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Market Regulator SEBI’s new IPO norms: IPO rules for new age companies

March 2, 2022 12:11 PM

Market Regulator SEBI’s new IPO norms: IPO rules for new age companies
Given how recent market corrections wiped out much of the gains made in tech IPOs, a review of the current issue pricing norms is welcome.

Market Regulator SEBI new IPO norms:

Given how recent market corrections wiped out much of the gains made in tech IPOs, a review of the current issue pricing norms is welcome.

Alarm bells rang for the markets, investors and securities and commodities market regulator Securities and Exchange Board of India (SEBI) when the much-awaited initial public offering (IPO) of Paytm tanked on debut.

Since then, the slide show has been going on for the payments company. The story of cosmetics retailer Nykaa has been a little different. It debuted at Rs 2,001, a 78 percent premium to its IPO price of Rs 1,125. However, it closed at Rs 1,294.20 on the BSE on Friday, February 25, 2020. Clearly, both these vaunted new-age companies have lost investor interest.

The last couple of weeks have been marked with massive market volatilities and corrections following an anticipated hike in US Federal Reserve interest rates, foreign-portfolio-driven outflows, and the ongoing Russia-Ukrainia conflict. Coupled with the investor losses of the much-awaited IPOs of new-age technology companies such as Zomato and Policybazaar, rising concerns and investor skepticism over the profitability of such companies have compelled  market regulator SEBI to undertake a review of the present norms for IPO pricing and provide a more realistic view of the future of such companies.

With investor wealth hugely eroded by these new-age companies, and many analysts calling out the outrageous valuations given to some of these loss-making firms, market regulator SEBI had decided to bell the cat – it has proposed rules to tighten the IPO pricing of such companies.

In this regard, a consultation paper was floated by SEBI in February, which proposes to mandate more disclosures and strive for further transparency from new-age technology companies. The idea is not to regress to a 1988-style merit-based system, where a bureaucrat decided the pricing and size of an IPO, but to improve the quality of disclosures so that investors can make a more informed decision.

In this regard, a consultation paper was floated by SEBI in February, which proposes to mandate more disclosures and strive for further transparency from new-age technology companies. The idea is not to regress to a 1988-style merit-based system, where a bureaucrat decided the pricing and size of an IPO, but to improve the quality of disclosures so that investors can make a more informed decision.

At present, the market regulator Sebi (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations) require companies to disclose metrics forming ‘basis of issue price’ such as earnings per share, price to earnings, return on net worth and net asset value of the company as well as a comparison of such accounting ratios with peers. However, as per Sebi, such traditional metrics are typically applicable to profit-making companies and are inadequate performance indicators for new-age technology companies.

The market regulator Sebi recognizes that such companies are primarily loss-making entities for a longer period until they break even as they typically aim for scale over profits. This makes it difficult and inappropriate for retail investors to view them through the same lens as well-established industries. In fact, over the past year, almost all IPO listings of technology start-ups have witnessed a higher IPO valuation than in the pre-IPO stage, only for such companies to trade well below their issue price post listing.

The proposed rules in the consultation paper, which are based on the recommendations of SEBI’s Primary Market Advisory Committee, suggest that the disclosures of existing “basis of issue price” metrics should be supplemented by disclosure of non-traditional parameters and any other key performance indicators (KPIs) shared with pre-IPO investors at any point of time during the three years before the IPO, to justify the pricing of its shares in the IPO. Such companies would also be required to explain in detail how these KPIs contribute to the issue price.

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Further, to lend more credibility to such disclosures and ensure that the KPIs disclosed in the offer documents are not misleading, the KPIs would also have to be certified by a statutory auditor. The companies would also be required to compare their KPIs with their listed peers in India and overseas.

Additionally, the proposed rules, if implemented, would require companies to disclose the valuation of their shares previously purchased or sold in secondary markets over a look-back period of 18 months before the filing of the offer documents with SEBI. In this regard, the consultation paper proposes disclosures of weighted average cost of acquisition of both primary issuance and secondary transactions. Issuers would also be required to disclose the rationale for offer price being (x) times of the primary issuance or secondary transaction price.

The above proposals would ensure that investors have a clear idea about the company’s past performance and the company’s ability to fulfil estimated projections. This would also eliminate any potential unfair IPO valuations, especially in light of recent times where some start-ups have reported sky-high valuations.

The year 2021 witnessed landmark fund raising, of more than $17 billion, with most of the IPOs oversubscribed. Considering rising consumer demand, issuers need to ensure that investor confidence and participation in equity markets are sustained. Further, market regulator  Sebi’s dual role—to protect investors and promote securities market development—would require it not only to ensure that such valuations are fair and transparent but also, at the same time, avoid excessive scrutiny of IPO pricing.

As the above-proposed rules would apply to companies that have not profited for the three years preceding the IPO, it would better equip investors to make informed investment decisions about such companies and balance all stakeholders’ interests.

Often, apart from consumer demand, industry comparable, growth prospects, etc., constitute key parameters for an IPO valuation. Since media hype and favourable demand could potentially sway investors in relation to the performance of a company’s shares, notwithstanding the actual fundamentals, reviewing offer documents containing key financial information has long been considered as a legitimate basis for making investments.

However, some new-age technology companies employ alternate performance metrics such as number of subscribers and sign-ups, website traffic, etc., which means that the existing parameters may not provide a clear insight into the company’s performance to prospective investors. Moreover, reviewing the financial statements of new-age digital start-ups is a challenge faced by many investors, especially since such information is usually not available in the public domain.

To prevent such information asymmetry and to ensure that investors have access to all relevant information, the above recommendations have been proposed. In fact, it would ensure that despite fast-paced technological advancements, investors have an accurate picture of the company’s past performance and future projections before investing.

Currently, traditional companies aiming to list on the stock exchanges, share with SEBI and other investors, various important ratios and earnings metrics, such as earnings per share (EPS), price-earnings ratio (PE), net asset value (NAV), and return on net worth (RONW), among others. However, such metrics do not exist for new-age companies, since they would be loss-making ones, hoping to breakeven and make a profit sometime in the long term (read, undefined future).

The proposed recommendations also become increasingly relevant at a time when the Indian securities market has seen maximum participation of retail investors in IPOs. Given that recent market corrections have wiped out much of these gains, a review of the current issue pricing norms is welcome. In fact, with a few other technology start-ups looking forward to tapping into the capital markets, an upgrade in disclosure requirements in offer documents in line with technological advancements is overdue.

Here’s a look at the new rules proposed, and the rationale for them. market regulator SEBI has called for public comments on the proposed rules until March 5.

These above rules proposed by SEBI will apply to new-age companies that have not been making a profit for the last three years preceding the IPO.

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