SEBI’s Public Offer Reforms: Money For Nothing, Exits For Few

The primary market is seeing a new wave of changes this January. In one of the most significant moves in recent times, the Securities and Exchange Board of India has brought in several changes to its framework governing public offers, primarily trying to play catch up in the wake of the long list of Indian unicorns looking to go public.

Limits On Using IPO Proceeds For M&A

Last year we saw over 70 initial public offers, including some by companies with household brands such as Zomato and Paytm. Several of these were digital-led businesses with rather unique business models and consequently unique requirements of capital.

Many digital businesses are keen to access public capital for growing their business through acquisitions and strategic investments instead of deploying it toward traditional capital expenditure. While using IPO money for specific and identified target acquisitions is not new, given the nature of dynamic nature of their business, digital companies have often sought to keep a ‘blind pool’ for acquisitions, i.e., without identifying a specific target.

As a reaction, SEBI has now restricted the use of IPO money for blind pool acquisitions to 25% of the total money raised and placed a combined limit of 35% for blind pool acquisitions and general corporate purposes.

Further, for companies raising over Rs 100 crore, SEBI now also requires the use of all the IPO money to be monitored by SEBI-registered credit rating agencies, as opposed to the earlier requirement to monitor 70-75% of the IPO proceeds by scheduled commercial banks or public financial institutions. As per SEBI, these changes were necessary to remove the ambiguity of a blind pool acquisition. Its impact, however, could limit companies, especially digital ones from raising necessary capital in line with their unique business needs.

Speed-Breaker On Exits

Interestingly, over the last few years, the market has also seen a lot more IPOs by companies that do not meet the SEBI prescribed track-record threshold for profitability. Capital raising by such companies is allowed subject to certain additional restrictions.

One such new and quite-significant restriction imposed by SEBI is to place a limit on how much a shareholder can offload in an IPO, via an offer for sale.

• Large shareholders holding over 20% of the pre-IPO shares can now sell only up to 50% of their holding, with their remaining shares locked in for six months.

• Further, shareholders with less than 20%, can sell only up to 10% of the pre-IPO share capital of the company.

• Also, SEBI has extended the lock-in for 50% of the anchor investors in the IPO from 30 days to 90 days.

These new restrictions could have far-reaching consequences for investors in IPO-bound companies. Of late, private equity investors have not shied away from acquiring large stakes in companies, most of the time going far beyond the 10% threshold.

SEBI has also made changes that make the procedural aspects of an IPO more equitable.

Price bands for IPOs now must have a minimum range of at least 5% and the non-institutional investor category will be bifurcated into two categories, one with an application size between Rs 2 lakh and Rs 10 lakh, and the other with an application size of over Rs 10 lakh.

Need Clarity On Applicability Of Rules

Except for the increased lock-in for half of anchor investors’ holdings, and this change in the allocation to NIIs, both of which will be applicable for IPOs launching after April 1, 2022, all the other changes are effective since the day these amendments were notified on Jan. 14, 2022.

The SEBI press release had indicated that changes with respect to the blind pool, limit on OFS size, and monitoring of funds, would apply only for draft offer documents that are filed after the amendment is notified. The actual amendment, however, is silent on this. Unless a clarification is issued, this could lead to heartburn for companies at advanced stages in their deals.

In addition to these changes, SEBI has also made some amendments and clarifications to provide some relief to existing shareholders and IPO-bound companies. SEBI has clarified that the bonus shares held by alternative investment funds, venture capital funds, foreign venture capital investors shall be exempt from the post-IPO lock-in, as long as the underlying shares on which the bonus shares were issued, along with the bonus shares have been held for at least six months.

Another change, with a potential significant impact is that SEBI now seems to have allowed financial statements (to be included in the offer documents) to be audited and restated by independent chartered accountants, in addition to the statutory auditors of the IPO-bound company.

One reasonable explanation for this change could be giving IPO bound companies the option to have their non-IndAS accounts re-audited under IndAS, something which their statutory auditors may not be inclined to do given the disconnect between SEBI requirements and the applicability of IndAS under the Companies Act, that auditors have of late been pointing out.

Without casting any doubts on the intentions of SEBI to encourage more and more companies to access public markets, these changes could very well have the opposite effect, at least to the extent they place additional restrictions on exits by investors and the ability of companies to use IPO money in a manner best for their business. However, we hope these changes do encourage companies, especially digital businesses, to continue to prefer India listings over listings in the United States.

Manshoor Nazki is Partner, and Priyadarshini Rao is Principal Associate, at IndusLaw. Views expressed here are personal and nothing contained herein is, purports to be, or is intended as legal advice and you should seek legal advice before you act on any information or view expressed herein.

The views expressed here are those of the authors, and do not necessarily represent the views of BloombergQuint or its editorial team.