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Indian Financial System

Notes promotes confidence of investors through transparency and non-discriminatory basis of
allotment. There is hardly any scope of artificial jacking up of prices if the issue is made public.
However, this method can be gainfully employed by large companies offering big issues because
of high costs involved in raising capital. Further, it is a time-consuming method as a lot of legal
formalities need to be complied with before floating an issue.
5.3.2 Offer for Sale

This method involves outright sale of shares enbloc by the company to issue houses or a group
of brokers at an agreed price who in turn resell them to the public at large. In such cases, the
issuing houses may act as agents of the company. The difference between the resale price and
purchase price is termed as spread and represents the profit of the issue houses. In the US, issuing
companies cannot approach the public directly. They are under obligation to sell their shares in
the first instance to underwriters, who then issue these shares to the investing public. In India,
this method has been employed on an experimental basis under the name 'bought out deals'
wherein the shares are first sold to the sponsor under an agreement that the sponsor shall sell
them to public within a specified period of time.
This method of distribution of securities has the advantage of ensuring success of the issue and
economizing on cost of new issues and thus the issuing company is relieved of the botherations
involved in selling securities to the public. The issue houses also stand to gain by charging
higher prices.

5.3.3 Private Placement

In this method, the issuing company offers issue privately to a select group of investors without
the prospectus. In this process, the issuer may call upon the services of brokers or issue houses.
This method works in a manner similar to the 'offer for sale method' whereby securities are first
sold to issue houses, etc., who then sell them at higher prices to individuals and institutions.
The SEBI has laid down certain restrictions on the reservation of securities in any public issues.

For example, the maximum permissible allotment through reservation is restricted to 10% for
permanent employees, 10% for shareholders of promoting companies, 20% for Indian mutual
funds, 24% for FIIS and 20% for Indian and multilateral development financial institutions.
This method of selling securities is very economical and less troublesome. As such, it suits the
requirements of small companies. To others, this method is useful especially when the stock
market is in bearish state and the public response is poor. However, the disadvantage of this
method is that the investor cannot resell the security for a specific period of time. This method
may also lead to concentration of securities in a few hands. There is also scope for creating
artificial scarcity for the securities, thus jacking up the prices temporarily and misleading the
general public.

5.3.4 Rights Issue

Rights issue method is an important method of distributing securities in which the existing
company offers shares to its existing shareholders in proportion to their existing ownership. As
per Section 81 of the Companies Act, 1956, existing shareholders get a right of 'pre-emption' and
they have the option to exercise the right to renounce it or throw away. For that purpose, a
company intending to increase its subscribed capital by the issue of new shares either after two
years of its formation or after one year of the first issue of shares whichever is earlier will have
to offer the shares to the existing shareholders with the right to reserve them in favour of a
nominee.

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