Friday, April 3, 2015

The Efficacy of a Listing Platform for Start-Ups

Last week, SEBI issued a discussion paper on “Alternate Capital Raising Platform and Review of Other Regulatory Requirements”, which is aimed at providing start-up companies the facility of listing their securities on a trading platform without going through the extensive onerous and listing requirements that might be applicable in the normal course. This is explicit recognition of the need to providing additional avenues to start-ups and small businesses to raise capital, and also to stem the tide of Indian companies approaching overseas markets for listing their securities. The purpose of this post is to highlight the key proposals made in the discussion paper, comments on them and conclude with some overall observations on the likelihood that these proposal will be effective to the desired extent.

The idea appears to be to ease the various requirements for an IPO when it comes to start-ups. Since there is no clear definition of what a “start-up” is, the discussion paper clarifies that “the new platform for raising money within the country will be initially made applicable to companies which are in the area of software product development, e-commerce, new-age companies having innovative business model, etc. which create new business opportunities or which serve important efficiency enhancement in existing business activities.” For such companies, the concept of promoter lock-in is proposed to be relaxed given that there may be no single person that holds a significant number of shares. Hence, the entire pre-issue share capital is to be locked in for a period of 6 months. Similarly, there will be complete freedom for start-ups in raising capital for any objective, including for general corporate purpose. Failing this, start-ups would find it difficult to come out with detailed plans for utilization of funds given that the business plan may not have been crystallized yet as the product or service would be at an early stage of development.

Under this proposed arrangement, considerable leeway will be provided to start-ups when it comes to disclosure in the offer document. The disclosure requirements for basis of the issue price could expansive and could include information other than those prescribed in detail for companies in general. Similarly, other disclosures which are considered costly and cumbersome are minimized for start-ups. Such disclosures include those pertaining to group companies, litigation and creditors. The purpose of these relaxed measures appear to be to ensure that the onerous disclosure requirements applicable to companies in general do not operate as a deterrent to start-up companies.

Due to the relaxations in the disclosure and the IPO process, start-ups can avail of this facility to issue shares only to sophisticated investors such as qualified institutional buyers (QIBs) and non-institutional investors (NIIs). Also, minimum application size and allotment requirements would ensure that only sophisticated investors can participate. Effectively, this facility would not be available for investment by retail investors.

Overall, this facility would provide additional access to capital for start-ups who may not be ready to go in for a full-blown IPO and listing on the main platform. Also, this may also be a good alternative for start-ups who may not want to access angel funding or venture capital as such investors would normally seek additional contractual protection and control rights. Investors investing through an IPO listing on a start-up platform may not avail such additional rights, thereby providing flexibility to the management.

At the same time, how effective this mechanism will be remains open. Given that only sophisticated investors can invest, the market may be somewhat restricted. Moreover, this would likely be an interim arrangement for issuers, and if start-ups grow beyond a certain size, they will nevertheless have to list on the main platform after undertaking the full-blown listing and disclosure requirements. Also, there may be other reasons for start-ups to want to list overseas, for example to obtain better international exposure and build up greater trust and credibility with its global clientele. Hence, while the proposals in the discussion paper are useful and will aid the progression of the start-up environment in India, the extent of its impact remains to be seen.

Finally, it is not clear as to what the ongoing obligations post-listing would be. For example, if there are onerous governance obligations on the start-ups, that might add to the continuing cost of listing and may deter start-ups. At the same time, there would have to be some minimal corporate governance measures embedded in the process so as to protect investor interests.

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