The year 2021 witnessed a large number of Indian companies going public, a sizeable number of which were new-age technology companies. This wave has confirmed that founders with ideas can create companies, private equity funds from around the world will support such startups and help them flower, and over time they will enlist their shares for public trading, creating wealth for founders, employees and early shareholders.
The steady wave of initial public offerings (IPOs) has kept our market regulator, the Securities and Exchange Board of India (Sebi), very busy. Sebi has always been proactive vis-a-vis the growth and development of public markets, with investor protection (particularly of retail investors) at the forefront of its proposed rule changes. In its board meeting held on 28 December 2021, Sebi ensured the year ended with a bang as far as regulatory changes for IPOs and preferential issues went.
To promote the growing need of companies, including new-age tech firms, for sufficient funds to consider acquisitions and the consolidation of businesses that may be strategic, Sebi has granted companies the flexibility to utilize a maximum of 35% of their equity-issuance proceeds (with a cap of 25% towards an unidentified acquisition) from an IPO. Previously, there was no regulatory cap of the nature proposed last week, although there were regulatory checks and the regulator did exercise some degree of flexibility.
Limits have been prescribed on the proportion of shares that may be offered for sale by an existing shareholder, based on the holder’s pre-IPO shareholding in the issuer, that apply to companies which do not meet Sebi’s track-record criterion for net worth/ profitability and also do not have identified promoters (as was indicated in Sebi’s consultation paper on the matter). Whilst the purpose of this proposal is to inspire confidence in investors by requiring significant investors to retain their “skin in the game" after listing at par with a company with identified promoters, such restrictions on the ability of investors to participate in an offer-for-sale could result in pre-IPO investors looking for alternate forms of exit before listing—even more so in cases where investors have limited fund life—and could curtail the issue size. For instance, under the new limits, shares offered for sale by shareholders (individually or with persons acting in concert) who hold less than 20% of a firm’s pre-IPO share capital shall not exceed 10% of its pre-IPO share capital. This could mean that a person with 10 shares will potentially only be able to sell one share in a public offer. We believe this may require a second look before it is notified in the official gazette.
Sebi has now permitted credit rating agencies registered with it to be appointed as monitoring agencies. Further, Sebi now requires that 100% of an issue’s proceeds be monitored and has increased the frequency of reviews by the audit committee. In addition, issue proceeds proposed for usage on general corporate purposes would also have to be monitored, which was not required earlier.
For book-built issuances, Sebi has ensured that the minimum gap in the offer price band be such that the cap price is at least 105% of the floor price. This, again, is an interesting intervention by the regulator, particularly because issuers were not providing a ‘real price band’. The change will now allow investors to have multiple price points at which they may bid for shares in an IPO.
From 1 April 2022, half the anchor investors in an IPO will be locked in for a period of 90 days, while the remaining 50% will be locked in for 30 days. Considering the discretionary allocation that anchor investors get, the process and manner in which different lock-ins will be made applicable to them is yet to be seen. The intention may well be to have investors stay invested longer in the company, but this intervention may not meet its objective if companies are unable to ensure that anchor investor stay beyond a quarter post-IPO.
Sebi has prescribed a revised allocation method to non-institutional investors (i.e. those investing more than ₹2 lakh in an IPO): one-third of the non-institutional investors’ portion is to be reserved for applicants investing more than ₹2 lakh but up to ₹10 lakh and the rest for such applicants investing more than ₹10 lakh. Further, allotment to non-institutional investors shall be through a draw of lots, as is done for retail investors, to ensure transparency in the allotment of IPO shares and allow for a sufficient allocation to ‘smaller’ non-institutional investors.
Apart from IPOs, preferential issue rules have seen a set of revisions too. These issues can now be undertaken for considerations other than cash. The pricing of preferential issues has undergone a substantial change. Keeping in mind the Indian stock market’s growth, (i) for frequently-traded securities, we have a shorter period for determination of the floor price, i.e. the higher of 90 or 10 trading days’ volume-weighted average price preceding the relevant date, or any such stricter requirement prescribed by an issuer in its articles of association; and (ii) for infrequently-traded securities, it is to be based on an independent valuation.
In order to ensure that this is not flouted in cases where a preferential issue results in the allotment of more than 5% of the issuer’s shares or a change in control and the pricing does not include any control premium, Sebi has mandated that, in such cases, a valuation report from an independent registered valuer would be required. Further, if a preferential allotment results in a shift of control, a committee of independent directors shall be required to provide a reasoned recommendation on all aspects of the preferential issuance, including its pricing—which must be disclosed to the public.
Like with IPOs, the lock-in period for such issuances has been reduced. In case of a preferential allotment to promoters, 20% shall stay locked in for 18 months and the rest shall be locked in for 6 months. A preferential allotment to other shareholders shall result in such shares being locked in for 6 months. Additionally, promoters shall be permitted to pledge such locked-in shares subject to certain conditions.
Some of these proposals are mainly a reaction to several IPOs and preferential allotments concluded earlier this year and have followed consultation papers issued by Sebi. While some of these changes could have a long-term impact on capital raising plans, the use of funds and growth of companies, a portion of them can be described as protective.
Sebi could additionally have prescribed more detailed disclosures and norms for continuous monitoring, with existing legal requirements kept in mind, including the need of shareholder approval for proposed acquisitions. As for capital markets, we hope that these changes do not substantially impact the plans of companies planning to list their shares on Indian stock exchanges.
Yash J. Ashar & Janhavi Seksaria are, respectively, partner and head, capital markets; and a partner at Cyril Amarchand Mangaldas
