensation that investors
require for taking on the higher risk associated with equity
investments compared to risk-free investments.
Key Points About ERP
 1. Positive Premium:
o The ERP is generally expected to be greater than

zero. This means that investors anticipate a return

on equities that exceeds the return on risk-free
investments. If the ERP were zero or negative, it
would imply that investors are indifferent to the
risks of holding stocks compared to risk-free
assets, which is not a realistic assumption given
the inherent risks of equity investments.
2. Relationship with Risk Aversion:
o The ERP increases with the risk aversion of

investors. Risk-averse investors demand a higher

premium for taking on additional risk. For
example, during times of economic uncertainty,
investors may become more risk-averse, leading
to an increase in the equity risk premium as they
seek greater compensation for holding riskier
assets.
3. Relation to Riskiness of Investments:
o The ERP increases with the riskiness of the

"average" risk investment. When the general

market perception of risk increases (e.g., during
economic downturns or periods of volatility),
investors require a higher risk premium for
equities. Conversely, if the average risk of equities
is perceived as lower, the ERP may decrease.
Factors Influencing Equity Risk Premium
 Economic Conditions: During periods of economic

uncertainty or downturns, the ERP tends to increase as

investors become more risk-averse.
 Market Volatility: Higher market volatility often leads
 to a higher ERP, as it signals greater uncertainty about
future returns.
 Investor Sentiment: Changes in investor confidence can
also impact the ERP. For instance, during bull markets,
investors may be less risk-averse, potentially leading to
a lower ERP.

Calculating the equity risk premium involves various

approaches, each providing insights into the additional
return that investors expect for taking on equity risk. Here’s a
breakdown of the three main methods mentioned:
1. Survey Method
 Description: This approach involves directly surveying

investors about their desired equity risk premiums.

Researchers or financial analysts gather data on how
much additional return investors expect from equities
over a risk-free rate.
 Process:

o Conduct surveys targeting a broad range of

investors, including institutional and retail

investors.
o Ask respondents to specify their expected equity

risk premium based on current market conditions.

o Calculate the average premium from these

responses to derive a consensus estimate of the

equity risk premium.
 Advantages: This method reflects the current
sentiment and expectations of investors in the market,
capturing their risk appetite and outlook.
2. Historical Data Method
  Description: This method assumes that the actual risk
premium delivered by equities over long time periods is
approximately equal to the expected risk premium. It
relies on historical returns to estimate the equity risk
premium.
 Process:

o Collect historical data on stock market returns and

risk-free rates over a significant time horizon (e.g.,

10, 20, or more years).
o Calculate the historical average return on equities

and subtract the average return on risk-free

assets during the same period.
o The result gives an estimate of the historical

equity risk premium.

 Advantages: This method provides a long-term

perspective based on actual market performance,

helping to mitigate the impact of short-term market
fluctuations.
3. Implied Premium Method
 Description: This approach estimates the equity risk

premium based on current market prices of assets. It

derives the implied risk premium from the relationship
between expected future cash flows (like dividends)
and current asset prices.
 Process:

o Use the Gordon Growth Model or other valuation

models to calculate the expected returns based

on current prices and anticipated future growth in
earnings or dividends.
o Determine the implied equity risk premium by

comparing the expected return (calculated from

 current prices) with the risk-free rate.
o The formula often used is:

Implied Risk Premium=Expected Return−Risk-Free Rate

 Advantages: This method reflects market conditions

and investor expectations as of today, providing a

forward-looking view of the risk premium.

D. Time Value of Money:

The Time Value of Money (TVM) is a fundamental financial
principle that asserts that money available now is worth
more than the same amount in the future due to its
potential earning capacity. This concept is grounded in the
idea that money can grow over time through investments,
making delays in accessing that money a lost opportunity for
growth.
Key Points:
1. Core Principle: TVM indicates that money can earn
interest, leading to the understanding that receiving
money today is more advantageous than receiving the
same amount later.
2. Formula: The TVM formula is used to calculate the
future value (FV) of money based on:
o Present value (PV): The current worth of the

money.
o Interest rate (i): The rate at which the money

grows.
o Number of compounding periods per year (n):

How often the interest is calculated and added to

the principal.
o Time in years (t): The duration for which the
 money is invested or borrowed.
The formula is expressed as: FV=PV×(1+i/n)^n×t
3. Compounding Interest: When money is invested, it can
earn compound interest. This means interest is earned
on both the initial principal and the accumulated
interest from previous periods. The more frequently
the interest is compounded (e.g., annually, quarterly,
monthly, or daily), the greater the future value.
4. Inflation Impact: Money that is not invested can lose
purchasing power over time due to inflation. For
example, hiding cash under a mattress may seem safe,
but the money will not earn interest and will be worth
less in real terms after several years.
5. Opportunity Cost: TVM relates to opportunity cost,
which is the potential gain lost when choosing one
alternative over another. Delaying cash payments or
not investing can result in losing out on potential
returns.
6. Importance in Finance: TVM is crucial for investment
decisions, financial planning, and valuation methods
like discounted cash flow (DCF) analysis. It helps in
comparing projects, making investment decisions, and
managing risks in finance.
Practical Implications:
 Investment Decisions: Investors can make informed

choices by evaluating the present value versus future

value of different cash flows.
 Project Evaluation: Businesses can assess projects

based on when they expect to receive cash flows, with

earlier returns generally being more desirable.
E. Agency Problem:
An agency problem refers to a conflict of interest that arises
when one party (the agent) is expected to act in the best
interest of another party (the principal). This situation is
common in corporate finance, where the interests of
company management (agents) may not align with those of
the shareholders (principals). While managers are supposed
to make decisions that enhance shareholder value, they may
instead prioritize their own financial interests.
Key Takeaways
1. Conflict of Interest: The agency problem highlights the
potential conflict between the agent’s self-interest and
the principal's interests.
2. Incentives: Agency problems can arise when agents
have incentives to act against the best interests of the
principals.
3. Mitigation: Solutions to reduce agency problems
include regulatory measures and creating incentives for
agents to align with principals’ interests.
Understanding Agency Problems
Agency problems exist in any principal-agent relationship. In
this setup:
 Agent: Performs tasks on behalf of the principal (e.g., a

manager hired by shareholders).

 Principal: Delegates tasks to the agent due to

differences in expertise or time constraints.

Causes of Agency Problems
Agency problems arise from:
 Discretion in Task Completion: Agents often have

discretion in how they perform tasks, which can lead to

actions that benefit them rather than the principal.
  Incentives: If agents are motivated by financial rewards
that do not align with the principals' interests, conflicts
can arise.
Minimizing Risks Associated With the Agency Problem
Agency Costs: These are costs incurred by the principal due
to inefficiencies in the agency relationship. While it's
impossible to eliminate agency problems completely,
principals can take steps to minimize risks:
1. Regulations: Implementing contracts or regulations can
help govern the principal-agent relationship. For
instance, the Fiduciary Rule mandates that financial
advisors act in their clients' best interests, thus
mitigating agency issues.
2. Incentives: Aligning the agent’s compensation with the
principal's interests can help reduce agency problems.
For example:
o Performance-based compensation for managers.

o Tying CEO compensation to stock performance to

motivate them to act in shareholders' interests.

3. Payment Structures: Adjusting how agents are
compensated (e.g., paying them based on project
completion rather than hourly wages) can also
minimize the risk of conflicts.

1.5 Capital Budgeting.

 Capital budgeting is the process of assessing the viability

and profitability of potential major projects or

investments. It helps companies determine which projects
align with their strategic goals and are worth pursuing.
 Examples of Projects:
 o Building a New Plant: A company may consider
constructing a new manufacturing facility to expand
production capacity.
o Investing in New Equipment: Upgrading machinery

to improve efficiency and production quality.

o Acquisitions: Taking a significant stake in an external

venture or acquiring another company.

Key Concepts
1. Objective: The main goal of capital budgeting is to assess
whether a prospective project's cash inflows and outflows
will generate sufficient returns to meet a predefined
benchmark.
2. Investment Appraisal: The capital budgeting process is
often referred to as investment appraisal because it helps
in determining which investments will yield the best
return over time.
Importance of Capital Budgeting
 Resource Allocation: Given the limited capital available,

companies must decide which projects are worth pursuing

to enhance shareholder value.
 Financial Analysis: The process involves analyzing
expected cash inflows and outflows, considering both the
potential returns and costs.
Common Methods of Capital Budgeting
1. Discounted Cash Flow (DCF) Analysis:
o DCF evaluates the present value of a project’s

expected cash flows, which include both inflows (like

revenue) and outflows (such as maintenance costs).
o The net present value (NPV) is calculated by

discounting future cash flows to their present value

using a risk-free rate (often based on U.S. Treasury
 bonds).
o DCF helps in determining if the project’s cash inflows

exceed its costs and opportunity costs, ensuring that

it meets or exceeds the hurdle rate (minimum
required return).
2. Payback Analysis:
o This method assesses how long it will take to recover

the initial investment.

o The payback period is calculated by dividing the

initial investment by the average annual cash inflow.

o While simple and quick, this method is less accurate

as it doesn’t consider the time value of money or

cash flows beyond the payback period.
3. Throughput Analysis:
o This more complex approach views the entire

business as a profit-generating system.

o It focuses on maximizing throughput (the amount of

material processed) through bottlenecks in the

system, recognizing that increasing throughput is key
to maximizing profits.
o It considers operating expenses and prioritizes

projects that enhance throughput at critical resource

points.
Discounted Cash Flow (DCF) Measures of Return are
fundamental tools in capital budgeting and investment analysis.
They help businesses evaluate the profitability of projects by
considering the time value of money. Two key DCF measures
are Net Present Value (NPV) and Internal Rate of Return (IRR).
Here’s a breakdown of each:
1. Net Present Value (NPV): NPV is the sum of the present
values of all expected cash flows from a project, including the
initial investment. It measures the profitability of a project by
assessing how much value it adds to the firm.
 Formula:

 Discounting Cash Flows: The cash flows are discounted to

reflect their present value because money available today
is worth more than the same amount in the future due to
its potential earning capacity. The discount rate reflects
the risk of the investment.
 Decision Rule:

o Accept the project if NPV > 0: This means the project

is expected to generate more value than its cost,

contributing positively to the company’s value.
o If NPV < 0, it should be rejected, as the project

would not meet the required return threshold.

2. Internal Rate of Return (IRR): IRR is the discount rate that
makes the NPV of a project equal to zero. It represents the
expected annualized rate of return from the project based on
its cash flows.
 Interpretation: IRR can be thought of as the breakeven

cost of capital. It shows the maximum rate of return that

the project can generate before it becomes unprofitable.
 Calculation: Finding the IRR involves solving the NPV

equation for rrr when NPV = 0: 0=∑(Ct(1+IRR)t)−C0

This is often done using financial calculators or software, as it
involves trial-and-error or iterative methods.
 Decision Rule:

o Accept the project if IRR > hurdle rate: This indicates

that the project is expected to yield a return greater

than the minimum required return (hurdle rate).
o If IRR < hurdle rate, the project should be rejected,

as it does not meet the required return threshold.

Summary of Key Differences
 NPV provides a dollar amount that indicates how much

value an investment is expected to add, while IRR

provides a percentage return expected from the
investment.
 NPV is more suitable when comparing projects of different

scales, as it reflects the actual dollar value added, whereas

IRR can sometimes be misleading when comparing
projects with different cash flow patterns or time frames.

Closure on Cash Flows refers to the final accounting of cash

flows related to a project, particularly concerning how to
handle cash flows at the end of a project's life or the estimation
period. Here’s a detailed explanation of the concepts you
mentioned regarding salvage value and terminal value:
1. Salvage Value: The salvage value is the expected proceeds
from selling the assets of a project at the end of its finite life. It
reflects the residual value of the project’s investment after the
project has concluded.
 Calculation:

o For projects with a finite and relatively short

lifespan, the salvage value is often set equal to the

book value of fixed assets and working capital at the
 end of the project’s life.
o This means that whatever the value of the assets is

recorded in the books at the end of the project, that

amount is expected to be received upon liquidation
or sale.
 Purpose: Including the salvage value is essential for

accurately estimating the overall cash inflows from the

project, as it contributes to the total return generated by
the investment.
2. Terminal Value: Terminal value is used when evaluating
projects with an infinite or very long life. It represents the
present value of all future cash flows that occur after the
explicit estimation period has ended.
 Estimation Period: In practice, cash flows are forecasted

for a finite period (e.g., 5-10 years). After this period, the
project may continue to generate cash flows indefinitely.
The terminal value captures this ongoing value.
 Calculation of Terminal Value:

o The terminal value can be calculated using the

Gordon Growth Model (also known as the

Perpetuity Growth Model), which assumes that cash
flows will continue to grow at a constant rate
indefinitely.
Terminal Value at year t=CF in year (t+1)/(Cost of Capital−Growt
h Rate)
In your example, assuming the cash flow in year 11 grows at a
rate of 2% (the inflation rate), the formula applied would be:
Terminal Value in year 10=
CF in year 11/(Cost of Capital−Growth Rate)
Substituting the values given:
o CF in year 11=715 million
 o Cost of Capital = 8.46% (0.0846)
o Growth Rate = 2% (0.02)

Terminal Value in year 10=715×(1+0.02)/0.0846−0.02=729.30.0

646≈11,275 million

Importance of Terminal Value

 Valuation: Terminal value accounts for a significant

portion of the total valuation of long-term projects. For

example, in discounted cash flow analyses, it often
represents the bulk of the value beyond the explicit
forecast period.
 Investment Decisions: Understanding both salvage value

and terminal value is crucial for making informed

investment decisions, as they impact the overall
assessment of a project's profitability and feasibility.

Overview of Equity Financing and Debt Financing

When businesses need capital, they typically have two primary
financing options: equity financing and debt financing. Most
companies use a mix of both, as each has distinct benefits and
drawbacks.
Key Differences -
 Equity Financing: Involves selling a portion of the

company's ownership (equity) in exchange for capital. This

means giving investors a stake in the business.
 Debt Financing: Involves borrowing funds that must be

paid back with interest over time. This does not involve
giving up ownership but requires regular repayments.
Advantages and Disadvantages
Equity Financing
Advantages:
 No Repayment Obligation: Companies do not have to

repay equity financing like they would a loan, which

reduces financial burden.
 Extra Working Capital: This type of financing provides

additional capital that can be reinvested in business

growth without the stress of debt repayment.
Disadvantages:
 Loss of Control: By selling equity, owners give up a portion

of their ownership, which can affect decision-making and

profit-sharing.
 Profit Sharing: Investors are entitled to a share of the

profits, which can diminish the returns for the original

owners.
 Expensive to Buy Out: If owners wish to buy back equity

from investors, it may be more costly than the original

investment.
Debt Financing
Advantages:
 Control Retention: Owners maintain full control of their

business since lenders do not have a stake in the

company.
 Tax-Deductible Interest: Interest payments on debt can be

deducted from taxes, lowering the overall cost of

borrowing.
 Predictable Expenses: Loan payments are consistent,

making financial forecasting easier.

Disadvantages:
 Repayment Obligation: Companies must adhere to

repayment schedules, which can strain finances, especially

 during tough times.
 Risk of Default: If a company fails to meet debt

obligations, it can lead to bankruptcy or asset seizure.

 Personal Guarantees: Lenders may require personal

guarantees, putting personal assets at risk.

Factors Influencing the Choice Between Debt and Equity
Financing
The decision to pursue equity or debt financing typically hinges
on several factors:
 Access to Funding: Which source of financing is more

readily available based on the company’s current financial

situation.
 Cash Flow: Companies with strong cash flow may prefer

debt to retain ownership, while those needing immediate

capital may lean towards equity.
 Control: How important is it for owners to maintain

control of their business? Equity financing dilutes

ownership, while debt does not.

Debt-to-Equity Ratio
The debt-to-equity (D/E) ratio is a financial metric that
compares the company’s total debt to its total equity. A lower
D/E ratio suggests that a company is using less leverage, which
can be favorable for future borrowing.
Sources of Financing
Debt Financing Sources
1. Term Loans: Loans with a fixed repayment schedule.
2. Business Lines of Credit: Flexible borrowing options up to
a set limit.
3. Invoice Factoring: Selling invoices at a discount to improve
cash flow.
 4. Business Credit Cards: Short-term financing with credit
lines.
5. Personal Loans: Loans from family or friends.
6. Peer-to-Peer (P2P) Lending: Borrowing from individuals
through online platforms.
7. SBA Loans: Government-backed loans with favorable
terms.
Equity Financing Sources
1. Angel Investors: Individuals who invest their personal
funds in exchange for equity.
2. Crowdfunding: Raising small amounts of money from
many people, typically via online platforms.
3. Venture Capital Firms: Professional investment firms that
provide funding in exchange for equity stakes.
4. Corporate Investors: Larger companies that invest in
smaller firms for strategic reasons.
5. Initial Public Offering (IPO): Selling shares of the company
to the public for the first time.

Types of equity, focusing on Owner’s Equity, Venture Capital

and Private Equity, and Common Stock:
1. Owner’s Equity
Definition: Owner’s equity, also known as shareholder’s equity
for corporations, represents the owner’s residual interest in the
assets of a business after deducting liabilities. It reflects the net
worth of the business from the owner's perspective.
Components:
 Capital Contributions: The initial investment made by the

owner(s) into the business.

 Retained Earnings: Profits that are reinvested in the

business rather than distributed as dividends.

  Drawings: Funds withdrawn by the owner from the
business for personal use, which reduce the owner’s
equity.
Importance: Owner’s equity is a critical measure of a company's
financial health. It can indicate how well the business is
performing and its capacity to generate returns for the
owner(s).

2. Venture Capital and Private Equity

Venture Capital (VC):
 Definition: Venture capital is a type of private equity

focused on investing in early-stage, high-potential startup

companies. VC investors provide funding in exchange for
equity, typically in the form of preferred stock.
 Characteristics:

o VC investments are high-risk, as they often target

unproven businesses.
o Venture capitalists not only provide funding but may

also offer mentorship, industry connections, and

strategic guidance.
o Investments are typically made in rounds, with

funding amounts increasing as the company grows

and proves its business model.
Private Equity (PE):
 Definition: Private equity involves investments in more

mature companies, often taking a controlling interest. PE

firms typically buy out companies, restructure them, and
aim to improve profitability before selling them for a
profit.
 Characteristics:

o PE investments are often larger than VC investments

 and focus on established companies.
o Private equity firms usually employ operational
improvements and strategic changes to enhance the
company’s value.
o Investors expect a significant return on investment
within a relatively short time frame, usually around 3
to 7 years.

3. Common Stock
Definition: Common stock represents ownership shares in a
corporation. Holders of common stock have voting rights and
the potential to receive dividends, although dividends are not
guaranteed.
Characteristics:
 Voting Rights: Common stockholders typically have the

right to vote on important company matters, including the

election of the board of directors and corporate policies.
 Dividends: Common stockholders may receive dividends

based on the company's profitability, but these dividends

are not fixed and depend on the company’s discretion.
 Claim on Assets: In the event of liquidation, common

stockholders are last in line to receive any remaining

assets after creditors and preferred stockholders have
been paid.
Importance: Common stock is a way for companies to raise
capital while providing investors with an opportunity to
participate in the company’s growth and success. The price of
common stock can fluctuate based on market conditions,
company performance, and investor sentiment.

Types of Debt
In corporate finance, debt financing plays a crucial role in
funding operations and growth. Here’s a brief overview of the
three main types of debt you mentioned:
1. Bank Debt
Definition: Bank debt refers to loans or credit facilities provided
by banks or financial institutions to companies. It can be
secured (backed by collateral) or unsecured (not backed by
collateral).
Key Features:
 Term Loans: Loans that have a specified repayment period

and fixed or variable interest rates.

 Revolving Credit: A line of credit that allows companies to

borrow, repay, and borrow again up to a certain limit.

 Syndicated Loans: Large loans provided by a group of

lenders, allowing risk sharing among financial institutions.

2. Bonds
Definition: Bonds are debt securities issued by companies (or
governments) to raise capital. Investors buy bonds and, in
return, receive periodic interest payments (coupons) and the
principal amount at maturity.
Key Features:
 Corporate Bonds: Issued by companies; can vary in risk

based on the company's credit rating.

 Convertible Bonds: Can be converted into equity shares at

a predetermined price, giving investors potential upside.

 Debentures: Unsecured bonds that rely on the issuer's

creditworthiness rather than collateral.

3. Leases
Definition: A lease is a contractual agreement where one party
(the lessee) pays for the use of an asset owned by another
party (the lessor) over a specified period.
Key Features:
 Operating Leases: Short-term leases that do not transfer

ownership of the asset; classified as off-balance-sheet

financing.
 Finance Leases: Long-term leases that transfer
substantially all risks and rewards of ownership to the
lessee; typically recorded on the balance sheet.
 Tax Benefits: Companies can often deduct lease payments

as business expenses, providing potential tax advantages.

"Life Cycle Analysis of Financing," illustrates how a company’s

financing needs and sources evolve throughout its life cycle.
This analysis helps in understanding the relationship between
revenues, earnings, and various types of funding as a company
progresses through different stages. Here’s a detailed
breakdown of each component of the figure:
Key Components of the Figure
1. Stages of the Life Cycle:
o Stage 1: Start-up: This stage typically involves the

initial setup of the business, where revenues are

negative or low. Companies often rely heavily on
external financing sources like owner’s equity and
venture capital to fund operations and growth.
o Stage 2: Rapid Expansion: As the business begins to

grow, revenue increases, but funding needs are still

high due to infrastructure development. Companies
may access private equity or venture capital.
o Stage 3: High Growth: Revenue and earnings grow

rapidly. Companies may begin considering an initial

public offering (IPO) or seasoned equity issues to
raise additional capital.
 o Stage 4: Mature Growth: Growth stabilizes,
revenues are moderate relative to firm value, and
internal financing becomes more feasible.
Companies may retire debt or repurchase stock
during this stage.
o Stage 5: Decline: Revenues and projects may

decline, leading to a reduced need for external

funding.
2. Revenues/Earnings:
o This axis reflects the company's performance over

time, illustrating how revenues and earnings evolve

as the company transitions through each stage.
Initially negative or low, revenues increase
significantly during the growth stages and may
decline during the decline phase.
3. External Funding Needs:
o High in the early stages due to the need for

investment in infrastructure and operations. These

needs decrease as the company matures and can
rely more on internal financing.
4. Internal Financing:
o Internal financing refers to the funds generated from

within the company, such as retained earnings. This

becomes more significant as the company matures,
especially during the mature growth stage, as
projects may dry up and the need for external
financing diminishes.
5. External Financing:
o Various sources of external financing are listed,

including:
 Owner's Equity: Investments made by the
 owners or founders.
 Venture Capital: Financing from investors

looking to fund high-growth potential

companies.
 Bank Debt: Loans from financial institutions.

 Common Stock: Equity raised by issuing shares.

 Debt Instruments: Bonds and convertibles that

provide additional funding options.

6. Financing Transitions:
o The figure likely outlines key transitions between

different types of financing as the company evolves.

For example:
 Transitioning from venture capital to an IPO for

broader access to capital.

 Moving from bank debt to bond issues as the

company matures and seeks more favorable

financing options.

The process involved in raising funds from private equity for the
expansion of a private firm:
1. Provoke Equity Investor’s Interest
To attract private equity investors, a firm must effectively
present its business case and growth potential. This involves:
 Identifying Target Investors: Understanding which private

equity firms are interested in the industry or market

segment in which the company operates.
 Creating a Compelling Pitch: Developing a persuasive

presentation that highlights the company’s unique selling

propositions (USPs), market position, competitive
advantages, and growth prospects.
 Demonstrating a Strong Management Team: Investors
 look for capable leadership with a track record of success,
as a strong team increases confidence in executing the
business plan.
2. Valuation and Return Assessment
Valuation is critical in determining how much equity investors
will receive in exchange for their investment. This step includes:
 Conducting a Business Valuation: Utilizing various

methods (e.g., discounted cash flow analysis, comparable

company analysis) to establish the company's worth.
 Assessing Return Expectations: Investors will assess

potential returns on their investment, often looking for a

target internal rate of return (IRR). A clear understanding
of how the investment will generate returns is essential
for convincing investors.
3. Structuring the Deal
Once interest is piqued and valuation is established, the next
step is to structure the investment deal. This involves:
 Defining the Investment Terms: Establishing the amount

of equity or debt financing, preferred shares, rights, and

obligations of investors and the company.
 Negotiating Terms: Engaging in discussions to agree on

key aspects such as governance rights, exit strategies, and

performance metrics that will guide the investment.
 Legal Considerations: Drafting legal agreements that

outline all terms and conditions of the investment to

ensure clarity and protect both parties' interests.
4. Post-Deal Management
After securing the investment, the focus shifts to managing the
relationship with investors and executing the business plan:
 Regular Communication: Maintaining open lines of

communication with investors through updates on

 financial performance, milestones, and strategic decisions.
 Implementing Growth Strategies: Utilizing the funds

effectively to drive business growth, optimize operations,

and achieve projected targets.
 Monitoring Performance: Continuously assessing
performance against agreed-upon metrics and making
adjustments as necessary to ensure the company remains
on track to meet growth objectives.
5. Exit
Eventually, private equity investors will seek to exit their
investment to realize returns. Exit strategies can include:
 Initial Public Offering (IPO): Taking the company public,

allowing investors to sell their shares on the stock market.

 Acquisition: Selling the company to another firm, often at

a premium, which can provide substantial returns.

 Secondary Sales: Selling shares to other private equity

firms or institutional investors.

The Costs of Debt

When a company takes on debt, it incurs several costs beyond
just the repayment of principal and interest. These costs can
significantly affect the company’s financial health and its
relationships with stakeholders. Two key types of costs
associated with debt are expected bankruptcy costs and
agency costs.
1. Debt Increases Expected Bankruptcy Costs
 Expected Bankruptcy Costs: As a company increases its

level of debt, the risk of bankruptcy also rises. This is due

to the fact that fixed interest payments must be met
regardless of the company's financial performance. If a
company experiences financial difficulties, the likelihood
 of bankruptcy increases, leading to potential costs
associated with the bankruptcy process, such as legal fees,
loss of assets, and disruption of operations.
 Impact on Stakeholders: Higher expected bankruptcy

costs can negatively impact the company's valuation and

deter potential investors or creditors. Stakeholders may
demand higher returns to compensate for the increased
risk of default, which can further strain the company's
finances.
2. Debt Creates Agency Costs
Agency costs arise from the conflicts of interest between
different stakeholders—in this case, stockholders (equity
holders) and bondholders (debt holders). These conflicts can
manifest in two primary ways:
A. Higher Interest Rates on Debt
 Perception of Risk: If lenders perceive a significant risk

that stockholder actions could jeopardize their investment

(e.g., through risky projects or excessive payouts), they
may adjust the terms of the debt accordingly.
 Increased Interest Rates: Lenders will often build their

expectations of potential conflicts into higher interest

rates. This compensates them for the increased risk
associated with lending to a company whose equity
holders might prioritize their own interests over those of
the debt holders.
B. Restrictive Covenants
 Bondholders often try to protect their interests by

negotiating restrictive covenants in debt agreements.

These covenants impose specific limitations on the
company’s actions to minimize the risk of actions that
could harm the bondholders' position. This can lead to
 two types of costs:
1. Direct Cost of Monitoring Covenants:
o Monitoring Expenses: The company incurs direct

costs associated with monitoring compliance with

the covenants. As these covenants become more
detailed and restrictive, the costs of ensuring
compliance also increase. This may involve
additional administrative work, audits, or reporting
requirements.
2. Indirect Cost of Lost Investments:
o Opportunity Costs: The company may miss out on

valuable investment opportunities due to the

restrictions imposed by covenants. For example, if
covenants prevent the company from pursuing
certain projects or changing its capital structure, it
may lead to suboptimal decisions that ultimately
impact growth and profitability.
o Inflexibility: As covenants become more stringent,

the firm’s operational flexibility is reduced,

potentially leading to a loss of competitive
advantage.

As companies grow, they need funds for operations, projects,

and paying employees. While sales generate income, most
companies also rely on external capital from investors (equity)
or lenders (debt). The key question is finding the right balance
between equity (selling stock) and debt (issuing bonds). Capital
structure theory helps analyse this decision.
Theories of Capital Structure
1. Net Income Approach
o Proposed by David Durand in 1952, this approach
 supports the use of financial leverage (debt) to
increase firm value.
o The theory suggests that as a company increases its

debt ratio, the overall cost of capital decreases,

which raises the firm’s value. This happens because
debt is usually cheaper than equity.
o However, this approach assumes there's an "optimal

capital structure," where the perfect mix of debt and

equity minimizes costs and maximizes the firm's
value.
2. Static Trade-off Theory
o This theory builds on the work of economists

Modigliani and Miller (M&M), who argued that in

perfect markets, capital structure doesn’t affect a
company’s value—its earnings and asset risk do.
o However, when considering taxes, M&M’s second

proposition suggests that financial leverage can

increase a company’s value by reducing the WACC
(Weighted Average Cost of Capital).
o Debt is cheaper because of tax-deductibility, but the

more debt a company takes on, the riskier it

becomes. The static trade-off theory seeks to find
the balance where the cost savings from debt
financing outweigh the risks.
3. Pecking Order Theory
o This theory prioritizes funding sources. Companies

prefer using internal funds (retained earnings) first,

then debt, and only issue new equity as a last
resort.
o Why this order? Using internal funds signals financial

strength. Debt indicates confidence in meeting

future obligations. Issuing new stock may signal
financial weakness, as companies tend to issue
equity when they think their stock is overvalued.
 MODULE–2: INDIAN EQUITY–PUBLIC FUNDING.

1. Primary Market
The primary market is where new securities are created and offered
to investors for the first time. It is crucial for companies to raise
capital by issuing shares or bonds. Here are the main components of
the primary market:
 Initial Public Offerings (IPOs): The process through which a

private company offers its shares to the public for the first time
to raise capital.
 Follow-on Public Offerings (FPOs): Similar to IPOs but are

conducted by companies that are already publicly traded to

raise additional capital.
 Rights Issues: Existing shareholders are given the right to

purchase additional shares at a discounted price before the

company offers them to the public.
 Reverse Book Building (RBB): A method for companies to buy

back their shares from shareholders, usually at a predetermined

price. It is commonly used for buybacks, tender offers, and
delisting of shares.
 Offer For Sale (OFS): A mechanism that allows promoters or

large shareholders to sell their shares to the public through the

stock exchange.
 Mutual Funds (Open-Ended): Investment funds that allow

investors to buy and sell units at any time based on the fund's
current net asset value (NAV).
 Securitized Debt Instruments: Financial instruments created

through the pooling of various types of debt and selling them to

investors.
  Real Estate Investment Trusts (REITs) / Infrastructure
Investment Trusts (InvITs): Investment vehicles that allow
individuals to invest in income-generating real estate or
infrastructure projects.
 Debt Securities: Instruments issued by companies or
governments to raise funds, including non-convertible
redeemable preference shares (NCRPS), municipal bonds, and
corporate bonds.
 Innovators Growth Platform (IGP): A platform for innovative

start-ups and small and medium enterprises (SMEs) to raise

funds by issuing securities.
2. Secondary Market
The secondary market is where previously issued securities are
traded among investors. This market provides liquidity and an
opportunity for investors to buy or sell their securities. Key
components include:
 Trading of Equity Shares: Buying and selling of shares that have

already been issued by companies on stock exchanges.

 Equity Derivatives: Financial instruments like options and

futures based on the value of underlying equity shares.

 Currency Derivatives: Contracts whose value is derived from

the value of a currency, used for hedging or speculation.

 Interest Rate Derivatives: Financial instruments that derive

their value from interest rates, commonly used for managing

interest rate risk.
 Commodity Derivatives: Contracts that derive their value from

the price of commodities like oil, gold, or agricultural products.

 Debt Securities: Trading of corporate bonds and government

securities that have already been issued and are being resold in
the market.
  Mutual Funds (Close-Ended): Investment funds that have a
fixed number of shares and are traded on the stock exchange,
allowing investors to buy and sell at market prices rather than
the NAV.

The process of going public through an Initial Public Offering (IPO)

involves several key steps that a private company undertakes to raise
capital by selling shares to the public for the first time. Here’s an
explanation of each stage in the going public process:
1. Choose an Investment Banker
 Selection Criteria: The company must select an investment

banker (or underwriter) that specializes in its sector. The right

banker should have experience with similar companies and
understand the industry dynamics.
 Client Base and Reputation: The investment banker’s client

base and reputation can significantly impact the IPO's success.

A well-regarded banker can attract more investors and enhance
the company’s credibility.
 Underwriting Agreement: In most IPOs, the investment banker

agrees to a fixed price for the shares (underwriting guarantee).

This means that they will purchase any unsold shares, thereby
providing a safety net for the company.
2. Assess Value and Set Offer Details
 Valuation Process: The lead investment banker will evaluate

the private company's worth and determine the price per

share. This price is based on the total number of shares and the
amount the company plans to offer.
 Share Quantity Determination: The total number of shares is

chosen based on the desired price range and the company's

cash needs. For instance, if the company is valued at $10 million
 and aims for a share price of $5, they would issue 2 million
shares.
 Pricing Strategy: Investment bankers often suggest lowering the

initial offering price by 10-15% to create a buffer against

potential pricing errors. This can help ensure that the shares sell
successfully.
3. Gauge Investor Demand
 Building the Book: The sales teams of the investment banks will

gauge interest among potential investors and portfolio

managers regarding the attractiveness of the offering price. This
feedback is crucial for setting the final price.
 Road Shows: The bankers and company management conduct

presentations (road shows) to showcase the company's

strengths and growth prospects, aiming to attract potential
investors.
 Adjusting Offering Price: If demand is exceptionally strong, the

offering price may be raised; if demand is weak, the price may

be adjusted downward to entice more investors.
4. Regulatory Filings and Prospectus
 Regulatory Compliance: Before making the offering, the

company must meet various regulatory requirements. In the

U.S., this includes filing a registration statement with the
Securities and Exchange Commission (SEC).
 Publishing a Prospectus: A prospectus is prepared for potential

investors, detailing the investment opportunity, financial data,

business plans, and associated risks. This document is critical
for transparency and regulatory compliance.
5. Share Allocation
 Investor Requests: Once the IPO is open, investors can request

shares. The investment bank is responsible for allocating shares

among investors.
  Oversubscription Management: If demand exceeds supply
(oversubscription), the investment banker must ration shares
among investors. Conversely, if demand is low, the banker must
fulfill their guarantee by purchasing any unsold shares at the
offering price.
6. The IPO and Post-Issue Management
 Trading Begins: On the offering date, the shares become

available for trading on the stock exchange. If priced accurately,

the shares may experience a significant price jump at the
opening.
 Windfall Profits: Investors who received shares in the IPO may

enjoy substantial profits if the stock performs well in the

immediate aftermath.
 Post-Issue Support: Investment bankers may provide support

for the stock if necessary, depending on their financial capacity,

to stabilize the stock price and prevent excessive volatility.

The Underpricing of IPOs: A Behavioral Perspective

The phenomenon of IPO underpricing refers to the tendency for
newly issued shares to debut at a lower price than their true market
value, often leading to significant price jumps on the first day of
trading. From a behavioral perspective, this can be explained by
several theories, including the Impresario Hypothesis and the
concept of Stable Buyers.
1. Stable Buyers
Definition: Stable buyers refer to investors who are consistent in
their buying behavior and have a long-term perspective on their
investments. They are typically institutional investors or retail
investors who buy shares for the long haul rather than for quick
profits.
Implications:
  Demand for IPOs: Stable buyers are more likely to invest in IPOs
if they perceive a genuine long-term value in the company.
Their consistent demand can lead to an upward adjustment in
share prices, resulting in underpricing at the IPO stage.
 Price Stability: The presence of stable buyers can stabilize stock

prices post-IPO, reducing volatility and providing a buffer

against significant price drops.
 Perceived Value: Stable buyers may focus on the fundamental

value of the company, leading to a more rational assessment of

the stock price compared to speculative investors.
2. The Impresario Hypothesis
Definition: The impresario hypothesis suggests that underpricing is a
deliberate strategy employed by underwriters to create a buzz and
demand for the IPO. The idea is that underwriters aim to generate
excitement and media attention around the offering, similar to how
an impresario (a manager or promoter of an entertainment event)
creates anticipation for a show.
Key Points:
 Creating Scarcity: By setting an initial offer price below market

value, underwriters create a sense of scarcity and urgency,

attracting more investors.
 Media Coverage: Underpricing leads to significant first-day

returns, which can attract media coverage and public interest,

further driving demand for the stock.
 Long-Term Relationships: The impresario hypothesis also

suggests that underwriters benefit from establishing long-term

relationships with institutional investors. By underpricing IPOs,
they can cultivate loyalty and ensure future business with these
investors.
Behavioral Factors Influencing Underpricing
  Investor Sentiment: Positive sentiment can lead to increased
demand for IPO shares, causing underwriters to underprice
shares to capitalize on this interest.
 Herding Behavior: Investors often follow the crowd, leading to
greater demand when they see others purchasing shares.
Underpricing can stimulate this herd behavior.
 Risk Aversion: Investors may perceive IPOs as risky;
underpricing mitigates this perceived risk by offering a buffer
against losses on the first day of trading.

2.1 Initial Public Offer (IPO)/Further Public Offer (FPO).

- Initial Public Offer [Reg. 2(w) of SEBI ICDR] is the process
through which an unlisted company offers its specified
securities (like equity shares) to the public for the first
time. This definition encompasses both the sale of new
shares by the company itself and the sale of existing
shares by current shareholders. The goal is to raise capital
from the public, allowing the company to grow while
giving investors the opportunity to buy a stake in a
previously unlisted entity.

Reg. 3 (Applicability of ICDR)

o Initial Public Offers (IPOs) by unlisted issuers.

o Rights Issues by listed issuers with an aggregate

value of ₹50 crores or more.

o Further Public Offers (FPOs) by listed issuers.

o Preferential Issues by listed issuers.

o Qualified Institutional Placements by listed issuers.

o Bonus Issues by listed issuers.

2. Special Provisions for Smaller Rights Issues: If a rights

 issue is less than ₹50 crores, the issuer must still prepare a
letter of offer according to the regulations and file it with
SEBI for information dissemination.
3. Exclusions: These regulations do not apply to the issuance
of securities mentioned in specific clauses of SEBI's
Substantial Acquisition of Shares and Takeovers
Regulations.

Reg. 5 (Entities Ineligible to make IPO)

1. Debarment from Capital Market:
o An issuer cannot proceed with an IPO if the issuer,

any of its promoters, promoter group, or selling

shareholders are currently barred by SEBI from
accessing the capital market.
2. Association with Debarred Entities:
o If any promoter or director of the issuer is also a

promoter or director of another company that is

debarred by SEBI from accessing the capital market,
the issuer is ineligible for an IPO.
3. Willful Defaulter:
o The issuer or any of its promoters or directors must

not be classified as a willful defaulter. A willful

defaulter is typically a borrower who has defaulted
on loans but has not made any genuine efforts to
repay.
4. Fugitive Offender:
o If any of the promoters or directors of the issuer is

considered a fugitive offender (someone who is

fleeing from law enforcement), the issuer is not
eligible to launch an IPO.
5. Outstanding Convertible Securities:
 o The issuer must not have any outstanding
convertible securities or rights that would allow any
person to receive equity shares of the issuer, except
for fully paid-up convertible securities that must be
converted before the Red Herring Prospectus or
Prospectus is filed. Employee stock options that are
part of a scheme are exempted from this restriction.
6. Note on Past Debarments:
o The restrictions in points (a) and (b) do not apply if

the persons or entities mentioned were debarred in

the past, and their period of debarment has ended
by the time the draft offer document is filed with
SEBI.

Reg. 6 (Entities Eligible to make IPO)

1. Financial Requirements (Regulation 6(1)):
An issuer can be eligible for a Main Board listing if it meets
Option I or Option II:
Option I:
To qualify under Option I, an issuer must meet the following
criteria:
 Net Tangible Assets:

o The issuer must have net tangible assets of at least

₹3 crores for each of the past three years.

o Additionally, no more than 50% of these assets can

be held in monetary assets (like cash or cash

equivalents).
 Average Operating Profit:

o The issuer should have an average operating profit

of at least ₹15 crores during the preceding three

years, with operating profit recorded in each of
 those years.
 Net Worth:

o The issuer must possess a net worth of at least ₹1

crore in each of the preceding three full years.

Option II:
If an issuer does not meet the criteria outlined in Option I, it
may still qualify under Option II by:
 Issuing through Book Building:

o Conducting the IPO through the book-building route

and ensuring that at least 75% of the shares are

allotted to Qualified Institutional Buyers (QIBs).
 Non-subscribed QIB Portion:

o If the QIB portion is not fully subscribed, the issue

will fail, even if it is oversubscribed overall.

2. Investor Allocation:
Depending on whether the issuer meets Option I or Option II,
the allocation of shares to different categories of investors will
vary:
 If Option I is met:

o Qualified Institutional Buyers (QIBs): Maximum

50% of the issue.

o Retail Investors: At least 35% of the issue.

o Non-Institutional Investors (NIIs): At least 15% of

the issue.
 If Option I is NOT met:

o Qualified Institutional Buyers (QIBs): Maximum

50% of the issue.

o Retail Investors: At least 10% of the issue.

o Non-Institutional Investors (NIIs): At least 15% of

the issue.
3. Special Conditions for SR Equity Shares (Sub-regulation 3):
If an issuer has issued Special Rights (SR) equity shares to its
promoters or founders, it must comply with additional
conditions to be eligible for an IPO:
 Technology and Innovation Focus:

o The issuer must leverage technology, intellectual

property, or similar fields to add substantial value.

 Net Worth of SR Shareholder:

o The net worth of the SR shareholder (as assessed by

a Registered Valuer) must not exceed ₹1,000 crore.

The valuation considers their investments in other
listed companies but excludes their holdings in the
issuer.
 Promoter Requirement:

o SR shares can only be issued to promoters or

founders who hold executive roles in the issuer.

 Authorization:

o The issuance of SR equity shares must be authorized

by a special resolution passed in a general meeting,

with detailed notice including the size of the issue,
voting rights, dividend rights, sunset provisions, and
matters regarding voting rights equivalence.
 Voting Rights:

o SR equity shares must have a voting rights ratio of at

least 2:1 and up to 10:1 compared to ordinary

shares.
 Face Value and Class of Shares:

o SR equity shares must have the same face value as

ordinary shares, and there can only be one class of

SR equity shares.

Reg. 7 (General Conditions ensured by IPO issuer)

1. Application for Listing (7(1)(a))
 An issuer must apply to one or more stock exchanges to

obtain in-principle approval for listing its specified

securities.
 The issuer must designate one of these stock exchanges as

the designated stock exchange for the IPO.

2. Dematerialisation Agreement (7(1)(b))
 The issuer is required to enter into an agreement with a

depository for the dematerialisation of specified

securities that have already been issued and those
proposed to be issued. This ensures that securities can be
held in electronic form, facilitating easier trading and
transfer.
3. Promoters’ Securities in Dematerialised Form (7(1)(c))
 Before filing the offer document, all specified securities

held by the promoters must be in dematerialised form.

This aims to enhance transparency and ease of
transaction.
4. Partly Paid-up Shares (7(1)(d))
 Any existing partly paid-up equity shares must either be

fully paid-up or have been forfeited before the IPO

process. This ensures that all shares are either completely
owned or are no longer valid, contributing to a clear
ownership structure.
5. Firm Financial Arrangements (7(1)(e))
 The issuer must have made firm arrangements for

financing at least 75% of the stated means of finance for a

specific project funded by the IPO proceeds, excluding the
amount to be raised from the IPO or from existing internal
accruals. This condition emphasizes that the issuer has
secured a significant portion of the necessary funding to
 ensure project viability.
6. Limit on General Corporate Purposes (7(2))
 The funds raised for general corporate purposes must not

exceed 25% of the total amount being raised in the IPO.

This limit is intended to ensure that the majority of the
funds are directed toward specific projects rather than
general operational expenses.
7. Definitions and Additional Conditions (Explanation)
 Project: Refers to the object for which funds are being

raised.
 For issuers that were previously a partnership firm or

limited liability partnership, their track record of

operating profit will only be considered if:
o The financial statements adhere to the format

prescribed for companies under the Companies Act,

2013.
o Adequate disclosures are made as per Schedule III of

the Companies Act.

o Financial statements are certified by a statutory

auditor to ensure compliance with accounting

standards and fair representation.
8. Special Conditions for Divisions of Existing Companies
 If an issuer is formed from a division of an existing

company, the profit track record from that division will be

considered only if it meets the financial statement
requirements similar to those for partnership firms or
limited liability partnerships.
9. Limit on Corporate Purposes and Investments (7(3))
 The amount allocated for general corporate purposes and

any objectives where the issuer hasn’t identified specific

acquisition targets cannot exceed 35% of the amount
 being raised.
 If the issuer has not identified a target for acquisition, this
limit reduces to 25%.
 However, if a specific acquisition or strategic investment is
identified, these limits do not apply, provided that
appropriate disclosures are made in the draft offer
document and the offer document.

Reg. 8 (Additional conditions for an offer of sale)

1. Holding Period for Shares:
o Only fully paid-up equity shares that have been held

by the sellers for at least one year prior to filing the

draft offer document can be offered for sale. This
ensures that the sellers have a substantial holding
period, promoting investor confidence in the
stability of the offering.
2. Convertible Securities Consideration:
o If the equity shares are received through the

conversion or exchange of fully paid-up

compulsorily convertible securities (like convertible
debentures) or depository receipts, the holding
period for these securities and the resulting equity
shares will be considered together to satisfy the
one-year requirement.
o This means that the total time both the convertible

securities and resultant shares have been held must

equal at least one year.
3. Timing of the Holding Period:
o The one-year holding period must be met at the

time of filing the draft offer document. This

emphasizes the importance of the holding period
 relative to regulatory compliance.
4. Completion of Conversion:
o If equity shares arising from the conversion of

convertible securities are being offered for sale, the

conversion must be completed before filing the offer
document (the red herring prospectus for book-built
issues and the prospectus for fixed-price issues).
Additionally, full disclosures regarding the terms of
conversion must be included in the draft offer
document.
5. Exemptions from the Holding Period Requirement: The
one-year holding period requirement does not apply in
the following cases:
o Government and Statutory Entities: Offers for sale

of equity shares by a government company,

statutory authority, or corporation engaged in the
infrastructure sector, including any special purpose
vehicle controlled by them.
o Equity Shares from Court-Approved Schemes: If the

shares were acquired under a scheme approved by a

High Court or tribunal or the Central Government
under specific sections of the Companies Act, 2013.
This applies when the business and invested capital
were in existence for over a year prior to the
scheme's approval.
o Bonus Issues: If the shares are issued as a bonus and

the underlying securities were held for at least one

year before filing the draft offer document, certain
conditions must be satisfied:
 The specified securities must be issued from

free reserves and share premium existing at

 the end of the financial year preceding the
filing.
 The shares must not be issued using
revaluation reserves or unrealized profits.

Reg. 14 (Minimum Promoters’ Contribution)

1. Minimum Holding Requirement (14(1))
 Promoters must hold at least 20% of the post-issue

capital.
 If the promoters’ shareholding falls below 20%, certain

institutional investors (like alternative investment funds,

foreign venture capital investors, banks, and others) can
contribute to meet this shortfall, but their contribution
cannot exceed 10% of the post-issue capital without being
classified as promoters.
 This requirement does not apply if there is no identifiable

promoter.
2. Forms of Contribution (14(2))
 Contribution Methods: Promoters can contribute through

equity shares (including special resolution equity shares)

or convertible securities.
o If the conversion price for equity shares is not

predetermined, promoters must commit to

subscribing to the equity shares upon conversion of
the convertible securities.
 Pricing of Shares:

o When convertible securities are involved, the

conversion price for promoter contributions should

not be lower than the weighted average price of
shares arising from conversion.
o For IPOs of convertible debt instruments without
 prior equity issuance, promoters must contribute at
least 20% of the project cost in equity shares, with
at least 20% of the issue size from their own funds.
3. Timing of Contribution (14(3))
 Promoters must meet these contribution requirements at

least one day prior to the opening of the issue.

4. Escrow Account Requirement (14(4))
 If the promoters need to subscribe to shares or

convertible securities, the contribution must be held in an

escrow account with a scheduled bank and released to
the issuer along with the issue proceeds.
o If the promoters' contribution has already been

utilized, the issuer must disclose the cash flow

statement detailing the use of those funds in the
offer document.
o For contributions over 100 crore rupees, if the IPO

involves partly paid shares, at least 100 crore rupees

must be deposited before the opening date of the
issue, with the remainder brought in on a pro-rata
basis before public calls are made.
5. Clarifications (Explanation)
 Promoters’ Contribution Calculation: This is based on the

post-issue expanded capital, considering full conversion of

convertible securities and any outstanding employee
stock options.
 Weighted Average Price:

o "Weight" refers to the number of equity shares

arising from the conversion of securities.

o "Price" refers to the conversion price based on

predetermined values at various stages.

Reg. 16 (Lock-in of specified securities held by promoters)
 Lock-in Period: This is a specified duration during which

promoters cannot transfer or sell their securities (shares)

in the company. This regulation aims to provide stability to
the newly issued shares and build investor confidence.
Lock-in Period Regulations
1. Minimum Promoters’ Contribution:
o The contribution made by promoters, alternative

investment funds, foreign venture capital investors,

scheduled commercial banks, public financial
institutions, or insurance companies registered with
the Insurance Regulatory and Development
Authority of India (IRDAI) (or any non-individual
public shareholder holding at least 5% of the post-
issue capital, or entities in the promoter group other
than the promoters) is subject to the following:
 Lock-in Duration: Eighteen months from the

date of allotment in the Initial Public Offering

(IPO).
 Exception: If the majority of the proceeds from

the issue (excluding the offer for sale) are

intended for capital expenditure (e.g.,
purchasing assets, constructing facilities), the
lock-in period extends to three years from the
date of allotment.
2. Promoters’ Holding in Excess of Minimum Contribution:
o Any shares held by promoters above the minimum

required contribution must adhere to a different

lock-in period:
 Lock-in Duration: Six months from the date of

allotment in the IPO.

  Exception: Again, if the proceeds are primarily
for capital expenditure, the lock-in extends to
one year from the date of allotment.
Explanation of Capital Expenditure
 The term “capital expenditure” includes various
investments such as:
o Civil works (construction).

o Miscellaneous fixed assets (equipment, etc.).

o Purchase of land, buildings, and plant machinery.

Special Clause for SR Equity Shares

 SR Equity Shares (shares with special rights) are under a

lock-in until:
o They are converted into equity shares with voting

rights equivalent to ordinary shares.

o Or, they follow the lock-in period specified in the

regulations, whichever is longer.

Reg. 17 (Lock-in of specified securities held by persons other

than the promoters)
Lock-in Period for Pre-issue Capital
1. Lock-in Duration:
o The entire pre-issue capital held by persons other

than the promoters is subject to a lock-in period of

six months from the date of allotment in the IPO.
This regulation is intended to prevent immediate
selling of shares, thereby stabilizing the market after
the IPO.
Exceptions to the Lock-in Requirement
The regulation includes specific exceptions where the lock-in
requirement does not apply:
1. Employee Stock Options (ESOs):
 o Equity Shares Allotted to Employees: Shares
allotted to employees (current or former) under an
employee stock option or employee stock purchase
scheme before the IPO are exempt from the lock-in
if full disclosures about these options or schemes
have been made in accordance with the applicable
regulations.
o Shares Held by Employee Stock Option Trusts:

Shares held by an employee stock option trust or

transferred to employees as a result of exercising
options under the employee stock option plan or
employee stock purchase scheme are also exempt
from the lock-in.
However, the equity shares allotted to employees must still
comply with lock-in provisions as specified under the
Securities and Exchange Board of India (Share Based Employee
Benefits and Sweat Equity) Regulations, 2021.
2. Venture Capital Funds and Alternative Investment Funds:
o Equity Shares Held by Specific Funds: Equity shares

held by a venture capital fund, alternative

investment fund (Category I or II), or foreign venture
capital investor are also exempt from the lock-in
requirement.
o Lock-in Duration for Funds: These shares must be

locked in for at least six months from the date of

purchase by the respective fund or investor.
Explanation of Additional Clauses
1. Conversion of Compulsorily Convertible Securities:
o If equity shares result from the conversion of fully

paid-up compulsorily convertible securities, the

holding period of these convertible securities and
 the resultant equity shares will be considered
together for calculating the six-month lock-in period.
o A convertible security is deemed "fully paid-up" if

the entire consideration has been paid at the time of

conversion, meaning there are no further payments
due.
2. Bonus Issues:
o In cases where equity shares have resulted from a

bonus issue, the holding periods for both the

original shares and the bonus shares will be
combined to calculate the six-month lock-in period.
o Conditions for Bonus Shares: The bonus shares

must be issued from free reserves and share

premium existing in the company's accounts at the
end of the financial year preceding the one in which
the draft offer document is filed. They cannot be
issued by utilizing revaluation reserves or unrealized
profits.

Reg. 23 (Appointment of Lead Managers, Other Intermediaries

and Compliance Officer)
1. Appointment of Lead Managers: The issuer must appoint
one or more merchant bankers registered with SEBI as
lead managers for the issue. If there is more than one lead
manager:
o Their rights, duties, and responsibilities, including

aspects like disclosures, allotment, refunds, and

underwriting, must be predetermined and
mentioned in the offer documents.
2. Lead Manager's Association with Issuer:
o At least one lead manager must not be an associate
 of the issuer as per SEBI's definition.
o If a lead manager is an associate of the issuer, it

must disclose this and its role will be limited to

marketing the issue only.
3. Appointment of Other Intermediaries:
o The issuer, in consultation with the lead manager(s),

appoints other intermediaries like brokers or

bankers. The lead manager must assess the
capability of these intermediaries to ensure they can
fulfill their obligations.
o The issuer must enter into agreements with the lead

managers and intermediaries, without limiting any

legal obligations they have under various laws like
the Companies Act or SEBI regulations.
4. Agreement with Banks (ASBA Process):
o Under the ASBA process (Applications Supported by

Blocked Amount), the issuer will have a deemed

agreement with self-certified syndicate banks.
5. Appointment of Syndicate Members:
o For issues conducted via the book building process,

syndicate members must be appointed. For other

types of issues, the issuer appoints bankers at
designated centers.
6. Registrar to the Issue:
o The issuer must appoint a registrar to the issue who

is registered with SEBI and has depository

connectivity.
o If the issuer itself is a registrar, it cannot appoint

itself for this role.

o A lead manager handling post-issue responsibilities

cannot also act as a registrar.

 7. Appointment of Compliance Officer:
o A compliance officer must be appointed to monitor

compliance with securities laws and handle investor

grievances.
o As per SEBI (LODR) Regulations, 2015, only a

qualified company secretary can be the compliance

officer for a listed entity.

Reg. 24 (Disclosures in the draft offer document and offer

document)
1. Material Disclosures: Both the draft offer document and
the final offer document must include all important
information that is true and sufficient. This is to help
potential investors make well-informed decisions about
their investments.
2. Specific Disclosures in Prospectuses: Different types of
prospectuses (Red-herring, Shelf, and regular) must
include:
o Disclosures required under the Companies Act,

2013.
o Disclosures listed in Part A of Schedule VI of the

ICDR Regulations 2018.

For a Follow-on Public Offer (FPO), additional rules
from Parts C and D of this schedule apply.
3. Due Diligence by Lead Managers: The lead manager(s)
(usually investment banks managing the issue) must
ensure all aspects of the issue, including the accuracy and
completeness of the disclosures, are diligently reviewed
and verified.
4. Obligations of Issuers and Sellers: The lead managers
must also make sure that the issuer, promoters, directors,
 or selling shareholders (in case of an offer for sale) fulfill
the obligations they stated in the draft and final offer
documents, according to the ICDR Regulations 2018.
5. Financial Information Timeliness: The financial data in
the offer document, specifically the audited financial
statements, should not be older than six months from the
date the issue opens for subscription. This ensures that
the financial information presented to investors is current
and relevant.

Reg. 25 (Filing of draft offer document and offer document)

1. Initial Submission:
o Before making an IPO, the issuer must file three

copies of the draft offer document with the regional

office of the Board (Securities and Exchange Board
of India, SEBI) where the issuer’s registered office is
located.
o This filing must adhere to the guidelines in Schedule

IV and be accompanied by the requisite fees from

Schedule III through the lead manager(s).
2. Lead Manager's Responsibilities:
o The lead manager(s) must submit the following

along with the draft offer document:

 Certificate of Agreement: Confirms an
agreement is in place between the issuer and
the lead manager(s).
 Due Diligence Certificate (Form A): Ensures all

required disclosures and compliance have

been met.
 Convertible Debt Instruments: If applicable, a

due diligence certificate from the debenture

 trustee (Form B).
3. Stock Exchange Filing:
o The issuer must also file the draft offer document

with stock exchanges where the securities will be

listed.
o They need to provide the Permanent Account

Number (PAN), bank account details, and, if

applicable, the passport number for individual
promoters, or the PAN, bank account details, and
registration details for corporate promoters.
4. Board Observations:
o The Board has 30 days to issue any changes or

observations from the date of receiving the draft

offer document or related clarifications from the
lead manager(s) or regulators.
o If changes are requested, the issuer and lead

manager(s) must submit an updated draft that

addresses these observations before filing the final
offer documents with the Registrar of Companies.
5. Updated Draft Requirements:
o If any changes arise related to Schedule XVI, a new

or updated draft offer document must be filed with

the Board along with the appropriate fees.
6. Final Offer Document Filing:
o Once the offer document is finalized, it must be filed

with both the Board and the stock exchanges via the
lead manager(s).
o Both draft and final offer documents should also be

submitted in a soft copy format.

7. Post-Observation Submission:
o After the Board's observations are received or the
 observation period expires (if no observations are
made), the lead manager(s) must submit several
documents, including:
 A certification statement confirming all
changes and observations have been
incorporated.
 A due diligence certificate (Form C).

 Board resolution authorizing the allotment of

specified securities.
 A statutory auditor's certificate confirming that

the promoters' contributions have been

received properly.
 A due diligence certificate (Form D) if any

material developments have been disclosed

publicly.

Reg. 26 (Draft offer document and offer document to be

available to the public)

Reg. 31 (Minimum offer to public)

1. Companies with Post-Issue Capital of ₹1,600 Crore or
Less:
o The company must offer at least 25% of each class

or kind of equity shares or debentures convertible

into equity shares to the public.
2. Companies with Post-Issue Capital Between ₹1,600 Crore
and ₹4,000 Crore:
o The company must offer an amount of equity shares

or convertible debentures equal to the value of

₹400 crore to the public.
3. Companies with Post-Issue Capital Above ₹4,000 Crore:
 o The company must offer at least 10% of each class
or kind of equity shares or debentures convertible
into equity shares to the public.
Additional Requirements:
 For companies under provisions (ii) and (iii) (with post-

issue capital above ₹1,600 crore), they must increase

their public shareholding to at least 25% within a period
of three years from the date the securities are listed, in a
manner specified by the Securities and Exchange Board
of India (SEBI).

Reg. 32 (Allocation in the net offer)

Shares or securities should be allocated to different investor
categories in public issues made through the book-building
process and other than book-building process discussed.
1. Book-Building Process (Under Sub-Regulation (1) of
Regulation 6):
In an issue where the book-building process is followed, the
allocation is divided among the following categories:
 Retail Individual Investors:

o At least 35% of the net offer must be allocated to

retail individual investors (small investors).

 Non-Institutional Investors:

o At least 15% of the net offer must be allocated to

non-institutional investors (HNIs, trusts, etc.).

 Qualified Institutional Buyers (QIBs):

o Not more than 50% of the net offer shall be

allocated to QIBs, with 5% of the QIB portion

reserved for mutual funds.
Unsubscribed Portions:
 Any unsubscribed portion from the retail individual or
 non-institutional categories can be reallocated to the
other categories.
Additional Mutual Fund Allocation:
 Apart from the 5% reserved for mutual funds within the

QIB category, they can also get a portion of the remaining

allocation for QIBs.

2. Book-Building Process (Under Sub-Regulation (2) of

Regulation 6):
In cases where the book-building process is slightly different,
the allocation changes as follows:
 Retail Individual Investors:

o Not more than 10% of the net offer should be

allocated to retail individual investors.

 Non-Institutional Investors:

o Not more than 15% of the net offer should be

allocated to non-institutional investors.

 Qualified Institutional Buyers (QIBs):

o At least 75% of the net offer must be allocated to

QIBs, with 5% of this portion reserved for mutual

funds.
Unsubscribed Portions:
 Any unsubscribed portion from retail individual or non-

institutional categories can be reallocated to the other

categories.

3. Anchor Investors (Sub-Regulation (3)):

 Anchor Investors (institutional investors who invest

before the public issue opens) can be allocated up to 60%

of the QIB portion.
3A. Non-Institutional Investor Allocation (Amendment
Effective from 2022):
For public issues of ₹10,000 crore or more, the allocation to
non-institutional investors is further subdivided:
 One-third of the non-institutional portion is reserved for

applicants with application sizes between ₹2 lakh and ₹10

lakh.
 Two-thirds of the non-institutional portion is reserved for

applicants with application sizes above ₹10 lakh.

Unsubscribed Portions:
 Any unsubscribed portion in these sub-categories may be

reallocated within the non-institutional investor category.

4. Non-Book-Building Process:
When an issue is made other than through the book-
building process, the allocation is as follows:
 Retail Individual Investors:

o At least 50% of the net offer must be allocated to

retail individual investors.

 Remaining Portion:

o The remaining portion will be allocated to other

individual applicants (non-retail investors) and

institutional investors (corporate bodies, etc.).
Unsubscribed Portions:
 Any unsubscribed portion from one category may be

reallocated to the other category.

Explanation:
 If retail individual investors are entitled to more than 50%

on a proportionate basis (due to demand), they will be

allocated a higher percentage in accordance with demand.
Reg. 35 (ABSA)
1. Acceptance of Bids:
o The issuer must accept bids only through the ASBA

facility. This facility is designed to streamline the

application process for investors participating in
public offers.
2. Regulatory Compliance:
o The acceptance of bids using the ASBA facility must

be conducted in the manner specified by the Board

(Securities and Exchange Board of India, SEBI).

Reg. 44 (Opening of issue)

1. Timeline for Opening:
o A public issue may be opened within twelve months

from the date of issuance of observations by the

Board (SEBI) as per Regulation 25. This provides a
window for issuers to prepare and launch their
public offering after receiving regulatory feedback.
2. Waiting Period:
o The public issue must be opened after at least three

working days from the filing of the red herring

prospectus (for book-built issues) or the prospectus
(for fixed-price issues) with the Registrar of
Companies. This waiting period ensures that there is
adequate time for the prospectus to be reviewed by
potential investors.

Reg. 45 (Minimum Subscription)

1. Minimum Subscription Amount:
o The issuer must receive a minimum subscription of
 at least 90% of the total offer as specified in the
offer document.
o However, this requirement does not apply to offers

for sale of specified securities (e.g., existing shares

being sold by current shareholders).
2. Allotment of Specified Securities:
o The minimum subscription is also subject to the

allotment of the minimum number of specified

securities, as defined under the Securities Contracts
(Regulation) Rules, 1957. This means that the total
amount raised must correspond to a minimum
number of shares or securities being offered.
3. Refund Procedures:
o If the minimum subscription is not achieved, all

application monies received from investors must be

refunded. This must be done promptly and no later
than four days from the closure of the issue.
o This provision ensures that investors are not left

with funds tied up in a failed offering and provides

them with a clear expectation of refund timelines.

Reg. 46 (Period of Subscription)

1. Minimum and Maximum Subscription Period:
o An initial public offer (IPO) must remain open for at

least three working days and no more than ten

working days. This ensures that investors have a
sufficient window to submit their bids.
2. Price Band Revision:
o If the issuer revises the price band, they must

extend the bidding period disclosed in the red

herring prospectus by a minimum of three working
 days, while still adhering to the maximum limit of
ten working days.
3. Force Majeure or Unforeseen Circumstances:
o In the event of force majeure, a banking strike, or

similar unforeseen circumstances, the issuer may

extend the bidding period for a minimum of one
working day. This extension requires a written
record of the reasons for the extension and is
subject to the provisions of the initial three to ten
working days.

- Further Public Offer [Reg. 2(q) of SEBI ICDR] is a

mechanism by which a listed company can issue new
securities to the public or allow existing shareholders to
sell their shares to the public. It serves as a means for
companies to raise additional capital while providing
liquidity for current shareholders, thereby enhancing
market activity and investor participation.

Reg. 102 (Entities Ineligible to make FPO)

Debarment from Capital Markets:
o An issuer (the company making the offer) is

ineligible if it, its promoters, promoter group,

directors, or selling shareholders are debarred by
the Securities and Exchange Board of India (SEBI)
from accessing capital markets.
2. Connections to Other Debarred Companies:
o If any promoter or director of the issuer is also a

promoter or director of another company that has

been debarred from capital markets by SEBI, the
issuer is not eligible.
 3. Financial Misconduct:
o The issuer or any of its promoters or directors

cannot be a wilful defaulter or a fraudulent

borrower. A wilful defaulter is someone who has
defaulted on loans while having the capacity to
repay, and a fraudulent borrower is someone who
has committed fraud to obtain a loan.
4. Fugitive Economic Offenders:
o If any promoter or director of the issuer is identified

as a fugitive economic offender, the issuer is

ineligible for making a further public offer.
5. Past Debarment:
o The restrictions mentioned above do not apply to

individuals or entities if their debarment period has

already expired by the time they file their draft offer
document with SEBI.

Reg. 103 (Entities Eligible to make FPO)

1. Name Change Restrictions:
o An issuer must not have changed its name in the

year preceding the date of filing the offer document.

If a name change has occurred, the issuer must meet
specific conditions:
 At least 50% of its revenue for the previous full

year must come from activities indicated by its

new name.
2. Book Building Process:
o If the issuer does not meet the revenue
requirement, it can still make a further public offer
if:
 The offer is conducted through a book-building
 process, which allows institutional investors to
bid on shares.
 The issuer must allocate at least 75% of the
net offer to qualified institutional buyers
(QIBs).
 If the issuer fails to meet the minimum
allotment to QIBs, it must refund the full
subscription money to investors.

Reg. 104 (General Conditions ensured by FPO issuer)

1. Stock Exchange Approval:
 The issuer must apply to one or more stock exchanges for

in-principle approval to list its securities (shares) on those

exchanges.
 The issuer must choose one of these exchanges as the

designated stock exchange in accordance with SEBI’s

Schedule XIX.
2. Agreement with Depository for Dematerialization:
 The issuer must have an agreement with a depository to

ensure the securities (already issued and those proposed)

are in dematerialized form. Dematerialization is the
process of converting physical shares into electronic form
for easier and secure trading.
3. Fully Paid-Up Equity Shares:
 Any partly paid-up equity shares (shares for which full

payment hasn’t been made by shareholders) must either

be:
o Fully paid-up (the full payment is received), or

o Forfeited (the shares are taken back if payment isn’t

received).
4. Firm Arrangements for Financing the Project:
  The issuer must make firm financing arrangements
(verifiable) for 75% of the capital expenditure required
for the specific project that the public offering will fund,
excluding:
o The amount to be raised through the public issue

itself.
o Existing internal funds that are identifiable.

 This ensures that a majority of the project’s financing is

already secured before the public offer.

5. Amount for General Corporate Purposes:
 The amount raised for general corporate purposes (as

specified in the offer document) cannot exceed 25% of

the total amount raised through the public issue. This
limits the portion of funds that can be used for
unspecified or general business purposes.
6. Amount for Undefined Acquisitions or Investments:
 The total amount raised for general corporate purposes

and unspecified acquisition/investment targets cannot

exceed 35% of the total amount being raised.
 However, for unspecified acquisitions or investment

targets, the amount cannot exceed 25% of the total

amount raised unless:
o The acquisition or strategic investment target has

been identified and disclosed in the offer

documents. In such cases, the 25% limit does not
apply, provided there are clear, specific disclosures.

Reg. 121 (Appointment of Lead Managers, Other

Intermediaries and Compliance Officer)
8. Appointment of Lead Managers: The issuer must appoint
one or more merchant bankers registered with SEBI as
 lead managers for the issue. If there is more than one lead
manager:
o Their rights, duties, and responsibilities, including

aspects like disclosures, allotment, refunds, and

underwriting, must be predetermined and
mentioned in the offer documents.
9. Lead Manager's Association with Issuer:
o At least one lead manager must not be an associate

of the issuer as per SEBI's definition.

o If a lead manager is an associate of the issuer, it

must disclose this and its role will be limited to

marketing the issue only.
10. Appointment of Other Intermediaries:
o The issuer, in consultation with the lead manager(s),

appoints other intermediaries like brokers or

bankers. The lead manager must assess the
capability of these intermediaries to ensure they can
fulfill their obligations.
o The issuer must enter into agreements with the lead

managers and intermediaries, without limiting any

legal obligations they have under various laws like
the Companies Act or SEBI regulations.
11. Agreement with Banks (ASBA Process):
o Under the ASBA process (Applications Supported by

Blocked Amount), the issuer will have a deemed

agreement with self-certified syndicate banks.
12. Appointment of Syndicate Members:
o For issues conducted via the book building process,

syndicate members must be appointed. For other

types of issues, the issuer appoints bankers at
designated centers.
 13. Registrar to the Issue:
o The issuer must appoint a registrar to the issue who
is registered with SEBI and has depository
connectivity.
o If the issuer itself is a registrar, it cannot appoint
itself for this role.
o A lead manager handling post-issue responsibilities
cannot also act as a registrar.
14. Appointment of Compliance Officer:
o A compliance officer must be appointed to monitor
compliance with securities laws and handle investor
grievances.
o As per SEBI (LODR) Regulations, 2015, only a
qualified company secretary can be the compliance
officer for a listed entity.

Reg. 122 (Disclosures in the draft offer document and offer

document)
1. Material Disclosures: Both the draft offer document and
the final offer document must include all important
information that is true and sufficient. This is to help
potential investors make well-informed decisions about
their investments.
2. Specific Disclosures in Prospectuses: Different types of
prospectuses (Red-herring, Shelf, and regular) must
include:
o Disclosures required under the Companies Act,

2013.
o Disclosures listed in Part A of Schedule VI of the

ICDR Regulations 2018.

For a Follow-on Public Offer (FPO), additional rules
 from Parts C and D of this schedule apply.
3. Due Diligence by Lead Managers: The lead manager(s)
(usually investment banks managing the issue) must
ensure all aspects of the issue, including the accuracy and
completeness of the disclosures, are diligently reviewed
and verified.
4. Obligations of Issuers and Sellers: The lead managers
must also make sure that the issuer, promoters, directors,
or selling shareholders (in case of an offer for sale) fulfill
the obligations they stated in the draft and final offer
documents, according to the ICDR Regulations 2018.
5. Financial Information Timeliness: The financial data in
the offer document, specifically the audited financial
statements, should not be older than six months from the
date the issue opens for subscription. This ensures that
the financial information presented to investors is current
and relevant.

Reg. 123 (Filing of draft offer document and offer document)

1. Draft Offer Document Filing:
o The issuer must file three copies of the draft offer

document with the Board through lead manager(s)

and comply with fees specified in Schedule III.
2. Additional Requirements:
o The lead manager(s) must also submit a compliance

certificate confirming adherence to conditions

specified in Part C of Schedule VI.
3. Stock Exchange and Board Notifications:
o Similar requirements for submitting documentation

to the stock exchanges and the Board apply as in the

initial offer process.
 4. Observation Period:
o The Board has the same 30-day observation period

for any changes or suggestions on the draft offer

document.
5. Finalization and Submission:
o The process for updating the offer document post-

observations is the same, including submitting

necessary certifications and due diligence
documents.

Reg. 129 (Allocation in the net offer)

Allocation of shares during the issuance process for a public
offering through the book building method is discussed.
1. General Allocation in Book Building Process
(1) Under Sub-Regulation (1) of Regulation 103:
 Retail Individual Investors:

o At least 35% of the shares must be allocated to this

category.
 Non-Institutional Investors:

o At least 15% of the shares must be allocated to this

category.
 Qualified Institutional Buyers (QIBs):

o No more than 50% of the shares can go to QIBs,

which includes a minimum of 5% specifically for

mutual funds.
 Unsubscribed Portions:

o If either the retail or non-institutional category does

not fully subscribe, the remaining shares can be

allocated to applicants in other categories.
 Mutual Funds Allocation:

o In addition to the 5% allocation, mutual funds can

 also access the remaining portion designated for
QIBs.
(2) Under Sub-Regulation (2) of Regulation 103:
 Retail Individual Investors:

o A maximum of 10% can be allocated.

 Non-Institutional Investors:

o A maximum of 15% can be allocated.

 Qualified Institutional Buyers (QIBs):

o At least 75% must be allocated to QIBs, with 5% for

mutual funds.
 Unsubscribed Portions:

o Similar to the first sub-regulation, any unsubscribed

shares in the retail or non-institutional categories

can be allocated to the other category.
 Mutual Funds Allocation:

o Mutual funds can also compete for the remaining

shares available for QIBs.

2. Special Provisions for Anchor Investors
(3)
 The issuer can allocate up to 60% of the shares meant for

QIBs to anchor investors, following specific conditions

outlined in Schedule XIII.
3. Non-Institutional Investors’ Category Allocation
(3A)
 For non-institutional investors, the allocation is structured

as follows:
o One-third of this category is reserved for applicants

whose application size is more than ₹2 lakh but up

to ₹10 lakh.
o Two-thirds are reserved for those with applications

exceeding ₹10 lakh.

  Unsubscribed Portions:
o If there are unsubscribed shares in either sub-

category, they can be allocated to applicants in the

other sub-category.
4. Allocation for Non-Book Building Process
(4)
 For issuances outside the book building process:

o At least 50% must go to retail individual investors.

o The remaining shares can be allocated to:

 Individual applicants who are not retail

investors.
 Other investors, including corporate bodies or

institutions, regardless of the number of shares

applied for.
 Unsubscribed Portions:

o Unsubscribed shares from either retail individual

investors or other categories may be reallocated to

applicants in the other category.

Reg. 132 (ABSA)

1. Acceptance of Bids:
o The issuer must accept bids only through the ASBA

facility. This facility is designed to streamline the

application process for investors participating in
public offers.
2. Regulatory Compliance:
o The acceptance of bids using the ASBA facility must

be conducted in the manner specified by the Board

(Securities and Exchange Board of India, SEBI).

Reg. 140 (Opening of issue)

 1. Timeline for Opening:
o Similar to Regulation 44, a public issue may be

opened within twelve months from the issuance of

observations by the Board under Regulation 123.
However, there are special provisions for fast track
issues that require compliance within a specific
period as stipulated in the Companies Act, 2013.
2. Shelf Prospectus:
o For a shelf prospectus, the first issue may be opened

within three months of the issuance of observations

by the Board. A shelf prospectus allows issuers to
raise funds through multiple issues over a specified
period without having to file a new prospectus each
time.
3. Waiting Period:
o Similar to Regulation 44, the issue shall be opened

after at least three working days from the filing of

the red herring prospectus (for book-built issues) or
the prospectus (for fixed-price issues) with the
Registrar of Companies.

Reg. 141 (Minimum Subscription)

1. Minimum Subscription Requirement:
o The minimum subscription that must be received in

a public issue is set at least 90% of the total offer

specified in the offer document. This requirement
ensures that a significant portion of the offer is
subscribed to make the issue viable.
2. Exemption for Offer for Sale:
o This minimum subscription rule does not apply in

cases where there is an offer for sale of specified

 securities, indicating a different set of criteria for
such situations.
3. Refund Policy for Non-Receipt of Minimum Subscription:
o If the minimum subscription of ninety percent is not met,

all application monies received from applicants must be

refunded promptly. The refund must be completed within
four days from the closure of the issue, ensuring that
applicants are not left waiting for their funds.

Reg. 142 (Period of Subscription)

1. Minimum and Maximum Subscription Period:
o A further public issue must also be kept open for at

least three working days and no more than ten

working days, mirroring the requirements for initial
public offers.
2. Price Band Revision:
o Similar to Regulation 46, if the price band is revised,

the issuer is required to extend the bidding period

disclosed in the red herring prospectus for a
minimum of three working days, while remaining
within the maximum limit of ten working days.
3. Force Majeure or Unforeseen Circumstances:
o Under the same conditions as Regulation 46, the

issuer may extend the bidding period for a minimum

of one working day due to unforeseen
circumstances. This extension must also be
documented in writing.

2.2 Preferential Issue/Allotment.

- Reg. 158 of SEBI ICDR deals with Preferential Issue.
 - Preferential Issue [Reg. 2(nn) of SEBI ICDR] is a targeted
capital-raising mechanism used by listed companies to
issue specified securities to selected investors through
private placement, while certain employee-related
offerings and foreign securities are explicitly excluded
from this definition.
- It does not include certain types of offers, such as:
o Employee stock options or purchase schemes.

o Sweat equity shares.

o Depository receipts issued outside India or foreign

securities.
Exclusions from Chapter V Provisions: The provisions in
Chapter V of the SEBI regulations do not apply in the following
situations:
1. Conversion of Debt Instruments: When the preferential
issue is made due to the conversion of a loan or
convertible debt instruments in accordance with the
Companies Act, either from 1956 or 2013, as applicable.
2. Approved Schemes:
o Schemes approved by a High Court or tribunal under

relevant sections of the Companies Act (sections

391-394 of the 1956 Act or sections 230-234 of the
2013 Act).
o However, pricing provisions apply if shares are

allotted only to a select group of shareholders under

these schemes.
3. Qualified Institutions Placement (QIP): Provisions of
Chapter V, except lock-in rules, do not apply to
preferential issues made in accordance with the QIP
regulations.
4. Rehabilitation and Debt Restructuring:
 o The regulations do not apply if the issue is part of a
rehabilitation scheme approved by the BIFR (Board
for Industrial and Financial Reconstruction) or a
resolution plan approved under the Insolvency and
Bankruptcy Code (IBC), 2016.
o For lenders converting their debt as part of a

restructuring scheme:
 RBI guidelines must specify the conversion

price, which must comply with the Companies

Act.
 The conversion price must be certified by two

independent valuers.
 The securities allotted must be locked in for

one year, although lenders can transfer their

securities during the lock-in period, as long as
the lock-in continues with the new holder.
 The lock-in period for shares arising from

convertible securities can be reduced based on

the extent of the lock-in already applied.
Specific Provisions
 The pricing and lock-in provisions do not apply to equity

shares allotted to:

o Financial institutions as defined under the Recovery

of Debts Due to Banks and Financial Institutions Act,

1993.
o Cases where SEBI grants relaxation under regulation

11 of the Takeover Regulations, provided adequate

disclosure is made in the general meeting notice.
Explanation of "Lenders"
 Lenders include all scheduled commercial banks
(excluding Regional Rural Banks) and All India Financial
 Institutions.

- Regulation 160 outlined the conditions under which a

listed issuer may conduct a preferential issue of specified
securities (like shares).
Conditions for Preferential Issue
1. Fully Paid-Up Shares:
o All equity shares allotted through the preferential

issue must be fully paid up at the time of allotment.

2. Special Resolution:
o A special resolution must be passed by the

shareholders of the issuer. This requires a higher

level of approval than a simple majority and typically
needs at least 75% of the votes in favour, ensuring
that shareholders are in agreement with the
preferential issue.
3. Dematerialized Shares:
o Any equity shares held by the proposed allottees

must be in dematerialized form.

4. Compliance with Listing Requirements:
o The issuer must comply with the conditions for

continuous listing of its equity shares as specified in

the listing agreement with the recognized stock
exchange where its shares are listed. This includes
adhering to the SEBI (Listing Obligations and
Disclosure Requirements) Regulations, 2015, and
any related circulars or notifications issued by SEBI.
5. Permanent Account Number (PAN):
o The issuer must obtain the Permanent Account

Number (PAN) of the proposed allottees. This is a tax

identification number required for all transactions in
 the securities market, aimed at preventing tax
evasion.

- Issuers Ineligible to Make a Preferential Issue [Regulation

159]
1. Prohibition for Recent Sellers: An issuer cannot make a
preferential issue of specified securities to anyone who
has sold or transferred their equity shares in the issuer
within the six months preceding the relevant date.
2. Relaxation by SEBI: SEBI may allow exceptions to this rule
for preferential issues of equity shares and compulsorily
convertible debt instruments under specific conditions
outlined in sub-regulation (2) of regulation 11 of the SEBI
(SAST) Regulations, 2011.
3. Promoter Group Restrictions: If any individual within the
promoter(s) or the promoter group sells or transfers
equity shares during the six-month period, all members of
the promoter(s) or promoter group become ineligible for
preferential allotment, not just the individual who sold
the shares.
4. Exemptions from Restrictions: The restrictions do not
apply in cases of:
o Inter-se transfers among qualifying promoters under

clause (a) of sub-regulation (1) of regulation 10 of

the SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 2011.
o Transfers due to the invocation of a pledge by

specified financial institutions or mutual funds.

5. Warrant Subscription Non-exercise: If any promoter or
promoter group member has previously subscribed to
warrants but did not exercise them, they are ineligible for
 preferential issuance for one year from:
o The expiry date of the warrants due to non-exercise.

o The date of cancellation of the warrants.

6. Fugitive Economic Offenders: An issuer is ineligible to

make a preferential issue if any of its promoters or
directors is classified as a fugitive economic offender.

- The provisions regarding allotment pursuant to a special

resolution as outlined in Regulation 170:
1. Timeframe for Allotment:
o The allotment of shares or securities following the

approval of a special resolution must be completed

within 15 days from the date the resolution is
passed.
2. Pending Approvals or Exemptions:
o If there are any pending applications for exemptions

from the SEBI (SAST) Regulations, 2011 or any

approvals from regulatory authorities or the Central
Government, the 15-day countdown starts from the
date of the order or approval granted on that
application.
3. Relaxation by SEBI:
o In situations where SEBI grants relaxation regarding

the SEBI SAST Regulations, 2011, the preferential

issue of equity shares or compulsorily convertible
debt instruments must occur within a timeframe
specified by SEBI in its relaxation order.
4. Open Offer Obligations:
o If the preferential allotment necessitates an
obligation to make an open offer under the SEBI
SAST Regulations, and no open offer has been made
 in compliance with Regulation 20(1) of the SEBI
SAST Regulations, the 15-day timeframe will start
from:
 The expiration of the period specified in

Regulation 20(1).
 Or, from the date of receipt of all necessary

statutory approvals for the completion of the

open offer under the SEBI SAST Regulations.
o In this context, the 15-day period will be counted

from the end of the open offer period, as defined by

the SEBI SAST Regulations.
5. Exceptions:
o The above-mentioned provisions regarding the 15-

day period do not apply to any offers made under

Regulation 20(1) of the SEBI SAST Regulations as
part of a preferential allotment.
Exemption for Stressed Assets:
 The 15-day allotment requirement does not apply to

allotments of specified securities on a preferential basis

made in relation to:
o Stressed assets under a framework specified by the

Reserve Bank of India (RBI).

o A resolution plan approved by the National

Company Law Tribunal (NCLT) under the Insolvency

and Bankruptcy Code (IBC), 2016.
Fresh Special Resolution:
 If the allotment of specified securities is not completed

within 15 days from the date of the special resolution:

o A new special resolution must be passed.

o The relevant date for determining the price of the

specified securities will be based on the date of this

 new special resolution.
Dematerialised Form Requirement:
 All allotments of specified securities must be made only in

dematerialised form.
 This requirement also extends to:

o Equity shares allotted as a result of exercising

options attached to warrants.

o Conversion of convertible securities.

2.3 Private Placement, Qualified Institutional Placement,

Institutional Private Placement.
- Private Placement [Section 42 of Companies Act 2013) is
the process by which a company can issue shares or
securities to a select group of persons, referred to
as identified persons (not exceeding 50 or higher), instead
of offering them publicly.
A private placement means any offer or invitation to a
select group of persons to subscribe to securities, other
than a public offer, satisfying the conditions laid down in
this section.
If a company issues shares to more than the prescribed
number of people, it will be treated as a public offer and
subject to public offer regulations.
Private Placement Offer and Application:
 The company must issue a private placement offer-cum-

application to the identified persons. These persons’

details must be recorded.
 The offer cannot be renounced (i.e., the identified person

cannot transfer their right to subscribe to someone else).

Subscription Procedure:
  Identified persons who wish to subscribe must submit the
application along with the subscription money via cheque,
demand draft, or banking channels (but not cash).
 The company cannot use the raised money until the

securities are allotted and the return of allotment is filed

with the Registrar.
Restrictions on Further Offers:
 No new offer or invitation can be made unless the prior

offer has been completed, withdrawn, or abandoned.

 A company can issue securities to different classes of

identified persons but must respect the cap on the

number of persons.
Time Limit for Allotment:
 Securities must be allotted within 60 days of receiving the

application money.
 If the company fails to allot the securities within this

period, it must refund the application money within 15

days, with a 12% interest if delayed beyond this.
Use of Funds Before Allotment:
 The money received from applicants must be kept in

a separate bank account and cannot be used for purposes

other than allotment or refund.
No Public Advertisement:
 The company is prohibited from using any form of public

advertisement, marketing, or media to inform the public

about the private placement offer.
Filing of Return of Allotment:
 After allotting securities, the company must file a return

of allotment with the Registrar within 15 days. This must

include details of all the allottees, like their names,
addresses, and the number of securities allotted.
Penalties for Default:
 If the company fails to file the return of allotment on time,

it (along with its promoters and directors) will face a

penalty of ₹1,000 per day, up to a maximum of ₹25 lakh.
 If the company raises money in violation of this section, it

(and its promoters and directors) will face a penalty up to

the amount raised or ₹2 crore (whichever is lower).
Additionally, they must refund all monies with interest
within 30 days of the penalty order.

Types of Private Placement:

1. Preferential Allotment:
o In this form, a company issues securities to a specific

group such as mutual fund companies, financial

institutions, or promoters at a fixed price.
o It is governed by Chapter XIII of SEBI (DIP)

guidelines.
o Investors in preferential allotment might face a lock-

in period (a time during which they cannot sell the

securities).
2. Qualified Institutional Placement (QIP):
o This allows a listed company to issue shares or other

securities to qualified institutional buyers

(QIBs) (such as banks or pension funds).
o It is primarily a way to raise funds from institutional

investors in the domestic market.

o QIPs are governed by Chapter XIIIA of SEBI (DIP)

guidelines.
Advantages of Private Placement:
1. Faster Financing:
o Private placements allow companies to raise funds
 more quickly than through a public issue, as it skips
many of the time-consuming steps involved in public
offerings.
2. Cost-Effective:
o The costs associated with private placement are

lower because there is no need to print

a prospectus, prepare application forms, or
advertise publicly.
3. Confidentiality:
o Since the offer is made to a select group, the

process remains confidential, unlike public offerings,

which require extensive disclosures.
4. Market Stability:
o The private placement market is more stable and

less volatile compared to the public stock market.

5. Smaller Capital Raising:
o Private placement is suitable for raising smaller

amounts of capital, whereas public issues are

usually reserved for larger fundraising needs.

- Qualified Institutional Placement [Reg. 2(tt) of SEBI ICDR]

refers to the allotment of eligible securities by a listed
issuer to Qualified Institutional Buyers (QIBs) on a
private placement basis.
 Includes:

o An offer for sale of specified securities by promoters

or promoter groups also on a private placement

basis.
 Eligible Securities: These include:

o Equity shares

o Non-convertible debt instruments

 o Warrants
o Convertible securities (excluding warrants)

Qualified Institutional Buyer (QIB)

 Definition: A QIB is a category of investors that meet

specific criteria set by SEBI, allowing them to participate in

QIPs.
 Categories of QIBs include:

o Mutual funds registered with SEBI

o Venture capital funds registered with SEBI

o Alternative investment funds registered with SEBI

o Foreign venture capital investors registered with

SEBI
o Foreign portfolio investors, excluding individuals,

corporate bodies, and family offices

o Public financial institutions

o Scheduled commercial banks

o Multilateral and bilateral development financial

institutions
o State industrial development corporations

o Insurance companies registered with the Insurance

Regulatory and Development Authority of India

(IRDAI)
o Provident funds with a minimum corpus of ₹25

crore
o Pension funds with a minimum corpus of ₹25 crore

o National Investment Fund set up by the Indian

government
o Insurance funds managed by the armed forces of

India (Army, Navy, Air Force)

o Insurance funds managed by the Department of

Posts, India
 o Systemically important non-banking financial
companies.
The conditions for a Qualified Institutional Placement (QIP) in
the context of issuing securities involve several specific criteria
and processes that a listed issuer must adhere to.
Relevant Date
 Equity Shares: The relevant date for allotting equity

shares is the date of the board meeting where the

decision to open the proposed issue is made.
 Convertible Securities: For eligible convertible securities,

the relevant date can be either:

o The date of the board meeting deciding to open the

issue of these convertible securities.

o The date when the holders of such securities can

apply for equity shares.

Conditions for QIP
1. Special Resolution Approval:
o A special resolution must be passed by shareholders

approving the QIP, specifying that the allotment is

through a QIP and mentioning the relevant date.
2. Completion Timeline:
o The allotment following the special resolution must

be completed within 365 days from its passing.

3. Non-applicability of Shareholders' Resolution:
o If the QIP is an offer for sale by promoters or

promoter groups to meet minimum public

shareholding requirements, no shareholders'
resolution is required as per the Securities Contracts
(Regulation) Rules, 1957.
4. Class of Equity Shares:
o Equity shares being allotted must be of the same
 class, meaning they rank equally concerning
dividends, voting rights, etc.
o If shares are being allotted through conversion of

eligible securities, these securities must have been

listed on a stock exchange for at least one year prior
to issuing notice for the special resolution.
5. Transferor Company Considerations:
o For a company involved in a compromise or

amalgamation, the listing period of the transferor

company’s equity shares on a stock exchange will
count towards the one-year requirement.
6. Fugitive Economic Offenders:
o The issuer is ineligible for QIP if any promoters or

directors are classified as fugitive economic

offenders.
Appointment of Lead Managers
 Merchant Bankers:

o The issuer must appoint one or more registered

merchant bankers (lead managers) for the issue. At

least one lead manager must not be associated with
the issuer to ensure impartiality.
o Any lead manager that is an associate must disclose

this relationship and can only participate in

marketing the issue.
 Due Diligence:

o Lead managers must conduct due diligence,

ensuring the adequacy and truthfulness of
disclosures in the offer document.
 Listing Approval:

o While seeking listing approval from stock exchanges,

lead managers must provide a due diligence

 certificate confirming compliance with QIP
requirements and submit a preliminary placement
document along with other necessary documents.
Placement Document
 Content Requirements:

o The placement document must include all material

information and disclosures required by the

Companies Act, 2013, and SEBI (ICDR) Regulations,
2018.
o If any issuer, promoter, or director is a willful

defaulter, additional disclosures must be included.

 Document Handling:

o The preliminary placement and placement

documents must be serially numbered and
circulated only to select investors.
o Both documents should be available on the issuer's

website and the relevant stock exchanges, along

with a disclaimer stating that it relates to a QIP and
that no public offer is being made.

Pricing and allotment of securities during a Qualified

Institutional Placement (QIP) involves several key guidelines
and stipulations that must be followed. Here's a detailed
explanation of the pricing conditions, application, and
allotment process:
Pricing of QIP
1. Issue Price Calculation:
o The issue price of equity shares in a QIP must be at

least equal to the average of the weekly high and

low closing prices of the equity shares of the same
class on the stock exchange during the two weeks
 preceding the relevant date.
o The issuer may offer a discount of up to 5% on the

calculated price, provided this discount is specifically

approved by the shareholders during the QIP
approval process.
2. Convertible Securities:
o For eligible securities that can be converted into or

exchanged for equity shares, the price of the equity

shares allotted upon conversion or exchange will be
determined based on the relevant date disclosed in
the special resolution.
o No shareholder approval is required for QIPs made

through an offer for sale by promoters aimed at

complying with minimum public shareholding
requirements, as specified in the Securities
Contracts (Regulation) Rules, 1957.
Adjustments to the Issue Price
The issue price may be subject to adjustments in the following
scenarios:
 If the issuer:

o Issues equity shares via capitalization of profits or

reserves, except through dividends on shares.

o Conducts a rights issue of equity shares.

o Consolidates its outstanding equity shares into fewer

shares.
o Divides its outstanding equity shares, such as

through a stock split.

o Reclassifies any equity shares into other securities.

o Engages in any other similar events or

circumstances, as deemed necessary by the
concerned stock exchange for adjustment.
 Application and Allotment Process
1. Bid Withdrawal:
o Applicants in a QIP cannot withdraw or revise their

bids downwards once the issue has closed.

2. Conditions for Allotment:
o Mutual Fund Allotment: A minimum of 10% of the

eligible securities must be allotted to mutual funds.

Any unsubscribed portion of this minimum
percentage may be allocated to other qualified
institutional buyers (QIBs).
o Promoter Restrictions: No allotment shall be made,

directly or indirectly, to any QIB who is a promoter

or related to the promoters of the issuer.
 However, a QIB who does not hold any shares

in the issuer and acquires rights in the capacity

of a lender is not considered a person related
to the promoters.

- Institutional Private Placement [Reg.

2.4 Rights Issue.

- Rights Issue [Reg. 2(xx) of SEBI ICDR] is an issue of
specified securities by a company only to its existing
shareholders as on a record date in predetermined ratio.
- A Rights Issue is defined as an offer of specified securities
(such as equity shares) made by a listed issuer to its
existing shareholders. The offer is based on the record
date that the issuer has fixed for this purpose.
- The record date is the date set by the issuer to determine
which shareholders are entitled to receive the new shares
 being offered in the rights issue.
Regulatory Applicability
- SEBI (ICDR) Regulations, 2018: These regulations apply to
rights issues by a listed issuer where the total value of the
issue is ₹50 crore or more.
- For rights issues with an aggregate size less than ₹50
crore, the issuer is still required to prepare a letter of
offer. This letter must adhere to specific requirements set
forth in the SEBI (ICDR) Regulations, 2018.
Filing Requirements
- The issuer must file the letter of offer with SEBI, which will
then be used for information dissemination on SEBI's
website. This process ensures transparency and
accessibility for investors.

- Eligibility Conditions (Regulation 61)

An issuer is not eligible to make a rights issue if:
- Debarment from Capital Market:
o The issuer or any of its promoters, promoter group
members, or directors is debarred from accessing
the capital market by SEBI. This means they cannot
participate in raising funds from the public or private
investors.
- Promoters or Directors of Other Debarred Companies:
o If any of the promoters or directors of the issuer is
also a promoter or director of another company that
is debarred by SEBI, this would disqualify the issuer
from conducting a rights issue. This clause aims to
prevent associations with individuals or entities that
have a history of non-compliance.
- Fugitive Economic Offender:
 o If any of the issuer's promoters or directors is
classified as a fugitive economic offender, the issuer
is ineligible for a rights issue. This condition aims to
maintain the integrity of the capital markets.
Note: The restrictions in points (a) and (b) do not apply to
promoters or directors who were previously debarred by SEBI,
provided that the period of debarment has expired by the time
of filing the draft letter of offer with SEBI.

- Conditions (Regulation 62)

The issuer making a rights issue must ensure the following:
- Application for Listing Approval:
o The issuer must apply to one or more stock
exchanges to obtain in-principle approval for listing
the specified securities. It must also designate one
of these exchanges as the designated stock
exchange.
- Partly Paid-Up Shares:
o All existing partly paid-up equity shares must either
be fully paid-up or forfeited. This condition ensures
that the issuer has a clean equity structure without
any outstanding obligations on partly paid shares
before proceeding with the rights issue.
- Firm Financial Arrangements:
o The issuer must have made firm financial
arrangements through verifiable means to cover at
least 75% of the stated means of finance for the
specific project funded by the proceeds of the rights
issue. This requirement excludes the funds raised
through the rights issue itself and any existing
identifiable internal accruals.
 o Explanation: The term "finance for the specific
project" refers specifically to capital expenditures.
- Limitation on Corporate Purposes:
o The amount allocated for general corporate
purposes, as indicated in the draft letter of offer and
the final letter of offer, must not exceed 25% of the
total amount raised by the issuer through the rights
issue.
- Wilful Defaulters:
o If the issuer or any of its promoters or directors is
classified as a wilful defaulter, the promoters or
promoter group cannot renounce their rights except
for the extent of renunciation within the promoter
group. This provision seeks to prevent any unfair
advantage or dilution of accountability among those
who have defaulted on financial obligations.

- Procedure for Making a Rights Issue:

- Check Authorized Share Capital:
o Ensure that the proposed rights issue falls within the
company’s authorized share capital. If the rights
issue exceeds this limit, the company must take
steps to increase its authorized share capital.
- Notify the Stock Exchange:
o Notify the relevant stock exchange at least 2 days in
advance of the Board Meeting where the rights
issue will be discussed.
- Board Meeting:
o Convene the Board Meeting to discuss and approve
the rights issue proposal.
- Notify Stock Exchanges:
 o Immediately after the Board Meeting, notify the
stock exchanges about the decision made by the
Board regarding the rights issue.
- Appointment of Merchant Banker:
o Appoint a merchant banker and prepare a draft
letter of offer to be submitted to SEBI for review.
- Obtain Observations from SEBI:
o Receive observations from SEBI regarding the draft
letter of offer and incorporate any necessary
changes.
- Convene Another Board Meeting:
o Hold another Board Meeting to finalize key
decisions, including:
 Quantum of Issue: Determine the total
amount of shares to be issued.
 Proportion of Rights Shares: Decide the ratio
of rights shares to be offered to existing
shareholders.
 Alteration of Share Capital: Make changes to
share capital if needed and consider offering
shares to individuals other than existing
shareholders as per Section 62 of the
Companies Act, 2013.
 Fix Record Date: Set a record date to identify
eligible shareholders.
 Appointment of Merchant Bankers and
Underwriters: Decide on any additional
financial intermediaries.
 Approval of Draft Letter of Offer: Either
approve the draft or authorize the managing
director or company secretary to finalize it in
 consultation with relevant parties.
- Open the Rights Issue:
o The rights issue must be open for at least 15 days
but not more than 30 days.
- File Letter of Offer:
o File a copy of the letter of offer with the stock
exchange where the company’s shares are listed and
obtain in-principle approval for listing the new
equity shares.
- Dispatch Offer Letters:
o Send letters of offer and Composite Application
Forms to shareholders via registered post.
- Public Advertisement:
o Release an advertisement announcing the
completion of the dispatch of letters of offer in at
least one English National Daily, one Hindi National
Paper, and one Regional Language Daily where the
company is registered. This advertisement should
also mention that shareholders can apply using plain
paper if they do not receive the application form.
- Application Acceptance:
o Ensure that arrangements are made with banks for
the acceptance of share application forms.
- Finalise Allotment:
o Consult with the stock exchange to finalize the
allotment of shares.
- Board Meeting for Allotment:
o Convene a Board Meeting to officially allot the
shares to the applicants.
- Application for Listing:
o Apply to the stock exchanges for permission to list
 the new shares that have been issued under the
rights issue.

General Obligations of the Issuer and Intermediaries

- No Incentives: No individual connected with the rights
issue may offer any direct or indirect incentives (cash,
kind, or services) to anyone for making applications for
allotment of securities.
- Compliance with ICDR Regulations: All public
communications, advertisements, and research reports
must adhere to the requirements set forth in the SEBI
(ICDR) Regulations, 2018.
- Consistency of Offer Document: The lead manager and
issuer must ensure that the contents of the offer
document on their websites match the printed versions
filed with the Registrar of Companies and are accessible to
the public.
- Post-Issue Activities: The lead merchant banker should
remain actively involved in post-issue activities, including
allotment, refunds, and addressing investor grievances.
- Appointment of Compliance Officer: The issuer company
must appoint a Compliance Officer responsible for
monitoring compliance with securities laws and
addressing investor complaints.

2.5 Fast Track Issue.

- Fast Track Issue [Reg. 226]
The provisions regarding Fast Track Issues outlined in your
excerpt refer to a streamlined process for issuers looking to
conduct a rights issue of International Depository Receipts
 (IDRs). This process allows issuers to bypass certain
regulatory requirements if they meet specific conditions,
facilitating a quicker and more efficient way to raise capital.

Fast Track Issue Conditions

1. Compliance with Regulations
 Material Compliance: The issuer must demonstrate

compliance with the provisions of the deposit agreement

and the applicable listing agreements (or listing
conditions) for at least three years preceding the date of
filing the offer document.
 Certification: A certification confirming this compliance

must be provided by the issuer.

2. Offer Document Review
 Home Country Regulator: The offer document for the

rights offering must be filed and reviewed by the

securities regulator in the issuer's home country. This
ensures that the rights offering meets the necessary
regulatory standards in the jurisdiction where the issuer is
primarily regulated.
3. Absence of Regulatory Issues
 Pending Proceedings: The issuer, its promoters, or whole-

time directors must not have any pending show-cause

notices or prosecution proceedings by the Board or
regulatory authorities in their home country. This
condition aims to ensure that the issuer has a clear
regulatory standing and is not facing restrictions that
could affect its ability to access capital markets.
4. Complaint Resolution
 Redressal of Complaints: The issuer must have addressed

at least 95% of the complaints received from IDR holders

 before the end of the three-month period immediately
preceding the month of filing the letter of offer with the
designated stock exchange. This condition ensures that
the issuer has been responsive to investor concerns,
promoting investor confidence.

Procedure for Fast Track Issue

1. Filing the Offer Document
 If the conditions listed in sub-regulation (1) are satisfied,

the issuer can opt for a rights issue of IDRs by:

o Filing a copy of the offer document that complies

with the requirements of the home country with the

Board.
o Including an addendum containing additional
disclosures as specified in Part C of Schedule VIII.
This addendum provides any necessary information
that may be required by the Indian regulatory
framework.
2. Record Purposes
 The filed documents serve for record purposes before the

issuer files the offer document with the stock exchanges.

This step helps ensure that the regulatory authorities are
aware of the issuer's intentions and compliance status.