Underwriting of Shares and Debentures & Types of Underwriting

UNDERWRITING OF SHARES AND DEBENTURES

Underwriting is an act of guarantee by a company for the sale of certain minimum amount of shares and debentures issued by a Public Limited company.

When a company goes in for an Initial Public Offer (IPO), it may face certain uncertainty about whether its offer of shares or debentures will be subscribed in full or not. As per SEBI guidelines, it is required that if the company is not able to collect 90% of the offer amount, then it needs to compulsorily return the amount to those who have subscribed to shares/ debentures and thus it leads to wastage of lot of issue expenses. This uncertainty could be avoided by the help of a specialized group of risk redeemers called underwriters.

CMA Inter Company Accounts and audit  Underwriters can be the firms or persons who are engaged in underwriting.

Underwriting commission is the commission payable to underwriters for underwriting. It may be paid in cash or in fully paid up shares or debentures or a combination of all these. It is calculated on issue price unless otherwise mentioned.

 

In other words, it is an agreement whereby the underwriters ensure the company, that in case the shares and debentures offered to the public are not subscribed by the public to the extent and the balance of shares and debentures will be taken up by the underwriters.

 

Advantages of Underwriting are as follows:

  1. The company is sure of getting the value of shares or debentures issued.
  2. It magnifies the goodwill of the company.
  3. It facilitates wide distribution of securities.
  4. The company gets expert advice from underwriters in case of marketing securities.
  5. It fulfills the requirement of minimum subscription.

 

Provisions regarding Underwriting:

  • A company cannot pay any commission on the issue of shares/ debentures unless permitted by its Articles.
  • The commission is limited to 5% of issue price in case of shares and 2.5% in case of debentures. However, SEBI has allowed underwriting commission only at the rate of 2.5% of issue price of equity shares.
  • The amount or the rate of commission should be disclosed in the prospectus.
  • In the prospectus, the directors must state that the underwriters are capable of meeting their obligations under the underwriting contract.

Marked or Unmarked Application

Normally shares or debentures of a company are underwritten by two or more underwriters in an agreed ration. Generally the forms are stamped with the name of the underwriters in order to differentiate between the forms of one underwriter from that of others. Such stamped applications when received are called marked applications. The application forms which are received by the company without any name of the underwriter are called unmarked application.

 

Underwriting account is a nominal account and is prepared by the underwriter to ascertain the profit or loss on underwriting.

 

Sole Underwriters:

When the issue is underwritten by only one underwriter then it is called sole underwriting. In such cases, the distinction between marked unmarked applications is not of such significance. For example: an issue of 1,00,000 shares of Rs.20 each of A Ltd is underwritten by Z.

In case of sole underwriter the liability will be equal to the number of shares or debentures underwritten minus shares or debentures applied for. If the issue is fully subscribed or oversubscribed, there will be no liability for the underwriter to take up any share or debenture.

 

Joint Underwriters:

When the company enters into underwriting arrangement with number of underwriters, then it is called Joint Underwriting or Co-underwriting. An individual underwriter will be responsible only to the extent of shares underwritten by him. For example, if an issue of 1,00,000 shares of Rs.20 each of A Ltd. is underwritten by M,N,O,P in the ratio of 2:2:1:1, it is the case of Joint Underwriting. In such case, the benefit of unmarked applications is given to the underwriters in the ratio of their gross liability. The benefit of marked applications is given to the concerned underwriters in whose favour applications have been marked. Thus it is desirable that the particular method to be followed should be clearly mentioned in the underwriting agreement.

Browse full video here to Understand Underwriting of Debentures and Shares

 

Types of Underwriting

 

1. Conditional Underwriting:

Under this type of underwriting, the underwriter agrees to take up shares or debentures only when the issue is not subscribed by the public in full.

 

2. Firm Underwriting:

Under this type of underwriting, the underwriter agrees to take up a specified number of shares or debentures irrespective of number of shares/ debentures subscribed for by the public. Under this, even if the issue is over-subscribed, underwriters are liable to take up agreed number of shares.

 

3. Partial Underwriting:

When a part of the issue of shares or debentures is underwritten by one person only. In such a case, only a part of the whole issue is underwritten only by one underwriter and the balance amount is deemed to have been underwritten by the company itself. In such a situation the unmarked applications are treated as marked application from the point of view of the company.

The liability is determined as follows:

Net Liability = Gross Liability – Marked Applications

  1. When a part (say 75%) of the whole issue is underwritten by the underwriters it is called as partial underwriting.

For Example, A Ltd. Decided to make a public issue of 1,00,000 equity shares of Rs.20 each out of which 90,000 shares are underwritten by M,N,O,P in the ratio of 2:2:1:1. It means 10,000 shares are underwritten by Company itself.

In this case if figure of marked application is not given separately, (Marked applications = Total number of applications received x percentage of underwriting.)

For the uncovered portion we can say company is liable, but company will not take its own share rather it will remain unsubscribed.

 

Example 1 (Full Underwriting):A Company issued a prospectus inviting applications for 5, 00,000 Equity Shares of Rs. 10 each.

The whole issued was fully underwritten by four persons:

A — 2, 00,000 Shares

B — 1, 50,000 Shares

C — 1, 00,000 Shares

D — 50,000 Shares

Applications were received for 4, 50,000 shares of which marked applications were as follows:

A — 2, 20,000;

B — 90,000;

C — 1, 10,000

D — 10,000

Find out the liabilities of individual underwriters.

 

Solution:

(1) The net liability of the underwriters is ascertained by giving credit to unmarked applications in the ratio of gross liability.

Total shares applied – Marked Application = Unmarked Applications 4, 50,000 – 4,30,000 = 20,000 shares

When the entire issue is underwritten by a single underwriter, there is no necessity to distinguish between marked and unmarked application and the liability for the underwriter would be 50,000 shares.

(2) However, if the credit given to the underwriters in proportion to the gross liability of the underwriters as reduced by the marked applications, the statement would appear as follows:

 

Net liability of Underwriters:

M N O P Total
Gross liability 200000 150000 100000 50000 500000
Less: Marked application 220000 90000 110000 10000 430000
Liability -20000 60000 -10000 40000 70000
Less: Surplus of M & O to N & P (3:1) +20000 -22500 +10000 +7500
Liability 37500 32500 70000
Less: Credit for Unmarked forms 12000 8000 20000
Net liability 25500 24500 50000

Example 2:A company issued 10,000 shares of which 75% was underwritten by an underwriter. Applications for 6,000 shares were received out of which 4,800 shares were marked by the underwriter. Determine the net liability of the underwriter.

Solution:

Gross Liability = 75% of 10,000 = 7,500 shares

Less: Marked Applications = 4,800

Net Liability = 2,700

(b) When a part of the issue of shares or debentures underwritten by a number of underwriters.

In such a case, only a part of the whole issue is underwritten by a number of underwriters and for the balance, the company is said to have underwritten the same. As such the company is said to have underwritten the same.

 

Example 3:A Company issued 1, 00,000 shares of Rs. 100 each.

These shares were underwritten as follows:

X — 30,000 shares and Y — 50,000 shares.

The public applied for 70,000 shares. Determine the liability of X, Y and the Company.

Solution:

Marked applications are not given in the problem. Therefore, applications are credited to underwriters including the Company on the basis of gross liability. The Company itself is treated as an underwriter for 20,000 shares.

Unsubscribed shares = 1,00,000 – 70,000 =  30,000

Thus the net liability of X = 30,000 * 30/100 = 9000 shares

Net liability of Y = 30000*50/100=15000 shares

Net liability of Company = 30000*20/100=6000 shares

 

 

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Important Tags : Underwriting of Shares and Debentures / Underwriting / Types of Underwriting / Advantages of Underwriting / difference between shares and debentures

 

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May 8, 2021

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