This post was authored by Praveen Sharma, a third-year student of B.A. LL.B. (Hons.) at Maharashtra National Law University, Mumbai.
India has come a long way post-liberalization and with growing entrepreneurship, India has been witnessing tremendous growth in the start-up industry. Many Indian start-ups have achieved the "Unicorn tag," which is given to a start-up whose valuation crosses the one billion US dollar mark. Many unicorn start-ups are operating in deficit in their initial years and after raising money through Angel Investors and Venture Capital firms, public listing allows the company to raise capital for its further expansion. Listing accords the leverage to these start-up companies undergoing a loss to sustain until they are profitable due to procurement of funds. The Public listing also provides a good exit to the early investors of the company. Angel Investors and Venture Capital firms make early investment in the start-up and given record of stellar listings in Indian Market, going public seems a good alternative for early investors to exit. Further, listing on the stock exchange allows retail investors to benefit by investing in a company when it is in a nascent stage. The liquidity of the company increases after listing as it opens the door for more investors to invest in the company thus enabling a larger participation in the trading of shares.
With more than 50 unicorns, it is high time for India to revisit its listing rules for loss-making companies. This post explores the public listing hurdles for start-ups in India.
2. QUALIFIED INSTITUTIONAL BUYERS ROUTE AND LOCK-IN REQUIREMENTS
As per Section 26 (2) of the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2009, companies that do not have a minimum of Rs 15 crore profit have to allot at least 75% of the shares offered to the Qualified Institutional Buyers ("QIB"). Section 2 (zd) of the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2009, define Qualified Institutional Buyers as institutional investors who are generally perceived to possess expertise in the Financial Market. Normally, QIBs consist of commercial banks, mutual funds, public financial institutions and foreign portfolio investors. Retail investors look up to the investments made by the Qualified Institutional Buyers. Most of the start-ups are loss-making in their initial stage, they are bound to allot 75% of their issued shares to QIBs when they go for an IPO. With such excessive allotment of shares to the QIBs, the price of shares becomes directly dependent on the stand of QIBs. As QIBs manage people’s savings, retirement pensions, etc., they emphasize a lot on “calculated risk” and tend to not get exposed to risk prone loss-making companies. As a result, loss-making unicorns might fail to get a successful listing due to over-exposure to the QIBs. Companies have often failed because of the indifferent approach by QIBs and it will continue to impact the future listing of unicorns in India especially when many successful start-ups are still loss-making. Considering the fact that more than 14 million Demat accounts were opened in the financial year 2020- 21, retail participation should be increased during an IPO. News reports have hinted that retail has largely contributed towards the bull rally post-COVID crash in March 2020 and allowing more quota to retail during listing will further help start-ups to achieve a successful listing.
Earlier as per Section 4.4.1 of the Lock-in requirements set by the Securities and Exchange Board of India ("SEBI"), the promoters had to lock in 20% of their post-IPO shareholding for a period of three years after listings. However, after SEBI (Issue of Capital and Disclosure Requirements) (Fourth Amendment) Regulations, 2017, SEBI reduced lock in period to eighteen months. While this move by SEBI will ease IPO process, current lock-in requirements still trouble start-ups who wishes to list in India. As start-ups raise capital by selling their equity share to Venture Capitalists and, Angel Investors, when they are in their nascent stage, often it is unlikely that the founders of the company hold around 20% of the share at the time of listings. Loss-making start-ups, particularly, are compelled to raise money by selling equity shares to investors; as a result, often none of the entities own 20% shares. It becomes difficult for the founding members of the company to offer shares for the lock-in period as they already give up ownership in the early stages of the funding. At times, when companies are choosing to be managed professionally, often, the founding members are reluctant to be disclosed as the promoters of the company. A straight 20% lock-in of promoter’s shares restricts the promoters of the newly listed start-ups to efficiently utilize their capital.
3. FOREIGN STOCK EXCHANGES REMAIN FAVOURABLE FOR INDIAN START-UPS
Despite witnessing huge success in India, many start-ups still prefer to incorporate themselves abroad, mostly in the US and Singapore. Companies such as Yatra, Make My Trip, etc. have opted to list overseas and have been successful. Singapore has always remained a lucrative option for Indian companies’ aspiring incorporation. No capital gains tax and no tax on dividends make Singapore an attractive base for Indian companies and for the same reason, Indian start-up companies always eye incorporation in Singapore. Further, the corporate tax in India stands at 30% whereas it is 17% in Singapore. Because of the tax structure of Singapore, several successful unicorns such as Flipkart, Practo, Grofers have chosen to list in Singapore instead of India.
Listing through Special Purpose Acquisition Company ("SPAC") is another method gaining popularity in India and Indian companies such as ReNew Power, Videocon have chosen to list in the US through SPAC. A SPAC is incorporated with the specific motive of raising funds through an IPO to finance a merger or acquisition of an unidentified target company. Listing through SPAC is comparatively faster and flexible as compared to regular IPOs especially when it comes to loss-making start-ups. Therefore, start-ups may opt to list overseas through SPAC to raise money easily and quickly. Furthermore, since the capital is raised on the goodwill of SPAC sponsors, it becomes easier for start-ups to raise public money through SPAC as start-ups find it difficult to gain public confidence because of their loss-making structure.
4. ATTEMPT TO ATTRACT START-UPS THROUGH INNOVATORS GROWTH PLATFORM
SEBI launched a separate platform called Innovators Growth Platform ("IGP") in 2019 that intended to encourage the listing of tech start-ups. SEBI further relaxed and eased the listing rules under IGP in March 2021. Earlier 25% of the share of pre-issue capital had to be held by the company’s eligible investors for two years which was brought down to one year. Reducing the time frame for pre-issue capital will allow more liquidity for the investors as they can utilize their capital after a year of listing which was previously locked for two years. As per the Substantial Acquisition of Shares and Takeover Regulations 2011, if an acquirer acquires more than 25% of shares or voting rights, it used to trigger an open offer however, this provision has been relaxed under IGP wherein an open offer gets triggered after 49% share acquisition. This relaxation provides more flexibility for start-ups to raise capital without triggering an open offer thus relieving them of burden and procedural affairs. Further, the delisting procedure by SEBI has been made easier wherein delisting is now considered if 75% of total shareholding and voting rights are acquired which used to be 90% earlier.
While loss-making companies such as Burger King and Zomato received overwhelming responses on their listing in India, yet, there is still a need to re-think listing policies for start-ups. SEBI’s attempt in 2015 to attract start-ups by launching Institutional Trading Platform ("ITP") failed; as a result, it was relaunched as Innovators Growth Platform in 2019. Despite being revamped and launched in 2019, no company has ever listed itself on IGP which suggests that Indian public markets are failing to evince interest from start-ups. It is high time that India gives a second-thought about its over-emphasis on the role of QIBs in the listing of loss-making start-ups. Given the high direct retail participation in the Indian stock market, SEBI playing the role of ‘retail protector’ might be virtuous but the extent of this role must be limited. A necessary eighteen month locking limit of 20% of the shares which has to be given by founders, seems way too harsh compared to the six-month lock-in period of the USA. With many new-age tech companies coming in and the start-up sector booming in India, regulatory barriers must be eased for start-ups to benefit from their valuation and GDP contribution.