This article has been written by Soumi Ghose, pursuing the Diploma Programme in M&A, Institutional Finance and Investment Laws (including PE and VC transactions) from LawSikho.

Introduction

A Merchant Bank is a firm or a financial institution (including but not limited to banks), which invests equity capital directly in businesses and are often engaged in providing advisory service to these businesses. In 1967, the concept of Merchant Banking was formally introduced in India by National Grindlays Bank, through its “merchant banking division”, thus, became the pioneer bank dealing in Merchant Banking in India. 

The history of Merchant Banks across the world dates back to 17th and 18th Centuries, and it originated in countries like France and Italy, when these banks either intermediated or assisted other businesses in financial matters by charging a small fee. The concept of modern Merchant Banking had its seat in the city of London, when these Banks also started extending support to the Government. 

In India, after the introduction of Merchant Banking by National Grindlays Bank, it was followed by CitiBank and thereafter by the State Bank of India, they had set up their own Merchant Banking division in the year in 1970 and 1972 respectively. Subsequently, Merchant Banking had accelerated its business by attracting several other banks in India like ICICI Bank, IDBI Bank, Syndicate Bank, Canara Bank, Bank of Baroda, Bank of India and the banks too felt the necessity of providing Merchant Banking services for keeping pace with the growing competition. 

Whether Investment Bank is a synonym for Merchant Bank?

In common parlance “Investment Bank” and “Merchant Banks” are used interchangeably, but there are striking differences between the two, specifically in terms of the services they provide. Investment banks offer their wide range of services to larger companies, whereas merchant banks serve those corporate bodies, which are large enough for venture capital firms to serve but are not that large to make a compelling public share offering through the stock exchange. In other words, Merchant Banks help companies and high net-worth individuals. 

Which institute can be a “Merchant Bank” – in India?

As per a notification released by the Finance Ministry of India defines a Merchant Banker as, “any person who is engaged in the business of issue management either by making arrangements regarding selling, buying, or subscribing to the securities as a manager, consultant, adviser in relation to such an issue management”. 

Simultaneously, the Foreign Exchange Management (International Financial Services Centre) Regulations, 2015 read along with the Banking Regulation Act, 1949 mentions that “Merchant Bank” as “Banking Institutions performing merchant banking activities are also required to follow the requirements laid down in the prudential exposure norms prescribed by RBI, as well as the statutory limits contained in Section 19(2) & (3) of the Banking Regulation Act, 1949. Merchant Banking Company is also required to comply with the provisions of the SEBI Act 1992 and shall ensure not to engage in any other financial activities as mentioned in section 45I(c) of the RBI Act 1934.

For commencement of a Merchant Banking company  minimum capital required is of 5 crore rupees for category 1, Rs 50 Lakhs for category 2, Rs 20 Lakhs for category 3. Further, for functioning as a Merchant Banking Company the following details are to be complied with:-

1. A Merchant Banking Company cannot accept or hold public deposits;
2. A Merchant Banking Company is a corporate body other than a Non-Banking Financial Company as per the RBI Act;
3. A Merchant Banking Company must not engage in any activity other than those connected to the securities market;
4. A Merchant Banking Company must have a minimum of 2 employees holding a prior experience in merchant banking;
5. A Merchant Banking Company must not be related to any other entity directly or indirectly registered as a “merchant banker”;
6. A Merchant Banker must not have found guilty for any economic offence.

General functions of Merchant Bank

The important functions of a Merchant Bank are as follows:- 

1. Raising funds for clients:- Merchant Banks help its clients to raise funds by issuing shares, debentures  and bank loans., both in the domestic and international market;
2. Obtaining Regulatory Approval:- Merchant Bank supports in getting the Regulatory approval for its clients for the commencement of business, expansion of business as well as modernisation of the clients’ business;
3. Brokers in stock exchange:- The merchant banks also perform the function of a stock exchange broker by buying and selling the stocks on behalf of their clients;
4. Managing the public issue of companies:- Merchant Banks player the role of an advisor as well as manages public issues of companies;
5. Varied services to different sectors:- Merchant Banks offer a wide range of services and these are tailor-made as per the needs and requirements of the respective clients. They provide several services to the public sectors including raising long-term capital, marketing of securities and foreign collaboration as well as managing the long-term finance.  
6. Management of Interests and Dividends: Merchant Banks extends their services in the management of interest of their clients as well as dividends on the invested shares by the clients, and regarding the rate of dividend and their timing.
7. Leasing Services: Some Merchant Banks also help in leasing services where the lessor allows the use of specific assets to the lessee for a certain period on behalf of rentals or fees.

Relevance of Merchant Banks in an acquisition transaction    

Merchant Banks deal with equities in the primary market and are engaged in activities like capital restructuring, underwriting and portfolio management, which have a direct impact on the growth and liquidity of the money market. Therefore, Merchant Banks are exposed to the market and are willing to take risks. 

Specialised services undertaken by Merchant Banks for supporting acquisition transactions are as follows:-

1. Project Counselling:-  It includes every minute details about any project including preparation of project report, financial planning, presenting the project with various institute for obtaining funds.
2. Management of Debt and Equity offerings:- Merchant Banks undertake the followings with a view to raise funds from the market for its clients:-  

1. Instrument Design / Issue management;
2. Pricing the issue;
3. Registration of the offer documents;
4. Underwriting support;
5. Marketing of the issue;
6. Allotment and refund
7. Listing on the stock exchanges. 

The above terminologies are briefly discussed below:-

• Instrument Design / Issue management

The Merchant Banks plays the role of intermediary between such entities having capital and are in need of capital.  While acting under SEBI guidelines, the Merchant Bank as the first step arrange a meeting between both the above-said entities to finalise opening and closing date of the issue, registration of prospectus, launching publicity campaign and fixing date of board meeting to approve and sign prospectus and pass necessary resolutions. The entities consult the Merchant Bank for fixing the price of the issue. 

• Advisers to the issue

The merchant bank’s manager for the issue of the respective clients, help the client in several ways like: – i) assist in the drafting of the prospectus, application forms and completion of all the necessary formalities under the Companies Act, the appointment of Registrar for handling “share applications”, “transfer as well as a listing of company’s shares” in the stock exchange.  The clients i.e the companies have the liberty to appoint one or more merchant banks, however, one of these merchant banks should be the “lead merchant bank”. Work by all these merchant banks shall be carried out only after consultation with the lead merchant bank. 

• Underwriting of Public Issue

Underwriting is a guarantee given by the underwriter that in the occurrence of under subscription, the amount underwritten would be subscribed by him. Merchant Banks have the limitation to underwrite only up to 15% only. 

• Portfolio Management

Merchant banks assume the duty of getting maximum benefits to its clients by guiding them to invest in various type of securities, ensuring minimal risk involvement.

•  Restructuring Strategies:-

Merchant Banks act as intermediaries and take part in negotiating for those companies who may choose to restructure their business by either merger or takeover. Merchant Banks successfully assist the management of their clients’ various restructuring activities in addition to other activities.  

• Non-resident investment:-

Merchant Banks also act as advisors to NRIs, assisting them with various investment opportunities including a selection of securities, investment management, and operational services like transacting securities. 

• Loan Syndication:-

Syndicate loans are those, which are raised for projects and the finance involved in it is comparatively huge. Thus, these loans are often obtained from multiple financial institutions too. Merchant Banks assists their clients for raising syndicated loan from various banks and financial institutes.  

•  Corporate Counselling and related services:-

The concept of corporate counselling is so wide that it includes the entire activities which a merchant bank extends to its clients, like from the very project counselling, capital restructuring, public issue management, loan syndication and resolution to client’s financial issues. Merchant banks also perform related issues like evaluating a cheaper source of funds for their clients. Merchant banks also advise their clients on different hedging strategies and suggest the appropriate strategy. 

• Placement and distribution:-

Merchant Banks assists its clients to distribute various securities like equity shares, debt instruments, mutual fund products, fixed deposits, insurance as well as commercial paper. The distribution network of merchant banks can be classified as institutional and retail in character. The institutional network consists of mutual funds, foreign institutional investors, private equity funds, financial institutions etc.  The size of such a network signifies the wholesale reach of the merchant banker. The retail network purely depends on networking with investors. 

Conclusion

It is evident that the Merchant Bank has an integral role to play in any acquisition transaction in India. Further, merchant banks are mainly concerned with international finance and provide trade finance assistance to their clients along with various other supports including restructuring, depending on the needs and requirements of their respective clients.