Start-up IPO frenzy – The Watchdog is back in Action

SEBI intervenes to protect investor interests, proposes stricter regulations for Start-up IPOs

“Too much of anything is the beginning of a mess”

2021 is turning out to be the paramount year for tech-savvy start-up IPOs. With debatable valuations, over-optimistic investors and buoyant markets, we saw a loss making Zomato’s stellar opening (although a desperate contingency plan), Nykaa’s dream debut and the flop show from the biggest IPO till date, Paytm, among many others.

Start-ups with astronomically high valuations and unconventional business models are raising funds with vague plans, blurred profitability roadmap and hefty pricing are creating a sense of ambiguity among investors, particularly the smaller ones in a bigger way.

Too much of this mad IPO rush is creating a mess in the Indian capital market, which prompted the Reserve Bank of India (RBI) to impose a limit of INR 1 crore/borrower for Non- Banking Financial Companies (NBFCs) financing IPO applications, effective 1st April 2022. This move is likely to somewhat stabilize the high-flying market conditions, by skewing IPO allotment, reducing funds available to High Network Individuals (HNIs) investors and mitigating listing gains.  

Following the RBI’s decision to cap IPO lending for wealthy investors, SEBI issued a discussion paper on 16th November 2021 on certain aspects of the framework of IPOs, and invited public opinion on the same till 30th November. The regulator proposed measures to ensure more transparency and accountability from the listing companies. A positive step to prevent unprecedented mishaps, and protect investor interests. However, it may affect prospective IPOs in a bigger way, as they would have to be clearer and elaborate on their business plans to potential investors.

The Proposed Changes

Be Specific on utilization of IPO proceeds

Funding of Inorganic growth initiatives’ is a phrase used by new age companies in the DRHP, as the objective to utilize the fresh proceeds from the IPO. This may include acquisitions, strategic investments and partnerships, etc. However, raising money for something still unidentified, creates a certain amount of ambiguity amongst the investors. In the recent past, some start-ups have invested in high-risk acquisitions and deals using IPO proceeds, without even informing the company’s investors at the time of the IPO.

The recent IPO wave saw some loss-making tech-driven start-ups raising funds, having ambiguous revenue roadmap, making it difficult for investors to understand their revenue sources and utilization of funds.

For example, one of the most valuable Indian unicorns, Byju’s is planning to come up with an IPO, early next year, after a final private funding recently. The edtech start-up follows an acquisition-based growth strategy. Even with mounting losses, Byju’s is on an acquisition spree, acquiring four companies in the last six months. This makes investment in such companies, a risky affair, requiring investor vigilance.

To prevent this kind of uncertainty, SEBI proposed a maximum combined cap of up to 35% to be allocated for General Corporate Purpose (GCP) and inorganic growth.

In this way, investors will be aware of the utilization of their money and know the primary objectives of the IPO. It is believed that this cap would make acquisitions a bit tougher for listing start-ups, while ensuring ample scrutiny and appropriate checks before making any such investments. 

Offer for Sale – Not an easy way out for existing investors

Currently, issuer companies’ Promoters are entailed to keep at least 20% of post issue capital, locked in for 18 months, after listing. However, companies with no identifiable promoters do not have such restrictions to follow.

Recently we have seen that IPOs have become the easiest route for promoters and investors to dilute their stake and exit their way out. Some companies are even going the 100% OFS (Offer for sale) route, where the entire IPO proceeds go to the existing investors, leaving almost no room for the new investors. For example, Vedant Fashions that runs the Manyavar brand has filed its papers for IPO, which is a 100% OFS.

The new regulations propose that significant shareholders’ (with over 20% holding) shares of companies (without identifiable promoters) will now have to keep 50% of their pre-IPO issue stake locked in for a period of at least six months from the date of allotment.

Anchor investors – the Pillars of Confidence

To dazzle any company’s listing popularity, Anchor investors are invited to subscribe the shares one day before the IPO at a fixed price. This improves the stock’s demand and fuels investor confidence. Anchor investors are institutional investors (mainly QIBS, mutual funds, wealth funds, etc.), having a minimum investment of INR 10 crore in the public listing. At present, companies can assign 60% of QIB portion to anchor investors on a discretionary basis, out of which one third is reserved for mutual funds. However, merchant bankers, promoters or their relatives are not allowed to apply for shares under this category.

The current lock-in period for anchor investors to exit their investment is 30 days. To boost investor confidence, SEBI proposed to increase this timeframe to 90 days or longer.

This may have a positive impact on the retail investors, as when there is a massive selling of any stock, particularly from the key investors, the overall share performance and price spirals down.

It is seen that many start-ups raise IPOs, primarily to give liquidity to their early investors. This restriction may impact the shareholder arrangements, as it may discourage big investors from putting in their money readily in any company. Further, such regulations may have a cascading impact on the overall capital markets.

General Corporate Purpose – Not so ‘general’ any more

As per the existing rule, GCP should not exceed 25% of the total IPO proceeds. Also, companies are not required to disclose any information about the GCP utilization and there is no monitoring of the same. SEBI has proposed to bring GCP utilization under scrutiny through disclosure in the quarterly Monitoring Agency report.

A necessary move for investor welfare

A good move by SEBI to protect investor interest, making investment in start-up IPOs more transparent and reliable. The proposed regulations are likely to make raising funds through IPOs, a bit tougher, for start-ups and new age companies. Starts-ups will have to be more transparent in their transactions, and disclose more information about their business and future plans.  However, this may also bring in some sort of stability in the current overwhelming capital market sentiments and ensure greater accountability for the company as well as its investors.

As Thomas Jefferson said, “Let the eye of vigilance never be closed”.