Introduction

The Initial Public Offering (‘IPO’) market has been booming ever since the dawn of 2020. As per the latest EY Global IPO Report, the year 2021 has been the best IPO year since the last 20 years. The recent pace of rise in Unicorns and filing of Draft Red Herring Prospectuses (‘DRHP’), makes it evident that the number of IPOs would witness further acceleration in the year 2022.

However, the Securities Exchange Board of India (‘SEBI’), being the guardian of investors, possesses a responsibility to strengthen security of the interest of the investors, especially retail investors, in this booming market, since the sudden increase of money in the stock market also increases the risk of market volatility. Against this backdrop, SEBI on 14 January 2022 had notified SEBI (Issue of Capital and Disclosure Requirements) Amendment Regulations, 2022 (‘ICDR Amendment Regulations’) with respect to changes and obligations that the IPO bound companies have to comply with while filing the DRHP.

This article seeks to provide an insight on the amendments made under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘ICDR Regulations’) vide the ICDR Amendment Regulations and the need to bring such amendments.

Analysis of certain amendments:

1. Quantitative restriction on utilization of IPO proceeds for unidentified inorganic growth

An IPO bound company cannot spend more than 35% of its IPO proceeds for the objects (as mentioned in the offer document) i.e. (i) general corporate purpose and (ii) any unidentified inorganic acquisitions or strategic investments target (‘Inorganic growth’) which has not been specified in their DRHP.

In case an acquisition target is not identified, then only 25% of the IPO proceeds can be spent towards such objects i.e. inorganic growth. However, if the company has already identified their acquisition and have specified the same in their DRHP or Red Herring Prospectus (‘RHP’), along with the amount to be utilized towards such acquisition, then such company shall be exempted from the aforesaid quantitative restriction.

SEBI has introduced this provision in the wake of instances where the company has no concrete plans for any acquisition or investment target, but chooses ‘Inorganic growth’ as an object in DRHP in order to attain a higher listing on day one. This obligation will force the companies to further strategize their IPO proceeds spending that would facilitate investors in making a reasoned decision before investing.

2. Quantitative restriction on offer for sale (OFS) to public in IPO

Now, any existing shareholder along with persons acting in concert cannot offer more than 50% of their pre-issue shareholding, if they are holding more than 20% of the share capital of the company. On the flip side, such shareholders holding less than 20% of the share capital of the company, cannot offer more than 10% of their pre-issue shareholding.

The ICDR Regulations never had any such quantitative restrictions in the past. The above restriction is vis-à-vis those companies who are listed under Regulation 6(2) of the ICDR Regulations via book building process (i.e. companies who does not satisfy the threshold requirement of having net assets, operating profits, and net worth under Regulation 6(1) of the ICDR Regulations, for making an IPO).

Absence of such restriction will make the retail investors more vulnerable if most of the existing shareholders exit the company or withdraw maximum of their shareholding. This would further weaken the confidence of the new investors since the mass withdrawal of existing shareholders could be a negative indication about the business operations and future growth of the company. Such an obligation will compel the existing investors, mostly private equity investors, to invest in the company with a sense to build a long-term business rather than just focusing towards an exit via IPO.

3. Change of Monitoring Agency and reporting of utilization of IPO proceeds

Regulation 41(1) of the ICDR Regulations requires that the use of IPO proceeds shall be monitored by the Scheduled Commercial Banks (‘SCB’) or Public Financial Institutions (‘PFI’), if the issue size, excluding the size of offer for sale by selling shareholders, exceeds INR One hundred crore. However, these shall now be substituted by Credit Rating Agencies (‘CRA’). This is a strategic proposal since the aims and objectives of the CRAs aligns in a better manner than SCBs or PFIs, as monitoring the activities of a company does not form the substantial and primary duty of an SCB or a PFI. Such monitoring shall now apply vis-à-vis 100% utilization of IPO proceeds instead of the erstwhile threshold of 95%.

The amount specified to be raised under general corporate purpose has also been brought under the scanner of the monitoring agency and a monitoring agency, via a report, has to submit details of utilization of IPO proceeds before the audit committee of the issuer company on quarterly basis instead of annual basis (as required earlier).

The above monitoring mechanism will prohibit the trend of misusing the IPO proceeds in a manner distinct from their objects as specified in the DRHP. The primary objective behind such cautioned approach is enhanced transparency and accountability of investors’ money.

4. Lock-in period for anchor investors

Part A of Schedule XIII of the ICDR Regulations prescribed a lock-in period of 30 days for anchor investors. However, SEBI has increased this period to 90 days i.e. 50% of the investment by an anchor investor shall be locked for the period of 90 days from the date of allotment. This amendment has come into force on 1 April 2022 and shall apply to all IPOs opening on or after 1 April 2022.

Such amendment will increase the confidence of the investors and will also rule out the internal arrangements of anchor investors (large institutional investors such as mutual funds) and the IPO bound companies, where even if the financials of the IPO bound company is weak, the hype created by these anchor investors before public issue increases confidence of the retail investors thereby leading to maximized subscription during the offer period. This hype is to achieve higher listing price at the stock market, and as soon as the lock-in period expires, they exit from the company, consequently calling for a big sell off which ultimately risks the investment of retail investors whose subscription comes at stake.

However, restricting anchor investors or existing shareholders, mostly private equity investors, from taking an exit beyond 50% might restrict them at the first place to invest in start-ups as they would not be able to get a complete exit.

5. Changes in preferential issue

1. For promoters and promoters’ group, the lock-in period has been reduced from (i) 3 years to 18 months from the date of trading approval for (a) specified securities (i.e. equity shares and convertible securities) allotted, and (b) the equity shares allotted pursuant to exercise of options attached to warrants issued, on a preferential basis and (ii) 1 year to 6 months for equity shares allotted over and above 20% of total capital of the issuer company, on preferential basis. For non-promoters, such period shall reduce from 1 year to 6 months.
2. The Promoters can now pledge their lock-in specified securities (i.e. equity shares and convertible securities) except SR (superior voting right shares) equity shares, for borrowing money from an SCB or PFI or a systemically important non-banking finance company or a housing finance company, only if such pledging is stated in the terms of loan and only for the purpose of financing the objects of issue.

This amendment is proposed to avoid siphoning of funds, as the corporates could pledge their shares for the purpose of utilization of borrowed amount for any other venture apart from the growth of such company whose shares are being pledged.

Conclusion

The aforesaid amendments are the by-product of SEBI’s cautious approach to safeguard investors’ interests and wealth. Such amendments have called for greater transparency and accountability with respect to utilization of the public money via IPOs. SEBI’s consultation paper on disclosure for ‘Issue of Basis Price’, released on 18 February 2022 for those IPO bound companies, which aims for listing through book building process via Regulation 6(2) of ICDR Regulations, is another approach towards ensuring a transparent process of listing.

However, these amendments also raise concerns towards red-tapism by the regulatory authority as increased compliance may compel the big investors to shy away from putting money into the market, which could also lead to stagnant growth of the market.

Amendments such as increase in lock-in periods and monitoring of the IPO proceeds utilization by a CRA could adversely impact the start-up market in India.

[The authors are Executive Partner and Senior Associate, respectively, in the Corporate and M&A advisory practice at Lakshmikumaran & Sridharan Attorneys, Gurugram]