Initial Public Offerings (IPOs) generally provide investors with an opportunity to earn returns, but they are also associated with a high level of risk. Recently, the Securities and Exchange Board of India (Sebi) has advanced the process of bringing changes in regulations by approving amendments to a wide range of issues at its meeting. Let us look into the amendments in regulations related to IPO and how it will be helpful to the investors.
According to Sebi, companies seeking to raise capital through an IPO must disclose key performance indicators that are not disclosed in their financial statements. This is because many firms tend to be loss-makers in terms of operation and it is difficult to value them purely on the basis of their audited financial performance. Hence Sebi has mandated the issuing firm to disclose the price per share in previous rounds of capital raising. As a result, investors will be better able to evaluate the IPO price.
Besides, it is necessary to disclose funds raised over the past three years. The disclosure is strengthened by the requirement that an independent board of directors makes a recommendation regarding the IPO price.
Moreover, Sebi has made some concessions regarding the pre-filing of offer documents. Currently, Sebi hosts the draft red herring prospectus on its website for several weeks, giving an unfair advantage to the issuer’s competitors. Issuers will now be able to pre-file their offer documents with Sebi without revealing them to the public. The content of this document would be confidential between the issuer and the exchange, and between the issuer and the Sebi. It will be beneficial for the firm if the offer is not approved, is postponed or withdrawn.
Benefits for investors
The recent amendments will ensure that there is no information asymmetry and the information available to the institutional investors will also be shared with all investors, including retail investors. Additionally, by providing a historic comparison of valuations, IPO managers are also held accountable for explaining how valuations are calculated. Thereby transparency related to IPO pricing is strengthened and the investors will be able to decide whether to participate in an IPO.
Availability of supplementary information to the investors based on these additional disclosures (as mandated by Sebi recently) will help them make informed decisions. Thus they have better chances of getting better listing gains. By disclosing the ratio of IPO price band to weighted average costs of shares in the previous placements in the prospectus, the investors will have a more comprehensive understanding of the pricing.
In addition to the above, from a company’s point of view, startups will be in a better position to convince investors of their potential since they can present more unique metrics beyond conventional metrics. Regarding the regulations related to pre-filing, it is possible for prospective investors in IPOs to gain early access to the regulator’s observations, as these would be incorporated into the offer document, thereby as a result, IPO lead times are reduced.
Address regulatory gaps
Companies such as Paytm, Zomato, Policybazaar, among others, came to public markets last year. Most of the offerings, however, resulted in investors suffering losses since the share price of most of these startups is much lower than the price at which they were initially listed. The new regulations add another dimension by means of bringing in post-IPO stability in terms of price and rationalising the offer price made by new firms, especially loss making firms and those who have negative cash flow from operations.
To conclude, the present move is in the right direction and is expected to control the volatility in stock prices and increase transparency and further boost investors’ confidence.
The writer is a professor of finance & accounting at IIM Tiruchirappalli. With inputs from A.Paul Williams, research staff at IIM Tiruchirappalli