By Harish HV
We saw nearly 150 IPOs in India in 2021 across BSE, NSE, and SME exchanges, which totalled up to about Rs 65,000 crore. They came from companies with varying themes and pricing, but there was one thing common to all—they were all plain vanilla equity. We seem to have killed all other instruments that gave the public options to hedge returns, get secured instruments, pay over time, have convertible instruments, warrants, etc.
Companies are only dependent on the banking system for debt and are not able to leverage the market by issuing debentures combined with equity or a warrant as a sweetener. They don’t have options where price can be determined at a future date. Neither do they have instruments that give flexibility in raising capital.
Investors have to take on the full equity risk if they go for IPOs or explore other sources for fixed income. A healthy capital market should give more options to investors and bankers. Companies need to explore these, and perhaps then we can hope to see some developments on this front in 2023. Many such options helped in building the capital market in the country and encouraging retail investors to participate.
It is helpful recollect here that Reliance pioneered different forms of convertible instruments and Tata Steel issued secured premium notes and Telco issued shares with differential voting rights. We see none of that innovation today, even though we have better regulation and disclosure that can prevent any attempts at mis-selling.
Summarised here are some of the instruments we saw in the past that could provoke bankers/companies to consider these or come up with more innovative options.
The issue of shares with one or more calls in the future gives investors the option to pay the share price over a period of time. Companies receive funds as and when they need it, rather than sitting on funds received in a single stroke. Companies can also consider options to adjust price downward if the IPO pricing was aggressive. This will help them avoid the permanent reputational damage of having overpriced the IPO, something we have seen in the case of a number of new-age companies. Giving call options was expensive in the past, with the requirement of sending notices by post, receiving cheques, tabulating, etc , but with today’s technology, this is not cumbersome. Subscribers can mandate their banks to debit their accounts when due, giving them a choice if they don’t want to pay.
This gave investors the option to buy equity at a pre-agreed price at a future date, and the company the ability to raise more capital if needed as also the option to not raise equity if they did not need additional funds. Warrants can be combined with other instruments such as equity or debentures.
These are in the form of debt, but are converted to equity in one or more tranches over 18 months. Investors earn interest till conversion, and companies can benefit with debt for an initial period as they build their business; dilution occurs when the company is expected to start delivering returns benefiting its valuation.
Partly convertible debentures (PCDs)
For PCDs, a portion is converted into equity, and the residual portion stays as a debenture. The market gave options for investors to sell these separately, boosting liquidity. We also had the famous khoka buybacks, where the debt portion was sold by retail investors to institutional investors and insurance companies, giving additional gains to the investors.
Optionally convertible debentures
Optionally convertible debentures are debt securities that allow an issuer to raise capital, and, in return, the issuer pays interest to the investor till the maturity. An investor in such debentures has the right to convert the debt into equities of the issuing company at a price and time that is determined at the time of the issue.
Secured premium notes (SPNs)
SPNs had the nature of both debt and equity, where the note carried no interest and was locked in for a certain period. The SPN came with a detachable warrant that could be exercised if the SPN was fully paid up.
Variations of these were NCD with warrants and PCD with warrants. Similar structures can be worked out with preference shares, and they can be fully or partly convertible with attached warrants.
Bringing back these instruments will attract a wider variety of investors to the market, give investors multiple options to invest with different objectives, and allow companies to raise capital in tranches and based on needs rather than issuing plain vanilla fully-paid-up equity as they do now. Clearly, it is time for IPO bankers to start innovating again. With their expertise, they can develop newer instruments. It will attract more investors to the market by addressing their need for different instruments, and will benefit companies, which are presently looking at pricing as the only variable when they plan IPOs.
(The author is director and managing partner, ECube Advisors)