New rules planned for startup listing

Source: Economic Times

A new definition, separate trading platform and higher entry barrier to discourage riskaverse small investors will form the contours of a new set of rules to enable startups to list on stock exchanges. Capital market regulator Sebi, which is preparing a discussion paper on the subject, will also relax disclosure norms relating to use of funds raised in maiden public stock offering by such companies.

Even though most startups — backed by venture capitalists and angel investors — are loss making and may not attract too many retail investors, the Securities and Exchange Board of India (Sebi) fears that an absence of listing opportunity in India could drive these firms to tap overseas bourses that offer softer regulations and easier listing facilities.

The regulator plans to define ‘startups’ — where no single stakeholder or interest group holds 25% or more equity stake — as “professionally managed companies”, said a person familiar with the discussions.

Most unlisted startups are funded by VCs, private equity (PE) houses and ultra high net worth individuals, with founders holding comparatively lower stakes. “It would greatly help to remove the requirement of having an identified promoter or requiring 20% of post-IPO shares to be locked up as promoter contribution. Founders of many startups may not have the necessary shareholding to lock up 20% of post-issue capital for three years as that would be diluted with progressive rounds of new investment and the private equity and strategic investors may well hold a larger stake. Also, PE and strategic investors would not want to be named as promoters and carry additional risk and liability,” said Sandip Bhagat, partner at law firm S&R Associates.

ISSUE PROCEEDS

Startups will also be allowed to state in the initial public offer prospectus that the main object of the issue proceeds would be used for “general corporate purposes” in line with the best global practices. At present, Sebi rules do not allow a company to use more than 25% of the fresh issue proceeds for general corporate purposes. Draft offer document could be rejected by the regulator if the fund use description is vague for a major portion of the issue proceeds.

Companies seeking to list in the US have greater flexibility in this respect. For instance, Alibaba raised approximately $8 billion through IPO by simply stating that the proceeds would be spent towards general corporate purposes and pending such use, would be invested in short-term, interest bearing debt instruments or bank deposits. Others, such as LinkedIn, stated in IPO prospectus that the purpose of the offering was to increase capitalisation and financial flexibility, increase visibility in the marketplace and create a public market for the shares. “While LinkedIn could not specify with certainty all of the particular use of proceeds, it intended to use the proceeds for general corporate purposes, including working capital, sales and marketing activities and general and administrative matters and capital expenditures. This is the kind of flexibility that would greatly help such Indian companies in their efforts to raise funds from the Indian public markets,” said Bhagat.

INVESTOR CATEGORIES

Since most startups are loss-making with no tangible assets and often have inexplicable business models, Sebi wants to keep small retail investors at bay. “So, there is a suggestion that minimum application size in such issues should be INR 5 lakh,” said another person. “Also, there should be minimum 500 investors in these issues,” said a person who is involved in framing the new regulation.

“The idea is to allow issuers to raise capital on an institutional platform where they can stay listed for one year after which they can migrate to the main board after complying with the eligibility criteria of the exchange,” he said.

The proposed platform may have only two categories of investors — qualified institutional buyers (QIB) and non institutional investors (NII). Shares would be allotted to the former on a discretionary basis while allotment to the latter would be on proportionate basis. There is also likely to be a cap of 5% for discretionary allotment to QIB. In case of under subscription in NII category, it would be made available to QIBs. At present, Sebi rules recognise three category of investors in IPOs — QIB, NII and retail investors.

Currently, loss-making entities can raise money on exchanges provided at least 75% of the shares are allotted to QIB investors as against 50% for profitable ones. The definition of QIBs may also be broadened to include systemically important non-banking finance companies and Sebi-registered family offices and trusts.

“Knowledgeable investors understand the worth of these companies and, therefore, we find such high valuations for these firms. Though, the Indian retail market may not be able to understand their business, operations and valuations, institutions in India would be better placed in understanding their businesses,” said Sanjay Israni, senior partner, Rajani, Singhania & Partners.

Last month, consultancy firm PwC said the e-commerce sector grew 34% (CAGR) since 2009 to $16.4 billion in 2014 and is expected to touch $22 billion in 2015.

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