Problems and Scope of Merchant Banking in India

“Merchant Banking refers to the financial intermediary services provided by specialised banks called Merchant Bank (other than commercial banks) for business corporates and individual with high net worth.”

Merchant banks act as an intermediary/ middleman between business corporates and investors. In other words, merchant banking is financial intermediation between the business entities which require funds and the investors who possess ready capital and seeking an opportunity for investment so that they can make a return. 

Problems

You may have added reporting requirements to meet.

A merchant bank will help you make sure that you’re aware of your regulatory requirements. What they will not do is create the reports for you. When you begin working with a merchant bank, there may be a need for added disclosure to any stakeholders that are associated with your business. There are almost always additional costs associated with added reporting and compliance requirements.

These merchant banking advantages and disadvantages help to show the power of investments within a portfolio. Some investments involved tangible assets, while others involve smart decision-making with stocks, bonds, and mutual funds. When you can put together a diverse portfolio for yourself or your company, a merchant bank will help you find ways to grow your assets, so you can reach your overall business goals.

Your account will be more expensive than a traditional bank account.

Merchant banks tend to charge higher fees for their services compared to traditional banking services and products. You may be required to have a minimum net worth to work with the bank, have a specific portfolio already developed, or have a strong credit profile with a history of project development to qualify for the bank’s services. Although you may receive the initial consultation or evaluation for free, there is no guarantee your company will be accepted.

You do not have a guarantee of a renewal or extension.

When funds are made available through merchant banking, they are generally accessible for a short time period only. Receiving an extension of the agreement, or a renewal, may be uncertain if not impossible. Long-term funding is sometimes available through merchant banking, but most of the projects that are approved are based on a 5-year period or less. The only exception to this rule involves those who use merchant banks for investment purposes instead of funding purposes.

You will be investigated as part of the funding process.

It may be marketed as a free evaluation, but what a merchant bank is really doing is a detailed investigation of all your business affairs. They will look at your financial structure, evaluate the security of your assets, and even judge your personal sureties. If something is found to be out-of-order during their investigation, it could impact the credit profile of the company. At the very least, the terms and conditions requested of you may be nearly impossible to meet, which means either changing the structure of your business or looking for funding elsewhere.

You may not have access to every potential product.

Traditional banks may be willing to lend money to you when a merchant bank does not. That is because traditional banks tend to offer a variety of products which lowers their overall risk profile internally, which is a practice that not every merchant bank may follow. If you’re thinking about creating CD ladders and other conservative investments, it may be worthwhile to see what your local bank or credit union could offer, even if your business is classified as a large corporation.

You may not receive complete funding.

One way that merchant banks help to spread risk levels around is to provide incomplete funding for leases, expansions, and other investment needs. That forces your company to work with multiple merchant banks instead of one. They benefit because each new contributor lowers their overall risk. You’re stuck making multiple payments for multiple products or paying duplicate fees for similar services until your risk profile can be lowered.

You have no control over your interest rates or returns.

This issue may be the biggest disadvantage of working with a merchant bank. Most will not provide a guaranteed return if you have them managing your investment portfolio. If you take on a lending product to expand the physical assets of your company, then you have little control over the interest rates assigned to the lending product. Your profile is based on the perceived and real risks that the bank feels are present when working with you. If your company is seen as high-risk, even if it turns out to be a low-risk venture, you’re going to pay more for the services received.

You’re not going to receive start-up funding.

Most merchant banks are in the business of helping your company scale upward. The focus is usually on international markets, but in the United States, moving into a new state or community may qualify for banking support. What you’re not going to receive is start-up funding. Your business must have an established record of some success to take advantage of the services which are being offered. And, if you are approved and your business is still young, you’ll have strict repayment guidelines and smaller amounts offered for funding.

You will always have the risk of a mixed chance for success.

Merchant banks might decide to work with you on a financing package, but that is only one step toward eventual success. Assets are often required for the underwriting process, especially when a business is new to an industry, first getting started, or entering into their first international market. Those assets might need to come from the personal assets of the C-Suite to secure some financing. Merchant banks are like all other banks they like to invest when they know there is a good chance for a return.

You have size considerations which must be met.

Thanks to the Internet, any startup or SMB has the potential to enter into an international market. Just because you are present somewhere internationally does not mean that you’re going to qualify for the services a merchant bank provides. There are usually size considerations that must be met, which may include revenue minimums, business structure, and more. If you’re structured as a partnership or sole proprietor, you’re less likely to get the chance to work with a merchant bank on a project unless you’re trying to expand the portfolio of the company.

Scope

1) Underwriting of Debt and Equity:

Underwriting/ management of debt securities such as debentures and share capital is one of the most important functions of a merchant banker. The merchant banks act as middlemen between the issuer of debt securities and individual or institutional investor and assists the companies in raising funds from the market. Merchant banks evaluate the value of the business and the number of shares or debentures is to be issued.

2) Placement and Distribution:

The merchant bankers facilitate in distributing various securities like equity shares, debt instruments, mutual funds, fixed deposits, insurance policies, commercial papers and distribution network of the merchant banker can be classified as institutional and retail.

3) Corporate Advisory Services:

Merchant bankers offer customised solutions to their clients’ financial problems and financial structuring includes determining the right debt-equity ratio and gearing ratio for the client and appropriate capital structure theory is framed as well.

Merchant banker explores the refinancing alternatives for the client and evaluates cheaper sources of funds. It also provides Rehabilitation, Turnaround and Risk management services such as designing a revival package in coordination with banks and financial institutions for sick industrial units, appropriate hedging strategies to reduce the risk associated.

4) Project Advisory Services:

Merchant bankers help their clients in various stages of the project undertaken by the clients:

• They assist them in conceptualising the project idea in the initial stage
• Once the idea is formed, they conduct feasibility studies to examine the viability of the proposed project
• They also assist the client in preparing different documents like a detailed project report

5) Loan/ Credit Syndication:

Merchant bankers arrange tie-up loans for their clients. This takes place in a series of steps. Firstly, they analyse the pattern of the client’s cash flows, based on which the terms of borrowings can be defined. Then the merchant banker prepares a detailed loan memorandum, which is circulated to various banks and financial institutions and they are invited to participate in the syndicate. The banks then negotiate the terms of lending based on which the final allocation is done.

6) Provide Venture Capital and Mezzanine Financing:

Merchant bankers help companies in obtaining venture capital financing for financing their new and innovative strategies. They also help small organisations and entrepreneurs to obtain initial funding, other business ideas and opportunities, Government policies and incentives.

In addition, merchant bankers also provide various other services as well.

7) Portfolio Management Services:

Merchant banks offer portfolio management service to their clients. They guide their clients regarding profitable, easy liquid and less risky investment avenue. They also update their clients with important and crucial news and updates regarding investment opportunities and market fluctuations.

8) Interest/ Dividend Management:

Merchant bankers also facilitate their client on computing, declaration and allocation of interest on debt securities such as debentures and dividend of shares/stocks.

9) Brokerage Services:

Merchant banks also act as a broker in the stock exchange. They purchase or sell the shares on behalf of their clients and also provide guidance on which or when to buy or sell shares.

10) Manage Money Market Instruments:

Merchant bankers also manage money market instruments like Government bonds, Treasury bills, commercial papers, certificate of deposits for the Government entities as well as large companies and financial institutions.