Impact of new SEBI regulations on IPOs

It is reassuring to know that SEBI is staying true to its commitment to promote complete disclosure rather than merely interfering with free market dynamics.

In recent years, the Indian start-up industry has produced a number of unicorns. Several companies have lately gone public, bringing new challenges to the fore. The Securities and Exchange Board of India (SEBI) has always attempted to be aggressively proactive in developing market-regulatory norms.

In keeping with this strategy, SEBI introduced adjustments to the widely used public issue and preferential issue structures at its board meeting on December 28, 2021 to ensure investor protection in such initial public offerings (IPOs).

Here are a few salient features of the amendments to the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations).

Non-disclosure of the fundraising purpose and target is restrained

We have recently noticed a trend where novel tech companies are soliciting funds through IPOs for the purpose of "financing of inorganic expansion efforts," without really identifying any such investment. This makes sense because locating new businesses takes a significantly long gestation period, and many of the acquisitions may have not even begun at the time the funding was raised. SEBI has made it clear that capital raised for inorganic expansion plus general corporate purposes (GCP) will be limited to 35% of the IPO size. This is an increase from the prior GCP-only limit of 25%.

Rating agencies will help keep an eye on how the money from the IPO is spent

SEBI has also agreed that the review report on the use of issue proceeds would now include 100% of the proceeds, rather than the current 95%, and money used for GCP will be included in its scope. This will be presented to the audit committee on a periodic basis (quarterly). The offer-for-sale (OFS) guidelines have also been changed by SEBI. There were a substantial number of promoters and private equity investors exiting through OFS during the past IPO boom. Of course, the OFS does not result in the company issuing any capital, nor does it result in any further entries into the balance sheet, since it only allows current shareholders to exit.

Existing shareholders can't sell their shares over and above the set threshold limit

It was found that larger, bloc investors ought not be allowed to totally withdraw huge investments through OFS in the IPO because some of these businesses may not have had the balance sheet and performance track record. For companies without a track record, SEBI has decided that shareholders owning more than 20% of pre-issue capital, collectively with persons acting in concert (PACs), cannot sell more than 50% of their shareholding, and shareholders holding only about 20% of pre-issue capital, along with PACs, cannot sell more than 10%.

While extending the "skin-in-the-game" criterion beyond promoters to certain other pre-IPO existing shareholders is a positive development, the relatively low shareholding barrier of 10% seems overly restrictive.

Restriction put on sale of shares by anchors

The lock-in period used for anchor investors has also been changed by SEBI. Anchor investors improve the IPO's desirability by instilling trust in retail investors, as a roster of reputable anchors indicates that they have skin in the game.

According to SEBI's consultation paper, anchor investors give a price indication and promote price discovery. Anchor investors can currently withdraw their whole IPO investment within 30 days of the IPO's listing. Given how short this period was, it was determined that 50% of the allocated amount would be locked in for 30 days after allotment, and the remaining for 90 days, in order to boost investor confidence. While a lengthier lock-in duration may increase investor confidence, the optimal lock-in length is unknown. Six months would provide more assurance than 90 days, and a year would be preferable to six months.

The purpose of anchor investors must be remembered, which is to provide an initial thrust to the issue and to facilitate price discovery. If the goal is to prevent share price swings like those observed recently in Nykaa and Paytm after their anchor investment periods expired, SEBI is only adding to the problem by interfering with the free flow of the marketplace through regulation. SEBI has seen that small non-institutional investors are being pushed out of the current proportional allocation mechanism by large non-institutional investors (NIIs). To address this and to ensure the diversity of public offerings, SEBI has determined that for book-built issues issued after April 1, 2022, a third of the portion accessible to NIIs will be allocated to those with application sizes ranging from ₹2 to ₹10 lakh. In addition, allotment of securities in the NII category will be based on a "draw of lots."

Free reign on the price range of IPOs is stopped

For all book-built issues, SEBI has additionally established a minimum price band of 105% of the floor price. This adjustment will promote accurate price discovery by preventing issuers from misrepresenting a fixed price issue as just a book-built issue.

The amendments to the Articles of Association (AoA) of PNB Housing Finance come in the wake of the failure of the PNB Housing Finance-Carlyle Group deal, whereby the preferential allotment to Carlyle Group had to be axed due to SEBI's directive that a valuation be performed by an independent valuer, in accordance with PNB Housing Finance's articles of association.

The method of determining a floor price in a preferential issue for a frequently traded security has been changed by SEBI, which now states that the floor price in a preferential issue for a frequently traded security shall be the higher of 90/10 trading days' volume weighted average price (VWAP) of the scrip preceding the relevant date or any stricter provision in the issuer company's AoA. A valuation report from a registered independent valuer would be required for an infrequently traded security. Furthermore, in the event of a change in control or allocation of more than 5% of the post-issue share capital, an allottee or allottees acting in concert, a valuation report is now required to determine the floor price.

SEBI requires that upon a change in control, a committee of independent directors submit a reasoned proposal as well as comments on all areas of preferential issuance, including pricing. This is in reaction to difficulties that have arisen as a result of the PNB Housing deal, and SEBI has attempted to close the regulatory vacuum. The necessity of a valuation report for each issue of shares with a market capitalization of more than 5% is overly restrictive and opens the door to future conflicts.

The market rate of securities is regarded as the best valuation once companies are listed and equities are often traded. Valuation reports may be required, which could lead to pricing discrepancies and conflict amongst shareholder groups. Although some of those adjustments were reactive, many were implemented with the extended pipeline of IPOs in mind, particularly those of new-age IT businesses with no track record.

It will be interesting to see if these adjustments accomplish their goal, but it is reassuring to know that SEBI is staying true to its commitment to promote complete disclosure rather than merely interfering with the free market dynamics that drive demand and supply for securities.

Miheer Jain is a Fourth-Year B.B.A L.L.B (Hons.) at NMIMS School of Law, Mumbai

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