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Sebi prioritises investor safety: An informed investor is a protected investor

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As IPOs become an exit strategy for companies, it is important that investors have sufficient information to make well-informed decisions

By Sandeep Jhunjhunwala

In the recent past, there has been a colossal increase in the number of individual investors accessing the Indian capital markets. Around 3 million new demat accounts were opened in November 2021 alone, more than seven times the monthly pre-pandemic average in 2019-20. This increase in retail participation and a buoyant capital market had made the decision of many corporates to go public a tad easier. This statement does not seem to be hyperbole when one looks at the fact that in 2021, the Indian capital market ranked seventh in terms of number of IPOs and eight in terms of proceeds raised from IPOs on a global level.

This robust growth of Indian capital markets has kept market watchdog Sebi on its toes. Sebi has forever believed that an informed investor is a protected investor. Many popular brands have made their debut on stock exchanges lately. Some of these companies are new-age tech companies that do not have a track record of operating profits as they are focussed on scaling up rapidly. Investors are attracted to these companies because of their perceived future growth potential. Yet, the nosediving of share prices of these newly listed companies on the trading floor has raised questions about their pre-IPO premium. The current trading price of many of these newly listed companies is much lower than their offer price, causing investors to lose wealth to the tune of around Rs 1.3 trillion.

On February 18, 2022, Sebi released a consultation paper seeking public comments on introducing stricter disclosure norms in offer documents filed by companies seeking listing approvals. The objective is to seek public comments on provisions in ICDR Regulations relating to disclosures for ‘Basis of Issue Price’ in offer documents. Presently, the requirement for ‘Basis of Issue Price’ section in the offer document covers disclosure of traditional parameters such as EPS, P/E, RoNW, and NAV of the company as well as a comparison of such parameters with peers. While these are useful parameters for profit-making companies, they do not provide much basis for the share issue price of new-age tech companies, which are usually loss-making. Sebi, therefore, felt the need to augment these traditional criteria by introducing some non-traditional ones for loss-making companies proposing to go public. These suggested unconventional standards include disclosure of KPIs considered for arriving at the basis of issue price. As deliberated in Sebi’s consultation paper, the issuer company would have to disclose all material and relevant KPIs shared with any pre-IPO investor in the three years prior to IPO. While it is not clear what a relevant KPI is, the consultation paper mentions that issuer company needs to provide an adequate explanation for considering any KPI as irrelevant. These KPIs need to be certified by Statutory Auditors and compared with peer-listed companies, including globally listed peers.

The consultation paper does not provide a list of KPIs, but metrics such as revenue growth rate, subscriber base, active customers, viral coefficient, traffic growth, data security measures, etc, could be effective performance indicators for new-age tech companies. Since KPIs could be sensitive to the economic environment in which a company operates, the advised approach of comparison with listed peers seems to be somewhat arduous and asymmetrical. The issuer company would also have to provide a disclosure of its valuation based on primary issuance and secondary sale of shares in a look back period of 18 months prior to date of filing DRHP and provide a detailed explanation for its offer price being different from primary issuance and secondary sale price. This disclosure could go a long way in allowing the investors determine the veracious worth of shares at the time of investing in an IPO and also make them more cognizant of financial risks involved. Though not recommended, a perpetual flow of such KPI data, even post-listing on a trading exchange, could keep investors hooked on new-age tech stocks.

Many times, promoters and founders resort to IPO as an exit strategy by selling their shares to the public. Therefore, IPOs have become a money-spinning avenue over time. While the valuations arrived at by issuer company may be accurate, it is important that investors have sufficient information at their disposal to make well-informed decisions, and Sebi’s intention behind recommending new disclosure norms, therefore, seems to be in the right direction. Even in the US, recently, the Securities Exchange Commission has been looking more closely at how projections and related valuations are presented and used in IPO documentation. While new-age tech companies would feel hard done by Sebi, on a positive note, these new disclosure norms provide the management of companies going public an opportunity to present their narrative of growth potential to investors in an ever-evolving stock market.

The author is Partner, Nangia Andersen LLP

Co-authored with Ankur Agarwal

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