Page 25 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Security Analysis and Portfolio Management

Notes and the sponsor(s). After a particular period of agreed upon between the sponsor and the company
the shares are issued to the public by the sponsor with a premium. The holding cost of such
shares by the sponsor may either be reimbursed by the company, or the sponsor may absorb the
profit in part or full as per the agreement, arising out of the public offering at a premium. After
the public offering, the shares are listed in one or more stock exchanges.
Advantages

Bought out deal is not only advantageous to the company going for it, but also it is advantageous
to the sponsors and common investors.
1. The company has the advantage of using the fund immediately without waiting as in the
case of direct public issue. In case of BOD, the company instantly obtains funds and is able
to focus its attention on project implementation without worrying about the source of
investment. Bought out deals are ideally suited for circumstances when money needs to
be arranged quickly, without which the project may suffer. Lowering or eliminating issue
cost from the preliminary expenses is another advantage to the company.
2. The time taken to raise money in the capital market by a company can be as much as six
months and this time is very high for a company in a stage of infancy. The waste of time
at the initial stage can be avoided by going for BOD.
3. In case of a new and untried product it is easier to convince an investment banker for an
investment in the company rather than the general public. Thus, BOD is an innovative
method of financing for such companies.

4. When the market sentiment is low and the secondary market is undergoing a bear phase,
a company may not like to come to the market with a public issue. In such a case, BOD is
a superior process to obtain funds for the company.
5. The merchant bankers also gain handsomely from a BOD. The merchant banks expect a
return of around 30% from a BOD whereas private financing institutions expect a return of
40% to 60% from a BOD. The gains can be tremendous, provided the sponsors select proper
issues and price it attractively to the investors.

6. The investors also gain from the BOD in a way that they get good issues where some
merchant banker has already invested in it. The common investors do not have enough
scope and information for proper evaluation of a company. The merchant bankers are
professionals and can make proper appraisal of a company.

Drawbacks

A BOD may also be disadvantageous to a merchant banker as well to the promoter.
1. There is a fear of loss of control of management because the sponsor is a holder of a large
chunk of equities at one time. The sponsor may also influence the policy decision, which
may affect the functioning of the company.

2. The investment banker who has to off-load the equities in the primary market at a later
date is entitled to ask for a higher price for the risk taken by him. But this price may scare
away the common investors.
3. If a company does not perform as per the expectations of sponsor, or if the promoter does
not cooperate with the sponsor later, the sponsor may have a tough time and may finds
that its entire investment has been eroded.

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