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Sebi proposes tighter rules for IPOs

The Securities and Exchange Board of India’s Primary Market Advisory Committee (PMAC) has released a new set of proposals relating to the initial public offering (IPO) framework for public consultation and comment. The PMAC wishes to tighten regulations pertaining to the stated purposes of the IPO, with a cap on raising funds for acquisition, and monitoring of funds raised for general corporate purposes (GCP). It also suggests a longer lock-in for pre-issue shareholders, and a cap on the offer for sale (OFS) component in an IPO. In principle, these proposals are well-intentioned. They should ensure stakeholders have more skin in the game. A clearer, more defined purpose for end-use of funds may enable investors to make informed decisions, and thus help in protecting their capital.

On the flip side, this could result in the loss of flexibility when it comes to future corporate strategy for new-age technology companies (NATCs). It may also lead to a slower pace of returns for private equity and venture capital firms. Currently, if a promoter holds at least 20 per cent of post-issue capital, that entity has a lock-in period of 18 months before it can divest stake. This is considered the Minimum Promoter Contribution (MPC). Other pre-issue shareholders, who have been investors for at least a year prior to the IPO, may divest their entire stake via OFS. In issues where nobody holds a 20 per cent stake, there are no barriers. The new proposal is that in such issues where no entity holds MPC of 20 per cent, stakeholders may not be allowed to offer over 50 per cent of their respective stakes on OFS. Also, there would be a lock-in of six months before they can divest the rest. Also, anchor investors subscribing to the qualified institutional buyer portion of an issue may have a lock-in of 90 days, instead of the current 30 days.

The extended lock-in could offer comfort and confidence to retail investors. The purposes of an IPO as mentioned in the prospectus include raising funding for inorganic growth via acquisition, without mentioning specific targets. This is especially true for start-ups in new market segments, which often grow through acquisitions. The PMAC feels that when targets are undefined, it is harder for investors to assess risks. The draft red herring prospectus also contains an undefined category of funds raised for GCP. Under current regulations, up to 25 per cent of an issue may be allocated to GCP. The new proposal is that GCP and funds raised for undefined inorganic acquisitions should, in aggregate, be capped at 35 per cent of the IPO size. If specific acquisition targets are mentioned, there would be no cap, since investors would be better able to judge risks.

The PMAC also proposes the utilisation of GCP funds be monitored with quarterly reports. This is tricky since GCP itself is not defined. A clearer definition of GCP is needed, and this will be difficult given a wide variety of businesses tapping the market. While these proposals should mean better protection for IPO investors, they would constrain NATCs, which often depend on acquisitions at short notice. It may lead to caution in the start-up ecosystem if early investors have to wait longer for returns. The regulator must consider these proposals carefully to find a balance in ensuring adequate disclosure, and improved investor protection, versus placing constraints on normal business processes.

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