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India opens market to start-up IPOs but changes are not enough to reel in big fish

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By Rashmi Kumar
25 Jun 2015

The Securities and Exchange Board of India (Sebi) is breathing new life into its capital markets by easing up on rules governing the listing of start-ups in the country. The changes are welcome but market watchers have been quick to point out the many shortcomings of the new regulations, which still pose a barrier to deal flow, writes Rashmi Kumar.

India’s capital markets regulator announced a slew of reforms to capital raisings by start-ups in the country, following a meeting of its board on June 23 in Mumbai. The rules have been in the works since March, when members of Sebi met heads of start-ups to discuss their grievances about listing on the country’s exchanges.

It then followed that up by publishing a discussion paper on changes it was considering, and sought feedback from the market. Two and a half months later, the votes are in and start-ups and ECM bankers in India are now happily claiming a small victory.

indepth_india_300pxOne of Sebi’s decisions includes expanding the range of companies that can raise capital in the future via the Institutional Trading Platform (ITP). Previously, just technology start-ups could access the market, but now firms across information technology, intellectual property, data analytics, biotechnology and nanotechnology industries have been given the green light to execute equity-raisings.

This will be so long as 25% of their pre-issue capital is in the hands of qualified institutional buyers.

Any other small-scale company will also be able to tap the ITP, provided half of its pre-issue capital is with QIBs.

“It’s a good starting point to expand the rules quite appropriately for all the other sectors,” said Manan Lahoty, a partner in the Mumbai offices of law firm Luthra & Luthra. “[Sebi has] introduced changes that will go a long way in making the new platform successful.”

Another positive rule Sebi is planning to implement concerns lock-up periods. At the moment, shareholders can be locked up for anywhere between one and three years following the listing. But this has now been shortened to just six months uniformly for all shareholders.

Investment bankers in India are particularly jubilant about this, as until now private equity investors — which often feature extensively as big shareholders in start-ups — have been loath to list firms domestically owing to the long lock-up.

One Mumbai-based head of capital markets at an international bank said he’s had a hefty pipeline of deals for the past year. “But not a single company has budged on its plans because on the one hand they are looking abroad for an IPO, but on the other hand, they want to remain rooted in India. There’s been just too much of back and forth, while they wait for Sebi to sort things out.”

Getting left out

The regulator has also tackled issuers’ woes on how they can use the proceeds from a listing. Previously, not more than 25% of the amount raised could be for general corporate purposes. On top of that, Sebi had been quick to reject offering documents if too much of the proceeds went towards creating intangible assets — the bread and butter of a tech-related firm.

Sebi has now scrapped the cap, which market watchers say is a big boon for issuers. But while these rules have brought some relief, it’s not enough, reckon bankers.

Some of them have been quick to lambast a ruling that will restrict a shareholder — individually or collectively — from owning more than 25% of the post-issued share capital of the company.

“The 25% ownership rule is negative because companies where promoters or a single private equity firm hold 25% or more can’t use this route to raise funds, and they will suffer,” said Lahoty. “The idea behind the new norms was that professionally managed companies should be allowed to list, but companies with PE backing could also be professionally managed.

“But if they can’t list because a PE firm owns 25%, they’ll be left out and Sebi hasn’t addressed that problem squarely.”

Big fish vs small fry

A second lawyer also pointed to a big change between when the discussion paper was floated and Sebi’s recommendations now. Start-ups that list on the IPT will have the option to move over to the main board after three years — in stark contrast to the original proposal of a migration after just one year.

Such a long transition period can be detrimental to a company’s growth and its hopes of raising further capital from more investors, he said.

This means that when issuers are juggling between the options of listing in India versus seeking fortunes in the US, the latter continues to hold more appeal.

“It’s good India is allowing non-profitable companies to list now, and it’s positive they are holding back retail investors who need to be protected from coming onto the playing field,” said a second investment banker. “But if a firm still picks the US I won’t be very surprised. They understand these kind of firms and liquidity is more there, so Sebi needs to throw in more benefits if it really wants companies to stay put.”

Among other rules that have been announced, allocation of stock between institutional and non-institutional investors should be kept in the proportion of 75% to 25%. Companies are still required to file draft documents with the regulator — something lawyers say will make the process more onerous for issuers.

“There are companies that do want to list but, even with these changes, the question remains whether these companies would list in India or still find listings outside more attractive,” said Juhi Singh, a capital markets partner at S&R Associates. “And even if they do translate to listings in India, how big will they even be? The question is whether we’ll see big fish or small fry listings here.”

The rules are still preliminary, with the final regulation expected to be put in place over the next few weeks, although there is no firm timing. 

By Rashmi Kumar
25 Jun 2015