SEBI Tightens Its Grip On End Use Of IPO Funds, Asks Companies For Accurate Details; Top 5 IPOs Destroyed Rs 3.5 Trillion In Wealth In FY22, Majority Of Indian Startups Eyeing IPOs In 2024 Struggle With Losses, Sense?
In the middle of a surge in initial public offerings (IPOs), SEBI is intensifying its scrutiny of issue documents filed by companies seeking to go public. Reports suggest that SEBI is tightening regulations to ensure accuracy in disclosing the utilisation of IPO funds. Consider the fact that the top five IPOs in FY22 resulted in a substantial erosion of wealth, totaling Rs 3.5 trillion and the majority of Indian startups preparing for initial public offerings (IPOs) in 2024 are grappling with losses. Among the 12 companies that have submitted their draft red herring prospectus (DRHP) to SEBI, eight are struggling to turn a profit, collectively accumulating losses amounting to Rs 8,000 crore. Yet, they could be allowed to issue IPOs; among this, SEBI wanting to increase its scrutiny on where IPO funds are being utilised - is a bit of a paradox!
The flourishing Indian stock market has driven nearly 50 companies to initiate public offerings in 2023 alone. With eight issues already completed, approximately 40 more await clearance from SEBI.
Recent reports indicate that India’s market regulator, SEBI, is intensifying its examination of issue documents submitted by companies seeking to go public, a move spurred by the escalating number of IPOs in the Indian market.
Also, companies intending to raise capital through IPOs must provide precise details regarding the intended utilisation of the funds; the heightened scrutiny of IPO disclosures has prompted several companies to revise their issue documents.
The action comes in response to observations that IPO funds are being allocated to purposes divergent from those stated in the application to the regulator.
Per SEBI regulations, funds procured through IPOs may be allocated for capital expenditure, debt reduction, general corporate purposes, and acquisitions. Should funds be utilised for debt reduction, promoters face an 18-month lock-in period for their shares.
Similarly, promoters are subject to a three-year lock-in period if funds are raised for capital expenditure. The term “promoters” denotes a regulatory classification in India that includes significant shareholders capable of influencing company policy.
Presently, if the majority of IPO proceeds are earmarked for capital expenditure, the lock-in period for promoters’ shares extends to 36 months.
However, if the IPO-bound company specifies loan repayments as the objective, the lock-in period shortens to 18 months.
The Loophole
Despite declaring loan repayment as the designated use of IPO funds, SEBI has noted instances where companies divert them towards capital expenditure requirements; hence, SEBI has informally urged companies to adhere to the regulations,
As per guidelines, even if a new loan is obtained to repay an existing loan, promoters’ shares must be locked in for 36 months if the underlying loan finances capital expenditure. Regarding IPO proceeds utilised for working capital requirements, the lock-in period can be 18 months.
Investment bankers overseeing equity offerings have confirmed SEBI’s inquiries into companies’ loan details, borrowing purposes, and repayment schedules.
Indian companies aim to raise over ₹1 lakh crore through IPOs in 2024, double the amount raised in 2023.
Addressing The IPO Rush
Understandably, undertaking an IPO marks a significant milestone for any private company seeking to sell shares to the public. The decision holds numerous advantages, such as granting shareholders access to a broader capital base and facilitating liquidity.
However, what motivates startups to opt for the public arena?
Does this move stem from a necessity to secure additional funding as venture capitalists withdraw, or do these companies perceive public markets as a gateway to future growth despite their inherent volatility?
Hence, a notable trend has emerged, drawing scrutiny and sparking discussions – why do loss-making enterprises opt for IPOs within the initial decade of their establishment?
The Temptation of IPOs
The choice to go public signifies a significant transition for any business, shifting from private ownership to becoming a publicly traded entity.
For loss-making enterprises, this decision carries both potential lifelines and risks, presenting an array of enticing factors like – capital injection and enhanced brand visibility/credibility.
Yet, an intriguing aspect of this phenomenon lies in the 10-year timeframe chosen by businesses, often still grappling with losses, to embark on their public offering journey, namely – exit strategies for venture capital and private equity.
Investors in startups and early-stage ventures typically anticipate exits within a 7-10-year timeframe, and loss-making businesses may face pressure to go public within this timeframe to provide an exit strategy for their investors or perhaps even for founders who are quick to park on the losses to retail investors.
Thus, This convergence of financial interests frequently expedites the IPO process.
Take On My Losses, Please!
Let us look at some past figures amid the IPO frenzy, companies freshly listed on the stock market encountered significant losses amounting to $231 million in the second quarter of the fiscal year 2022.
The year witnessed a wave of IPOs from startups that have yet to achieve profitability; despite their public debut, some of the leading startups in the Indian tech scene remain in the red financially.
Notably, the founders’ stake in companies like Zomato, Paytm, Policybazaar, CarTrade Tech, and Delhivery was less than 10%, exempting them from the promoter category and thus relieving them from the obligation to disclose share transactions in the open market.
The sharp decline in these stocks post-IPO was attributed to the rush of pre-IPO investors, including promoters, employees, and institutional shareholders, seeking to exit after the lock-in period expired, indicating a lack of perceived value even at reduced prices.
What’s In Store
Now, coming to FY24 – the majority of Indian startups preparing for initial public offerings (IPOs) in 2024 are grappling with losses.
Among the 12 companies that have submitted their draft red herring prospectus (DRHP) to the SEBI, eight are struggling to turn a profit, collectively accumulating losses amounting to Rs 8,000 crore.
Prominent unicorns such as FirstCry, MobiKwik, and Ola Electric are among those facing this challenge.
Swiggy and Ola Electric stand out as the primary contributors to the staggering Rs 8,000 crore loss. Additionally, other startups, including Portea Medical, Awfis, FirstCry, MobiKwik, and PayMate, have also reported losses in their recent filings.
While IPOs do not mandate profitability, the National Stock Exchange (NSE) requires companies to exhibit operating profit or earnings before interest, depreciation, and tax for at least two of the preceding three financial years.
Investors, however, tend to scrutinise trends in operating profitability rather than immediate net profit, especially when evaluating high-growth startups.
Despite facing losses, some of these startups have witnessed significant sales growth over the past financial year. For instance, Ola Electric’s revenue surged nearly sixfold to Rs 2,782 crore by the end of FY23, while FirstCry doubled its revenue to Rs 5,632 crore during the same period, albeit with an increased net loss.
Hence, for startups gearing up for IPOs, prioritising scaling operations over profitability is a common strategy.
Among the companies in the pipeline for IPOs, Go Digit, a hospitality, travel company, and FirstCry have filed their DRHP and await regulatory approval.
On the other hand, PayU, Unicommerce, Swiggy, and Garuda Aerospace are yet to file their papers; MobiKwik, which received Sebi approval in 2021 but deferred its listing, is expected to submit fresh IPO papers soon.
The Viewpoint
Why Are Loss-Making Companies Being Allowed to List for IPOs?
The decision to allow loss-making companies to list for IPOs has sparked significant debate and raised concerns among investors and industry experts alike.
While not new, this practice has garnered renewed attention due to recent events highlighting the risks associated with such ventures.
One key argument in favour of permitting loss-making companies to go public is the notion of fostering innovation and growth. Many startups operate in sectors characterised by rapid technological advancements and fierce competition.
Allowing these companies access to public capital markets can provide them with the necessary resources to fuel their expansion, invest in research and development, and scale their operations.
Advocates argue that this approach supports entrepreneurship and enables companies to pursue ambitious goals that may not be immediately profitable but hold the potential for substantial long-term returns.
However, critics of this practice emphasise the inherent risks involved.
History has shown that investing in loss-making companies can be highly speculative and volatile, and without a proven track record of profitability, investors may be exposed to significant financial losses if these companies fail to deliver on their promises or face unforeseen challenges.
The recent decision by SEBI to investigate where IPO funds are being used is a welcome step however the decision to allow loss-making companies to list for IPOs raises questions about market integrity and investor protection.
The primary purpose of regulatory bodies SEBI is to safeguard the interests of investors and maintain the integrity of capital markets.
Allowing companies with uncertain financial prospects to access public markets without adequate scrutiny could undermine investor confidence and expose unsuspecting investors to undue risks.
Therefore, disclosure requirements must be enhanced, thorough due diligence must be conducted on prospective issuers, and penalties for non-compliance with regulatory standards must be imposed.
An example of the same is Paytm, which is under ED scrutiny, yet SEBI allowed Paytm to come out with its IPO, which was the most significant market debacle as we know it!
