Disinvestment, Buybacks, Delisting, Debt Securities, and SME Platforms: Key Merchant Banking Mandates (Part 4 of 4)

In addition to managing public issues and takeover codes, merchant bankers play a vital role in executing specialized corporate actions such as disinvestments, buybacks, equity delisting, debt issuance, and the structuring of alternative capital markets for Small and Medium Enterprises (SMEs). This concluding study note provides an authoritative, exam-oriented analysis of these diverse merchant banking activities under Indian corporate and securities law.

1. Disinvestment in Public Sector Undertakings (PSUs)

Disinvestment refers to the direct or indirect sale by the Central Government, State Government, or a government company of shares, voting rights, or control over a target company that is a public sector undertaking. Merchant bankers act as strategic advisors or managers in these sovereign divestment mandates.

A. Types of Disinvestment Transactions

Disinvestment transactions are generally executed through two primary structures:

1. Prospectus Route (OFS / Fresh Issue): This involves an Offer for Sale (OFS) by the selling government shareholder through a prospectus, which can occasionally be combined with a fresh issue of securities.
2. Stock Exchange Mechanism: Executing the Offer for Sale directly through a dedicated trading window on the stock exchanges.

B. The Advisory Role of the Merchant Banker

When advising a government entity, the merchant banker must strictly align their recommendations with the guidelines issued by the Department of Public Enterprises (DPE).

• Corporate Actions Planning: For instance, if a bonus issue is recommended, the advisor must evaluate the impact it will have on the PSU’s rating due to an expanded equity base and the likelihood of a lower Earnings Per Share (EPS).
• Performance Evaluation via Composite Score: To systematically review the performance of a PSU, a composite score is calculated based on its financial performance over the preceding three years. This score evaluates six specific performance indicators:

• EPS Scoring Scale (Face Value of Rs. 10): The scoring system assigns points to the EPS parameter using the following scale:
  • EPS >= 30: 10 points
  • EPS >= 20 & < 30: 8 points
  • EPS >= 10 & < 20: 6 points
  • EPS >= 5 & < 10: 4 points
  • EPS >= 0 & < 5: 2 points
  • EPS >= -5 & < 0: 0 points
  • EPS >= -10 & < -5: -2 points

2. Buyback of Equity Securities

A company may decide to buy back its own shares or specified securities to return surplus cash to shareholders or optimize its capital structure, subject to Sections 68 to 70 of the Companies Act, 2013 and the SEBI (Buy-Back of Securities) Regulations.

A. General Prohibitions & Permitted Methods

• Anti-Delisting Rule: A listed company is strictly prohibited from buying back its shares or other specified securities for the purpose of delisting them from the stock exchange.
• Approved Buyback Methods: A company must only buy back its securities using the following methods:
  • From existing security holders on a proportionate basis through the tender offer route.
  • From the open market through either a book-building process or the stock exchange route.
  • From odd-lot holders.
• Open Market Cap: An offer of buyback from the open market is strictly capped and must be less than 15% of the paid-up capital and free reserves of the company.
• Banned Transactions: Companies are strictly prohibited from buying back securities through negotiated deals (on or off the stock exchange), spot transactions, or private arrangements.
• Cooling-off Period: A company cannot make any fresh buyback offer within a period of one year reckoned from the date of closure of the preceding buyback offer.
• Information Integrity: Any person or insider is prohibited from dealing in the securities of the company on the basis of unpublished information relating to the buyback.

B. Merchant Banker Responsibilities in Buybacks

• The promoter of a listed company must appoint a registered merchant banker before executing a buyback.
• Public Announcement Verification: The public announcement (PA) for the buyback must contain a full, complete disclosure of all material facts. The PA must be dated and signed on behalf of the Board of Directors by the company manager or secretary, and by at least two directors (one of whom must be the Managing Director, where there is one).

3. Voluntary and Compulsory Delisting of Shares

Delisting refers to the permanent removal of a company’s equity shares from the trading platform of a recognized stock exchange. This is governed by the SEBI (Delisting of Equity Shares) Regulations.

A. Voluntary vs. Compulsory Delisting

• Voluntary Delisting: Triggered when the issuer company no longer wishes to remain listed and provides an exit option to its public shareholders.
• Involuntary/Compulsory Delisting: Initiated by the stock exchanges as a disciplinary action against the company for non-fulfillment of listing criteria or regulatory non-compliance.

B. Key Regulatory Restrictions on Delisting

No company can apply for, and no stock exchange can permit, the delisting of equity shares:

1. Pursuant to a buyback of equity shares.
2. Pursuant to a preferential allotment.
3. Unless a minimum period of 3 years has elapsed since the date of listing.
4. If there are any outstanding convertible instruments of the class sought to be delisted.

C. Major Enforcement Penalties

• Ten-Year Market Ban: Where a company has been compulsorily delisted by an exchange, the company, its promoters, its whole-time directors, and all companies promoted by any of them are barred from directly or indirectly accessing the securities market or seeking listing for any equity shares for a period of ten years from the date of delisting.
• Fair Valuation: In a compulsory delisting, the recognized stock exchange must appoint an independent valuer(s) to determine the fair value of the delisted equity shares.

D. Operational Steps for Merchant Bankers in Delisting

• Appointment & Escrow: Before making the public announcement, the acquirer/promoter must appoint a SEBI-registered merchant banker. They must also establish an escrow account and deposit the total estimated amount of consideration, calculated based on the floor price and outstanding public shares.
• Dispatch Timeline: The letter of offer must be dispatched to the public shareholders no later than 2 working days from the date of the public announcement.
• Bidding Restriction: Promoters or PACs are strictly prohibited from bidding in the delisting offer. The merchant banker is personally responsible for enforcing this restriction.

4. Issue and Listing of Debt Securities

Merchant bankers advise and manage the public issue and private placement of debt instruments under the SEBI (Issue and Listing of Debt Securities) Regulations.

A. Key Operational Rules for Debt Issues

• Due Diligence and Comment Resolution: The lead merchant banker must ensure that all comments received from the public or SEBI on the draft offer document are suitably addressed prior to filing the final document with the Registrar of Companies (RoC).
• Pricing Models: Debt pricing can be determined at a fixed coupon rate or through an online book-building process in consultation with the lead manager.
• Shelf Prospectus: The option to issue a Shelf Prospectus (which allows multiple issuances without filing a fresh prospectus each time) is restricted to certain designated categories of issuers.
• Minimum Subscription: The issuer can decide and disclose the minimum subscription amount they seek to raise in the offer document.
• Security & DRR: For secured debt, proper security must be created within specified regulatory timelines, and a Debenture Redemption Reserve (DRR) must be created.
• Over-subscription Retention: Issuers are legally permitted to retain over-subscription money up to a maximum of 100% of the base issue size.
• Private Placement Boundary: In private placements of debt, there is a strict limit on the number of potential investors who can be approached. If this limit is breached, the transaction is legally deemed a public issue, triggering all public issue compliance rules.
• Technological Facilities: Public debt issues are permitted to utilize online applications, and investors can access the Application Supported by Blocked Amount (ASBA) facility.

5. Share Based Employee Benefits and Dissenting Shareholder Exit Offers

A. Share Based Employee Benefits (ESOPs, ESPS)

• Listed companies can issue shares to employees through schemes like Employees Stock Option Schemes (ESOS) and Employee Stock Purchase Schemes (ESPS).
• Merchant Banker Mandate: The company must appoint a registered merchant banker for the implementation of these schemes up to the stage of obtaining in-principle listing approval from the stock exchanges.

B. Exit Opportunity to Dissenting Shareholders

• Context: If a listed company decides to change its business objects or vary the terms of a contract referred to in its prospectus, it must provide an exit offer to dissenting shareholders under the Companies Act, 2013.
• Advisory Obligation: The exit offer must be structured by the promoters or controlling shareholders.
• Exempt Scenario: This exit obligation does not apply if there are no identifiable promoters or controlling shareholders in the listed issuer.

6. Small and Medium Enterprises (SME) Exchange

To facilitate fundraising for smaller enterprises, SEBI provides an alternative platform within recognized stock exchanges, known as the SME Exchange.

A. Core Distinctions: SME vs. Main Board

• An SME Exchange is a dedicated trading platform of a nationwide stock exchange permitted by SEBI to list specified securities of SMEs, and does not include the Main Board (Main Exchange).
• Minimum Application Value: The issuer must stipulate a minimum application size in the offer document, which cannot be less than Rs. 1 lakh per application.
• Minimum Allottees: No SME initial public offer can proceed with allotment if the total number of prospective prospective allottees is less than fifty (50).

B. Migration Rules Between Exchanges

• Migration to SME Exchange: A listed issuer whose post-issue face value capital is less than Rs. 25 crore may migrate its securities to the SME Exchange. This requires shareholder approval via a special resolution passed through postal ballot, alongside meeting the SME Exchange’s listing criteria.
• Migration to Main Board: An issuer listed on the SME Exchange may migrate to the Main Board if its post-issue face value capital is more than Rs. 10 crore and up to Rs. 25 crore.

C. Compulsory Market Making

• To ensure liquidity for tightly held SME shares, the merchant banker must facilitate compulsory market making through registered stock brokers of the SME Exchange.

7. Key Takeaways & Exam Pointers

• PSU Performance Indicators: The DPE composite score uses 6 parameters with specific weightages. Net Profit to Net Worth carries the highest weightage (25%), followed by Inter-Sectoral Performance (20%).
• Delisting 10-Year Ban: Compulsory delisting carries a severe penalty—promoters, directors, and their companies are banned from the capital markets for 10 years.
• SME Allottees Limit: An SME IPO requires a minimum of 50 prospective allottees to complete allotment.
• Open Market Buyback Limit: Open market buybacks cannot exceed 15% of a company's paid-up capital and free reserves.
• Unclaimed Special Escrow Funds: Any unclaimed balances in a special escrow account are transferred to the SEBI Investor Protection and Education Fund (IPEF) after exactly 7 years.

Important Formulas (Simple Line Format)

• Open Market Buyback Limit = Total Buyback Value < 15% of (Paid-up Capital + Free Reserves)
• Minimum SME Application Threshold = Minimum Application Value per Investor >= Rs. 100,000
• Maximum Debt Over-subscription Retention = Base Issue Size * 100%
• Minimum SME IPO Allotment Count = Total Prospective Allottees >= 50