Ind-Ra: SEBI IPO Norms a Boost for Start-ups, But Risk of Misuse Remains

Securities and Exchange Board of India's (SEBI) decision to ease IPO norms for start-ups will encourage Indian start-ups to raise equity in the country as against tapping overseas markets, says India Ratings and Research (Ind-Ra). However, relaxed disclosure requirements and shorter lock-in periods for promoters may pose a risk. Easier exit through a public listing may cause start-ups to attract more investors than has been the case in the past. The discussed regulations allow Category I and II Alternative Investment Funds (AIF) to invest a minimum amount in unlisted securities. Investments in such listed start-ups may be treated as investment in 'unlisted securities' for such purposes.

Start-ups often try out new business models or products and to that extent face a high failure rate; of course, limited ones that are successful provide outstanding returns. SEBI has done well to restrict retail investors' participation in this segment. Start-ups will be traded on Institutional Trading Platform (ITP) where the minimum trading lot will be INR1m, ensuring participation by investors who have a higher ability to withstand losses than retail investors.

 

SEBI has provided flexibility on deciding the basis of issue price as deemed fit by issuers. As such, most start-ups do not have sufficient earnings and would not be able to use standard valuation parameters such as price to earnings or earnings per share. To the extent the economics of vaulations is driven by an entity's ability to generate free cash flows at some point in time in future, in absence of standard valuation metrics even institutional investors may find valuation a challenge. In extreme cases, this may lead to the creation of 'start-up' bubbles.

Likewise, SEBI has provided the flexibility to disclose only broad objects of the issue and has removed the cap on the amount raised for general corporate purposes. Such flexibilities are likely to ease the issuance process of bonafide technology start-ups.

Even institutional investors find valuations difficult, and to that extent the liquidity of such trades will be significantly affected. However, the agency expects confident start-ups with aspirations for entering into the main exchanges after three years to voluntarily go for a higher level of disclosures to build confidence in market participants.

Additionally, one needs to be wary of corporates taking advantage of such flexibilities to raise capital for spurious reasons. A rare errant promoter may exhibit a lack of accountability since the lock-in period for promoters and other pre-listing investors has been reduced to six months, as against three years for other companies. Insofar, the economic viability of most start-ups may be difficult to assess. Thus, all concerned should be cautious that the current mode of capital raising is not misused for saving taxes or making other gratuitous payments.

Powered by Capital Market - Live News