How Investment Bankers Help Promoters Retain Control?
Companies want to go public because it helps them raise cash, which can be used for further expansion. However, the promoters of these companies often do not want to go public since this would mean that their stakes would be diluted and that they would lose control over the company. A low promoter’s stake in a company is often considered to be a sign of weakness. This is one of the parameters which the opposition evaluates when they want to make a hostile takeover bid. This is the reason that promoters have often asked investment bankers to devise ways using which they can actually raise capital without actually diluting their stake in the company. Some of these ways have been listed in the article below.
- Market Purchases: The most obvious way for any promoter to raise their stakes in their own company is to buy their own shares from the market. However, there are two problems with this. Firstly, it assumes that promoters have the money which is required to make this purchase, which may not be true in several cases. Also secondly, in many markets all over the world, there is a limit to the number of shares that a promoter can buy in their own company in a given year. Hence, using this method, promoters cannot increase their stake drastically overnight. If the promoters have the required time and can wait for a few years before their stake is increased, this may be the preferred route.
- Rights Issue: Investment bankers have often used rights issues to help promoters increase their holdings in the company. Under normal circumstances, the rights issue provides an equal opportunity for all shareholders to subscribe to the issue.
Anyone who is already a shareholder can be allowed to buy shares in the same proportion. However, here investment bankers use timing to their advantage. They deliberately schedule the issue at the worst possible time. This is because they want the market conditions to be bad.
During a recession or a slowdown, most investors would not want to invest more in the company. Hence, a lot of the shares being issued will be left unsubscribed. This is where the promoters can come into action. They can buy leftover shares at a reasonable price. Hence, during this issue, they end up buying more shares than the other shareholders. Therefore, the proportion of their holding in the company changes during the course of the issue.
- Buy Backs: Investment bankers also suggest the promoters indulge in buybacks from the open market. This is because, during a buyback, the company purchases shares from the open market and extinguishes them. This means that the number of shares available to the general public is reduced. Now, it must be understood that the shares being extinguished come out of the public quota, whereas the promoters’ shares stay untouched. Hence, in the overall situation, the percentage of promoter shares increases.
Let’s understand this with the help of an example. For instance, the company has a total of 100 shares, out of which 20 are owned by the promoters and the rest by the public. This means that promoters have 20% shares of the company. Now, if the company buys and extinguished 20 shares, the total shares outstanding will be 80. Out of 80, the promoters will still have 20 shares. Hence the shareholding of the promoter will increase to 25% (20 out of 80 shares).
This mechanism is preferred by a lot of promoters since it allows them to use the company’s funds to increase their own shareholding in the company.
- Allotment to Promoters: In some cases, the investment bankers might try to simply get more shares allotted to the promoters. This allotment depends upon the law prevailing in the country.
In some countries, companies are allowed to issue additional shares to promoters as long as they pay the price, which is higher than the prevailing market price.
In some other countries, the concept of sweat equity also exists. This means that the company can allot more shares to promoters in lieu of their salary or any other intellectual asset that they may provide.
- Private Placement: Investment bankers also help promoters use private placements in order to increase their shareholding in a company. In many countries of the world, direct placement to promoters may not be allowed. This is where investment bankers come in. They use complex financial structures to allow promoters or their allies to get control of the company by getting more shares issued.
- Tiered Shares: Last but not least, investment bankers can use tiered shares as a workaround. In this arrangement, the shares issued get dividends like normal shares. However, they may not have equal voting rights. In some cases, the shares issued may not have any voting rights at all. This arrangement helps achieve both purposes. On the one hand, promoters are able to raise the cash that they require, whereas, on the other hand, there is no dilution of stake!
It is common for investment bankers to prepare a detailed strategy for the promoters. This means that only one technique is not used. Instead, a combination of several means is used, and that too is staggered over a larger period of time.
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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
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- The Components of an Investment Bank
- How do Investment Banks Make Money?
- Types of Investment Banks
- Important Regulations in Investment Banking
- Conflict of Interest in Investment Banking
- Challenges to Investment Banking Business
- How Investment Banks Source Deals?
- A Primer on Private Placements
- Precedent Transaction Analysis
- Qualified Institutional Placements
- Investment Banks and Underwriting
- Prime Brokers in Investment Banking
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- Floatation Costs and Investment Banking
- Roadshows in Investment Banking
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- Investment Banking and Delisting
- Junk Bonds in Investment Banking
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