By Sandeep Parekh
The Securities and Exchange Board of India (Sebi) recently released a consultation paper inviting public comments on proposed changes to the existing framework governing initial public offerings (IPOs) under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018.
These recommendations are largely directed towards bringing about greater transparency in the market, and can be viewed as an attempt to recalibrate the framework to cater to emerging trends, including the rise of new-age technology companies and their models of inorganic growth, and the shift in the nature of corporate ownership. They propose to provide increased flexibility in raising funds, but at the same time increase the levels of supervision and checks and balances required to ensure that funds are properly utilised.
Limiting the deployment of funds towards unidentified purposes: Under the current regulatory framework, all companies are required to state the objective towards which the funds raised are to be utilised (in the offer document during an IPO), and are permitted to allocate up to 25% of the proceeds from the IPO for general corporate purposes (GCP). GCP can be seen as an un-demarcated portion of the money raised that doesn’t have to specifically be used for a project.
The consultation paper, instead, proposes to prescribe a combined limit of 35% on funds that can deployed towards unidentified purposes, including GCP and inorganic growth initiatives, such as intended acquisitions or strategic investments, out of the total proceeds of the fresh public issue. This limit has been proposed against the backdrop of the practice of disclosing objects of a public issue as ‘Funding of Inorganic Growth Initiatives’ by new-age technology companies that are asset-light and prioritise acquisition of new businesses, customers, technology, etc, as a substantial milestone in their growth trajectory over traditional objectives such as investment in fixed assets and capital expenditure. But this limit will not be applicable in the event that these inorganic growth initiatives are identified, and specific disclosures in relation to the same are made.
While not a blank cheque IPO like the American concept of Special Purpose Acquisition Company (SPAC), this does increase the flexibility of companies to grow inorganically through freshly-raised funds.
This proposed limit is likely to improve flexibility of companies, incentivise companies to make specific disclosures about the utilisation of proceeds from the public issue towards prospective growth initiatives, and enable investors to make more informed choices about their investment, after a thorough assessment of the value of the acquisition or strategic investment and the risk factors involved.
However, bearing in mind that such growth initiatives are considered highly strategic before being finalised, certain relaxations may need to be discussed to balance transparency with the issuer company’s flexibility and competitiveness in the market. While the benefit would be available to all companies, it is likely most useful for asset-light new-age companies which don’t need too much capital, but instead need the firepower to acquire companies and their innovations. By nature, these assets could be yet undiscovered, or discovered, but not disclosable to the public (lest the price shoots up).
Capping offer for sale by significant shareholders: The consultation paper seeks to impose a limit on the number of shares that can be offered for sale by existing shareholders by way of an offer for sale (OFS) in an IPO. Under the proposed framework, only 50% of the pre-issue shareholding can be divested under an OFS in an IPO, and the remaining is subject to a lock-in period of six months from the date of allotment in the IPO.
This proposed limit shall be applicable on an OFS by a ‘significant shareholder’, i.e. shareholders holding more than 20% of the pre-issue capital, specifically for IPOs of companies where there are no identifiable promoters. The proposal is premised on the gradual shift in the nature of corporate ownership, from a traditional promoter-held model to a dispersed shareholding model, without any identifiable promoters. In the absence of a distinct promoter group, and consequent minimum promoter contribution and post-issue lock-in requirements, the proposal is a positive step towards ensuring that the divestment of shareholding in such companies does not disrupt market forces and price discovery, and is not viewed as a loss of confidence in the issuer company.
Lock-in period for anchor investors: Under the current framework, a certain percentage of the IPO can be allocated to anchor investors prior to the issue-opening date. These shares are subject to a lock-in period of 30 days to inspire confidence in the issue and improve price discovery. The consultation paper seeks to increase the prescribed lock-in period, or alternatively reserve a higher percentage of anchor book for anchor investors who are agreeable to a higher lock-in period.
On a comparison of both proposals, providing anchor investors with the discretion of agreeing to an increased lock-in period for a higher reservation in the anchor book is likely to incentivise such investors to invest, as opposed to a mandatory prescribed higher lock-in period for all, which may have a dissuading effect.
Monitoring of funds used for GCP: Under the current framework, issuer companies are permitted to allocate up to 25% of the fresh issue portion of the IPO towards GCP, which virtually exempts issuer companies from disclosing the specific purposes or object towards which such funds shall be utilised. Moreover, the portion of the IPO allocated towards GCP falls outside the purview of the monitoring agency that tracks and discloses the utilisation of sale proceeds.
In light of the increasing issue sizes of recent IPOs and the substantial amount allocated to GCP, the consultation paper seeks to introduce monitoring of the utilisation of such funds, and mandatory disclosures in the monitoring agency report. This proposal can be viewed as one of Sebi’s many attempts to prevent the misuse of funds and ensure greater accountability and transparency in the market.
All in all, the proposals outlined in the consultation paper seem promising and well-intentioned in terms of catering to the emerging trends in public issuances and the unique challenges that they pose to market stability and investor protection.
The author is managing partner, Finsec Law Advisors
(Anil Choudhary, partner, and Mihir Deshmukh, associate, Finsec Law Advisors, contributed to this article.)