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Indian market regulator SEBI proposes new rules to avoid misuse of IPO funds

Written by Moulishree Srivastava Published on     3 mins read

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SEBI wants a cap on IPO funds that startups can deploy for M&As unless they specifically disclose takeover targets beforehand.

At a time when a string of high-profile startups are opting to go public in India and receiving attention from the global investor community, the country’s market regulator, the Securities and Exchange Board of India (SEBI), has proposed a slew of rules that require these companies to disclose specific details to ensure funds raised through IPOs are not being misused.

Existing SEBI rules require a company to state the objectives of an IPO in the offer document, which entails how it plans to use proceeds from the fresh issue of equity. In a consultation paper floated on Tuesday, SEBI said that lately, some companies, in their draft offer documents, are proposing to raise money through listing for funding their inorganic growth initiatives, which include future acquisitions, investments in new business initiatives, and strategic partnerships without identifying the target acquisition or specific investments.

The majority of such issuer companies are new-age technology companies, SEBI said. Being usually asset-light organizations, their growth comes from expanding into new micro-markets and acquiring new customers, companies, and technology, among other things.

However, raising funds for unidentified acquisitions leads to some amount of uncertainty and ambiguity on how the proceeds will be utilized, SEBI noted.

These uncertainties about the utilization of IPO funds increase further “in case a major portion of the fresh issue portion is earmarked for such unidentified acquisition,” especially given that under the extant rules, companies can allocate up to 25% of the proceeds for the general corporate purpose (GCP), which is not required to be monitored by a SEBI-approved monitoring agency.

SEBI thus wants a cap on IPO funds that startups can use for mergers and acquisitions (M&As) unless they explicitly identify takeover targets beforehand.

“It is proposed to prescribe a combined limit of up to 35% of the fresh issue size for deployment on such objects of inorganic growth initiatives and GCP, where the intended acquisition or strategic investment is unidentified,” SEBI said in the consultation paper.

However, such limits shall not apply if the proposed acquisition or strategic investment objective has been identified or disclosed at the time of filing of the offer document, it added.

Furthermore, SEBI is looking to start monitoring IPO funds allocated for GCP by companies preparing to list on Indian bourses.

“It is clear that issuer companies are coming up with very large issues. Thus, with a larger issue size, the GCP amount also becomes very substantial in terms of absolute numbers,” SEBI said.

For example, suppose a company is raising INR 100 billion through a fresh equity issue in the IPO. In that case, it can set aside up to INR 25 billion under GCP without disclosing any specific plan regarding the deployment of the GCP amount.

“Given the large size of IPOs, there is a need to provide adequate information about the utilization and monitoring of such a large portion of issue proceeds, earmarked under GCP,” SEBI said. “It is proposed that the issue proceeds earmarked under GCP may also be brought under monitoring. The utilization of GCP amount by the issuer company may need to be disclosed in the quarterly monitoring agency report.”

Notably, Paytm has raised INR 83 billion from a fresh issue of equity shares in the USD 2.47 billion IPO that concluded on November 10, while Zomato raised INR 90 billion when it went public earlier in July. The massive size of these IPOs seems to have pushed the regulator to come up with additional regulations for companies going public.

Meanwhile, to inspire the confidence of other investors in startups’ public issue, SEBI said companies with promoters (those involved in the formation and incorporation of the company) are required to maintain minimum promoter contribution (MPC)—at least 20% of post-issue capital (the paid-up share capital of a company after IPO)—for 18 months post listing.

“MPC is meant principally to ensure skin is in the game for promoters to inspire confidence while approaching public shareholders to raise fresh capital,” SEBI said.

In case there are no identifiable promoters, the regulator said significant shareholders (those holding more than 20% stake) should be able to offload only up to 50% of their pre-issue holding during the IPO, while their remaining stakes should be locked for a period of six months.

The paper also proposed to extend the lock-in period for anchor investors in startup IPOs to 90 days from the current 30 days. Currently, companies can allocate anchor investors up to 60% of the public issue’s portion reserved for qualified institutional buyers a day before the IPO.

SEBI has sought comment from stakeholders on the proposal by November 30.

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