Latest Expert Exchange Queries
sitemapHome | Registration | Job Portal for CA's | Expert Exchange | Currency Converter | Post Matrimonial Ads | Post Property Ads
 
 
News shortcuts: From the Courts | News Headlines | VAT (Value Added Tax) | Service Tax | Sales Tax | Placements & Empanelment | Various Acts & Rules | Latest Circulars | New Forms | Forex | Auditing | Direct Tax | Customs and Excise | ICAI | Corporate Law | Markets | Students | General | Indirect Tax | Mergers and Acquisitions | Continuing Prof. Edu. | Budget Extravaganza | Transfer Pricing
 
 
 
 
Popular Search: VAT Audit :: empanelment :: ARTICLES ON INPUT TAX CREDIT IN VAT :: form 3cd :: ACCOUNTING STANDARDS :: VAT RATES :: due date for vat payment :: cpt :: TAX RATES - GOODS TAXABLE @ 4% :: list of goods taxed at 4% :: ACCOUNTING STANDARD :: Central Excise rule to resale the machines to a new company :: TDS :: articles on VAT and GST in India :: ICAI offer Get Windows 7,Office 2010 in Rs.799 Taxes
 
 
News Headlines »
 Invoking Writ Jurisdiction For Income Tax Matters
 How to file income-tax returns online
 How Income Tax Returns Are Scrutinised
 All About New Income Disclosure Scheme to make Demonetisation successful
 Your deposit may draw income tax notice
 Accepting payment under IDS 2016
 New disclosure scheme could see 50% tax and 4-year limit on cash use for unaccounted deposits
 Pay 50% tax on unaccounted deposits, or 85% if caught, says Modi government
 Deadline to pay property tax in old currency extended
 Cabinet clears amendments to Income Tax Act
 Have you got interest on your income tax refund?

Importance of risk capital
June, 21st 2007
Instead of subjecting current shareholders to `high-risk, high-return' strategies, corporates should be allowed to look for investors with the appetite for such risks...

A well-governed corporate thinking of taking up risky projects, instead of subjecting its current shareholders to `high-risk, high-return' strategies, should be permitted to look for investors retail and wholesale who have the appetite for such risks, and seek funding through innovative structures.

Look at a pharma company set on developing a New Chemical Entity (NCE) or getting into a litigation in the US over a patent/exclusivity issue, or a software company wanting to develop a product usable as an industry platform, or an oil company embarking on a large-scale exploration programme in an unexplored area.

Other than the one strikingly common aspect of all these endeavours unpredictable outcomes they have at least three other similar things.

One, they all have a large upside potential, whose fruition is contingent on the happening or otherwise of one or more events.

The downside might simply be frightening such as the failure of a molecule or the dismissal of a court case, or simply not being able to complete and put in place a software programme of acceptable quality in time, or the extensive exploration finding no exploitable mineral.

Two, they all involve large investments, whose quantum goes up sharply every subsequent stage. And, yet, success is not assured.

These situations need risk capital and attempts to substitute it with debt, of any shade, often meet with failure at the start itself; worse, a later-stage failure can threaten the very survival of the company.

Thus, a company badly needs risk capital. Depending on the industry, every company goes through this dilemma, the only difference is the magnitude of the problem and the stage when this problem hits.

The act of compromise

What is the best time to raise risk capital? Is it when the projects demand or when the market permits? And what if the market is not favourable when the money is needed or if the market is supportive, projects may not need money?

Should one raise money when one can and sit on it?

Will such money be as usable when the need arises? These are some of the hard issues thatkeep cropping up, and eventually forces the Chief Financial Officer to make compromise. The questions before every CFO faced with similar situation are:

How to fund this activity without risking the company and risking shareholder wealth?

How does one carry the message to the shareholders will they take it or dump it?

However much the existing shareholders might have supported the decisions of the company in the past, these high-risk, high-return investments frightens them.

This happened in the case of a pharma major that kept chasing a molecule in the global market and finally when the case bombed in a US court, the shareholders had to bite the bitter pill, running down the valuation of the company dramatically overnight.

This raises a corporate governance issue: Does the management have the right to gamble with shareholder wealth on a high-risk strategy without their explicit approval? So what does the company do?

Wanted, a new model

A corporate, usually, goes to the existing shareholders for funds before approaching new members. Divisional stock, for instance. But despite being used for some time now in the Western market, it has not gained wide currency. A divisional stock would be traded under the umbrella of the main stock, and reflect a division's activity. This method was used when some of the brick companies went to the click.

Traded option

An option despite being written on the equity is neither issued nor traded by the company. The only occasion a company issues its own options is to the employees under ESOP and these are governed by SEBI Guidelines.

A seller of a call gets a premium (income plus cash flow) but gives the buyer the option to acquire shares at a predetermined price, before a predetermined date. A buyer buys the call for the potential upside it holds. By varying the call maturity and strike price, the current income/cash flow can be varied by the seller.

Three provisions administer the regulatory framework for options:

The Securities Contract Regulation Act: Under this Act, a security includes derivatives, and the law permits trading in them. Who has issued the option is not relevant under this Act.

The Companies Act, 1956. allows either equity or preference capital. Equity can be any combination as long as the basic framework is maintained. Issue of option for risky projects will not offend this provision, as eventually the option will either die or become an equity share, depending on the outcome.

SEBI approval under its Investor Protection Guidelines. SEBI approval is the real test. For right reasons, SEBI would want control on the issue of corporate writing its own option.

The most important will be what kind of companies and projects will meet the requirements? And what pre-requisite of corporate governance/rating of the specific risk will be needed? And over what time horizon should the risk get resolved? How should the market be kept informed of the resolution of the risk?

The question is, will SEBI bite the bullet?

Surely, this will herald the junk bond and the long-term options market, which are essential to the opening the pension funds market.

Life of a traded option

When a corporate embarks on, say, a drug discovery, it needs money that will not hurt its performance. The money is worth much more if the clinical trial is successful, and the wealth can be shared with those who participated in its generation, which at the start was quite risky.

If the clinical trial of the phase concerned is not successful, the loss does not hit the current performance, and those who took the risk, will indeed end up with zero. The corporate has got the money (by way of call premium) by selling its own long-term call/call matching the time horizon of the clinical research.

And being an income, and not capital, is in a position to set off the expenses of development without hurting current performance.

If the project is successful, the company needs more money to implement the next phase, or commercialise the product. But the corporate is also ready to spin off the activity as a separate company, and allot shares to the option holders, at a pre-agreed price.

The India Inc strategy

Faced with regulatory constraints, and pressure for current income, the Indian pharma industry has been adopting a combination of strategies:

Out-licence the development for the periodic milestone payments and royalty. Not only the risk of failure of the molecule is hedged, but there is also no pressure to raise resources.

Spin-off specific molecules into a separate company with financial assistance from venture capitalists.

In both the models, the current shareholder, while protected from any downside of failure, is denied the opportunity to invest in the upside of the molecule/development, and gets to have the benefit either through the milestone payments received or the parent company's small investment in the new outfit.

Till the regulatory framework is put in place, the investor and the corporate have no other option but to go through indirect ways of hedging event risks, though in the process the upside also gets bartered away. It will be incorrect to say that it is a problem specific to pharma industry, though it is quite serious with pharma. It is now for industry and SEBI to work together to find a way out of this problem.

P. B. Ramanujam
R. Muralidhar

(The authors are former employees of global pharmaceutical majors.)

 
 
Home | About Us | Terms and Conditions | Contact Us
Copyright 2016 CAinINDIA All Right Reserved.
Designed and Developed by Binarysoft Technologies Pvt. Ltd.
Bath SEO Company Birmingham SEO Company Bradford SEO Company Brighton and Hove SEO Company Bristol SEO Company Cambridge SEO Company Canterbury SEO Company Carlisle SEO Company Chester SEO Company Chichester SEO Company Coventry SEO Compan

Transfer Pricing | International Taxation | Business Consulting | Corporate Compliance and Consulting | Assurance and Risk Advisory | Indirect Taxes | Direct Taxes | Transaction Advisory | Regular Compliance and Reporting | Tax Assessments | International Taxation Advisory | Capital Structuring | Withholding tax advisory | Expatriate Tax Reporting | Litigation | Badges | Club Badges | Seals | Military Insignias | Emblems | Family Crest | Software Development India | Software Development Company | SEO Company | Web Application Development | MLM Software | MLM Solutions