Francisco A. Laguna
This week, TransLegal continues our series on recent legislative changes in India, focusing on a proposal by the Securities & Exchange Board of India (“SEBI”) that could ultimately affect an Indian company’s ability to raise capital and provide possible exit strategies for early stage investors.
Numerous Indian start-ups have innovative business models that seek to create or expand business opportunities or increase efficiency for existing business activities, including software development and e-commerce companies. These companies tend to be run by professional management, have low asset bases, long gestation period and limited founding member equity participation.
SEBI refers to these companies as “Knowledge-based Technology Companies”. SEBI understands that the laws currently applicable to these start-ups, including those governing small and medium enterprises (“SME”) do not allow them to raise capital effectively. To address this issue, SEBI proposes to amend the listing rules to enable these Knowledge-based Technology Companies to raise capital from India’s public markets.
The SEBI proposal would introduce the following changes.
Knowledge-based Technology Companies would be permitted to raise capital on the Institutional Trading Platform (“ITP”) through initial public offerings, provided that no person or persons acting in concert hold over 25% of the share capital.
Investors would be limited to qualified institutional buyers (“QIBs”) and non-institutional investors (“NIIs”). Retail investors will not be permitted to purchase shares of Knowledge-based Technology Companies at the IPO stage. The definition of a QIB would be expanded to include NBFCs and family offices / trusts, provided they are registered as alternate investment funds ( AIFs), as well as any entity registered with the SEBI with a net worth of more than INR 500 Crores.
75 % of the IPO must be reserved for QIBs. Allotments would be on a discretionary basis, provided no QIB is allotted more than 5 % of the issue. Allotments for NIIs would be proportional and spill-over from the NII portion would be allowed.
Investment in this segment would be treated as unlisted for Category I and II AIFs to allow them to satisfy their investment limits in unlisted securities.
The minimum application size will be INR 10 lakhs and the offer must be subscribed by no less than 500 allottees.
The issuer would need to remain listed on this restricted segment of the exchange for at least 1 year after the IPO, at which point it can apply for listing on the national exchanges, provided they satisfy applicable listing criteria.
The entire pre-issue capital must be locked-in for 6 months, with no separate lock-ins for promoters.
The issuer will be required to file a draft IPO document with SEBI for comments. However, rules for Knowledge-based Technology Companies would be slightly more flexible, as described below.
The main purpose of the IPO can include general corporate purposes and the disclosures may be restricted to broad objectives.
IPO disclosures related to the determination of the issue price falls within the discretion of issuers; however, the offering may not include income or other financial projections.
The issuer has discretion to include disclosures related to group companies, litigations (other than criminal cases, regulatory and tax matters) and creditors (though complete details to be made available on the website) based on whether such disclosures are material for purposes of determining whether to invest in the company.
Given the range of business activities available to start-up Knowledge-based Technology Companies, the SEBI should promote a broad definition for eligible companies to allow as many entities to participate in this approach to raising capital.
As indicated above, the founders of Knowledge-based Technology Companies typically end up as minority shareholders. Consequently, they need promoters. The SEBI recognizes this reality, and its proposal provides more flexible rules for post-issue lock-in requirements than those generally applicable to listed companies., The SEBI Proposal is silent on the criteria for determining promoters or whether the issuer will be permitted to list without a named promoter.
Although founders are often minority shareholders, most Indian start-ups have more than 1 founder. These founders tend to be unrelated parties, except for their joint operational control which results from the fact that each is a shareholder. If these founders are deemed to be”persons acting in concert”, their combined holdings would likely exceed 25%, which would disqualify the company from this participating in this avenue to raise capital. SEBI has yet to issue any proposed guidance on this issue.
SEBI’s final qualification criteria and related definitions will determine the program’s success. If this issue is not appropriately addressed, the program will have limited practical effects.
Considering that retail investors will not be permitted to invest in the IPOs of the Knowledge-based Technology Companies, it is unclear why SEBI has imposed a minimum 500 subscriber requirement. Since most QIBs are often unwilling to assume limited positions, most issuers may not be able to meet this threshold for practical reasons.
Importance for Private Equity
SEBI’s proposal would result in a change in access to India’s public capital markets, which is likely to have long-term effects on the country’s venture capital and private equity industry. SEBI’s proposed reforms would allow Knowledge-based Technology Companies and other Indian start-ups much necessary access to institutional and other qualified investors.
Call TransLegal with your questions concerning Indian laws and regulations and how they may impact your proposed FDI projects.