Sebi’s new ITP regulations are a breakthrough. We are finally ready for listings of domestic start-ups on domestic bourses
In the late 1990s, as the Indian IT sector witnessed its first surge of growth, many companies decided to go public.
The problem, however, was that at the valuations many such companies were enjoying, the then mandated 25% minimum public offering size would have led to huge unsellable deal sizes coupled with the fact that these IT companies did not need that much of capital. Recognising this challenge, Sebi had modified its guidelines by allowing such companies to go public with a 10% dilution. Many of today’s blue chips, including HCL and TCS, got listed thus. This special carve-out was then extended to the biotech and communication sectors also, and then to big market cap companies across all sectors.
In 2011, recognising the special characteristics of SMEs, Sebi launched the SME platform to allow small companies to raise capital, with several exemptions, but taking care of all the negatives of the much-hailed but badly-faired OTC Exchange of India in the early 1990s. In fact, 127 companies have since listed on the SME platforms of BSE and NSE, and the pipeline continues to be strong.
Over the last few years, there has been significant investment of private capital in Indian companies, particularly in the unlisted space. Very recently, in 2014, realising that private equity investors in many companies may like to exit not necessarily through the public offering route, Sebi introduced the SME-Institutional Trading Platform (ITP), where such companies could list without an offering but get traded. And 42 companies have since listed on this platform.
Now, recognising the special nature of the booming start-up sector, Sebi, after extensive consultations with the industry and associates, has announced new ITP regulations. These would be available to companies which are intensive in the use of technology, information technology, intellectual property, data analytics, biotechnology or nano-technology, to provide products, services or business platforms with substantial value-addition.
Many concessions/exemptions have been made compared to the main board IPO regulations. Most of the start-ups are e-commerce companies, not necessarily requiring funds for fixed assets but, say, for marketing. The normal IPOs have to strictly follow the guidelines on objects of the issue, providing granular details, and with 75% of the issue amount to be deployed for creation of tangible assets. This has been dispensed with for start-ups and only broad objects of the issue are required to be disclosed. The three-year profitability record which is essential for regular IPOs has been done away with. The minimum number of allottees has been kept at 200, as against 1,000 in the main board IPOs. And 75% of the allotment can be made to institutional investors, all of it on a discretionary basis.
Lock-in of the entire promoter’s capital for three years has been reduced to six months. Further, besides QIBs, family trusts and systematically important NBFCs registered with RBI and intermediaries registered with Sebi, all with net-worth of more than R500 crore, have now been allowed to be treated as institutional investors.
Though many start-ups are excited and have started preparatory work for their eventual IPOs, some demands are already being made for changes in regulations. For all the concessions/exemptions given in the ITP regulations compared to the main board regulations, the only “downside” is that it cannot be made to retail investors. As the name suggests, investors in these IPOs can only be institutions/HNIs, which clearly keeps retail investors out.
It should be understood that these regulations are primarily aimed at start-ups where multiple investments have come in from private equity investors, which have resulted in significant dilution of the promoters’ holding, and these have become not promoter-managed but professionally-managed companies.
As such, only such start-ups can do an IPO where the minimum pre-issue holding of registered QIBs is 25%. The regulator has insisted on institutional participation in the new-generation companies and start-ups not only because the risks are high but also because mature investors are in a position to steer, as also regulate, such companies in a better way. The requirement of minimum 25% institutional holding also gives the right to stop special resolutions.
Some people want non-registered VC/PE funds to be also reckoned. The registration requirement is only to ensure credibility of the issuer accessing the platform, otherwise any individual or entity can claim to be a VC/PE investor. A high level of due-diligence in the investments is ensured when these are made by regulated entities. If there are genuine unregistered PE/VC funds, it takes little effort to get registered with Sebi.
Recognising that most such companies are not promoter-driven but professionally-managed and promoters’ holding is often less than even 20%, another stipulation requires that no entity should hold 25% or more of the post-issue capital. There is a demand that an entity’s holding, if it exceeds 25% post issue, can be locked in, is against the very argument that these companies are not promoter-held but professionally-managed. In any case, if the promoters holding post issue is more than 25%, the main board option is available.
As per the main board requirement, also made applicable for ITP, all outstanding convertibles are required to be converted into equity before the IPO. There is a demand that this requirement be relaxed. The requirement, that no convertibles should be outstanding after IPO, ensures that the balance sheet and capital structure of the issuer are clean. If convertibles and other such hybrid instruments are allowed to subsist, then the capital structure shall remain opaque, which may render the financials incomprehensible for IPO investors. Many international markets do not permit holders of outstanding convertibles to continue holding such instruments post listing.
There is also a demand that Futures & Options on securities listed on ITP should be permitted. Considering that liquidity in securities in the ITP is yet to be ascertained and that it is likely to be low, it may be too early to consider derivatives on ITP-listed stocks.
As most start-ups are high-risk investments, with limited disclosures on use of proceeds, Sebi has kept retail investors out from this platform. To this end, it has stipulated that the application and trading lot size be Rs 10 lakh.
The demand for lowering this limit is questionable given the growing HNI investing population, but may be re-examined at some point of time, say, to bring it to R5 lakh. In any case, when these companies mature and move to the main board, retail investors shall have access to them. There is also a demand that to increase liquidity, market making should be made mandatory. Market making can still be done if the issuer opts for it. The request for companies listed on ITP to be included in existing benchmark indices is premature, but can be considered after weighing pros and cons.
There is also a demand that differential/super-voting rights and special rights at the time of listing should be permitted. It must be noted that structures with special rights are complex and governance related issues crop up when companies with special rights list and hence these are prohibited on the main board. However, considering that investors on the ITP platform are sophisticated, this option is worth exploring, but such rights would have to be annulled at the time of moving to the main board.
Though a discussion on this is some time away, some experts want that the criteria for migration to the main board may be based on achieving certain quantitative factors like market capitalisation, trading turnover and number of investors, and that profitability track record may not be insisted upon. However, for migration, it is fair for such companies to comply with the main board requirements; there should be no regulatory arbitrage available between listing on the main board and migrating to the main board from ITP.
The new ITP regulations are a breakthrough. We are finally ready for listings of domestic start-ups on domestic bourses, and see many of these emerge over the years as star performers on the stock markets. These should also stop the potential flight of Indian start-ups to foreign jurisdictions for listing. Surely, as has happened with almost all other regulations, these too would be suitably modified as experience is gained on this front.
The author is the founder-chairman of Prime Database