- Apprentice Lawyer
- Legal Jobs
Indian companies may access the public capital markets to raise equity capital for the first time through the route of initial public offers (“IPOs”). The regulation of the capital markets is quite complex and may be overwhelming to someone seeking to access such markets for the first time. In order to simplify the maze of regulations governing IPOs, we have presented here a brief overview of this legal regime. An unavoidable fall out of this approach is that we have to be selective. For instance, we have not delved into details specific to certain types of companies, such as banks or insurance companies, or discussed general laws and regulations that may have a bearing on IPOs, such as foreign investment regulations. In addition, we have not discussed issues specific to public issues of debt securities. Our focus in this article is on the key features of the regulatory regime for IPOs under the Companies Act, 1956 (the “Companies Act”), the Securities Contract (Regulation) Act, 1956, the Securities Contract (Regulation) Rules, 1957 (the “SCRR”) and the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 (the “ICDR Regulations”).
Offers to the Public
In terms of the Companies Act, any offer of, or invitation to subscribe to, shares or debentures is regarded as an offer to the public unless such offer or invitation is a ‘private placement’, i.e., the offer or invitation (i) can, in all the circumstances, be regarded as not being calculated to result in the shares of debentures being available for subscription or purchase by persons other than those receiving the offer; or (ii) can, in all the circumstances, be regarded as a ‘domestic concern’ of the persons making and receiving the offer or invitation; and (iii) is made to less than 50 persons. While in the case of private placements the Companies Act leaves wide amplitude to the freedom to contract, in relation to public offers, it naturally imposes stricter substantive and procedural requirements.
No company may offer, or invite subscriptions for, its shares to the public unless it prepares and registers with the Registrar of Companies a ‘prospectus’. A prospectus is a document inviting offers from the public for the subscription or purchase of any shares in, or debentures of, a body corporate. A prospectus must contain all material information which is true and adequate so as to enable investors to take an informed investment decision, including such information as is required in terms of Section 56 read with Schedule II of the Companies Act and the ICDR Regulations. Companies seeking to issues shares in an IPO at a price determined through an assessment of demand for such shares (known as the ‘book building process’) may also issue a prospectus that is incomplete to the limited extent that it does not contain the issue price and the number of securities offered. Such a prospectus is known as a ‘red herring prospectus’. All requirements of a prospectus apply mutatis mutandis to a red herring prospectus also.
A prospectus must not contain any untrue statement, including statements that are misleading in the form and context in which they appear or are calculated to mislead on account of an omission. The Companies Act and the Securities and Exchange Board of India Act, 1992 (the “SEBI Act”) provide for civil and criminal liabilities against the issuer company, its directors and certain other persons responsible for issue of a prospectus for misstatements and omissions in it, subject to certain defenses available to such persons.
Regulatory overview and scrutiny
Under the scheme of the SEBI Act and in terms of Section 55A of the Companies Act, the Securities and Exchange Board of India (“SEBI”) exercises regulatory oversight over companies making public offers of securities and consequently getting such securities listed on one or more stock exchange in India. SEBI exercises such oversight directly, through a review of draft prospectuses of companies seeking to make public offers, and indirectly, by mandating that such public offer processes, or parts of such processes, be managed only by SEBI registered intermediaries such as, merchant bankers, registrars to issues and bankers to issues.
A company is required to appoint one or more merchant banker (commonly referred to as an ‘investment bank’) as a ‘lead manager’ to manage an IPO. Such lead manager, apart from advising the company in relation to the IPO, are required to satisfy themselves about all aspects about the offering as well as the accuracy and veracity of the offer document. A lead manager certifies to SEBI the conformity of the prospectus with the documents and materials relevant to the issue and the applicable legal requirements as well as the fairness and adequacy of the disclosures in the prospectus in order to enable an investor to make a well informed investment decision. Lead managers issue such a certificate based on their ‘due diligence’ of the company, its ‘promoters’ (who are persons who control the company, or are named as promoters in an offer document of the company or are instrumental in formulation of the plan for the IPO) and its business. Such due diligence exercise includes legal, financial, accounting and business due diligence. They may seek the assistance of lawyers, accountants and other experts for conducting such due diligence, however, reliance on such experts does not relieve the lead managers of their responsibility to ensure the fairness and adequacy of the disclosures in the prospectus. In terms of a recent amendment to the Securities and Exchange Board of India (Merchant Bankers) Regulations, 1992, merchant bankers are required to retain “records and documents pertaining to due diligence exercised in pre-issue and post-issue activities of issue management”. The precise scope and extent of this retention requirement has not been provided by the Regulations, but market practice is expected to evolve and arrive at a consensus.
Before a company decides to make an IPO, it must take into account certain legal requirements that will influence the structure of the IPO. We elaborate upon a few of such considerations. The ICDR Regulations permit a company to make a public offer by way of a fresh issue of new shares or by way of an offer for sale of existing shares, or a combination of a fresh issue and an offer for sale. In any case, the minimum size of the offer must be equal to at least 25 per cent of the post-offer equity share capital of the company. Only public sector companies and companies with a post offer capital of at least Rupees four thousand crores are allowed to make a public offer of less than 25 per cent of the post offer capital, subject to a minimum offer size of 10 per cent of the post offer capital. It may be noted that this minimum offer size is independent on the minimum public float requirements – even if any existing shareholder of the company falls within the category of ‘public’ shareholders after the IPO, such existing shareholding will not act to reduce the minimum offer size.
A company must also identify its promoter or promoters. The prospectus is required to contain specific disclosures about such promoters. Further, at least 20 per cent of the post issue share capital of the company held by the promoters is subject to ‘lock-in’, i.e., such shares may not be transferred, for a period of three years after the IPO. (In the case of all other pre-IPO shares, the lock-in is for a period of one year). Separately, the promoters will continue to have ongoing obligations after the IPO under the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 and the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992.
The ICDR Regulations prescribe certain track record requirements for companies making an IPO. Companies which satisfy the track record requirements must allocate no more than 50 per cent of the shares offered in the IPO to a specified class of sophisticated institutional investors (known as Qualified Institutional Buyers, or QIBs), at least 15 per cent of the shares to non-institutional investors (which include other Indian companies and high net worth individuals) and at least 35 per cent of the shares to retail individual investors. Companies which do not satisfy the track record requirements must allocate at least 50 per cent of the shares to QIBs, with the allocation to the other categories of investors remaining the same. By ensuring a minimum number of sophisticated investors in such companies, other investors may derive confidence about the quality of the issuer company.
We hope that this piece has succeeded in providing a birds-eye view about the key features of IPOs in India. In the following months we intend to provide a similar overview of other forms of capital raising in the Indian equity capital markets.
Gaurav Gupte is a Principal Associate and Tanika Singh is an Associate with Amarchand Mangaldas.