Why SEBI’s e-IPO norms are two steps forward and one step back

Why SEBI’s e-IPO norms are two steps forward and one step back

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Later this week, India’s capital market regulator SEBI is likely to announce a set of measures aimed at stopping the exodus of high potential start-ups from India in search of easier stock market listings. The measures – collectively called e-IPO (electronic initial public offering) – promise to offer a new platform to start-ups to raise money quickly by cutting paperwork and relaxing listing norms. There are going to be other benefits like faster turnaround by greater use of technology. These measures are supposedly refined by incorporating suggestions from various stakeholders after SEBI issued a draft earlier in January. These steps have been necessitated following overseas listing plans of several high profile ecommerce start-ups including Flipkart and Snapdeal.

Two steps forward

Raising funds from IPOs is a herculean task in India since SEBI has enacted stringent listing requirements. Prominent among these are:

  • Companies desirous of raising funds through IPOs need to be profitable for at least three years.
  • Promoters are required to lock at least 20% of their post-issue capital for three years (yes, no problems with your eyes).

There are other requirements but let’s spend some time here. The first one is a regurgitated version of what has been bank’s attitude to lending. No collateral, no funding. It practically says no matter how promising your start-up is; don’t dare to think of raising funds from general public. Most of e-commerce start-ups are forced to focus on market share instead of profits in initial years. Winning profitability without enough market share is a perfect recipe for disaster. In other words, this sort of strategy has the potential to transform Flipkart to Fauja General Store in Karol Bagh.

The second one needs no explanation. Three years is just too long, especially in the case of new-age start-ups which are typically low on capital investment and high on intellectual investment. Forget about the promoters’ capital, most start-ups don’t have a runway of three years.

In its e-IPO norms, SEBI is likely to ease these restrictions to remove the profitability clause and reduce the lock-in to six months. Very well, these two are small steps for SEBI, but giant leaps for start-ups.

One step back

Where SEBI falters is with its decision of keeping retail investors out of action. The regulator is believed to be strongly in favour of restricting the use of this electronic platform to institutions and high net worth individuals, because of the “risks involved”. The regulator considers the start-up game is too risky for small investors.

SEBI’s intentions aren’t flawed here as scores of companies with no history of profitable operations and with minimal promoter shareholding took the public route in the last three decades, robbing small investors crores in lost shareholders’ value. That explains the above mentioned requirements.

While SEBI’s objectives are not flawed, these measures have hardly helped the cause of retail investors. The requirements have not stopped companies and lead managers from not leaving any money on the table with the end result being investors losing their shirts in all the seven IPOs except VRL Logistics and Inox Wind so far this year.

With this single step, SEBI will probably rob small investors their already low probabilities of chancing upon the next Flipkarts and Snapdeals.

Equity investments are all about risk

In its bid to protect the interests of small investors, the overzealous regulator would be essentially doing quite the opposite. One of the roles of the market regulator is to bring small investors into the mainstream. SEBI has done commendable job in unearthing certain scams and punishing the guilty (see here and here); however, it is difficult to see the planned exclusion in positive light from any angle.

It is understood by all that equity investments are risky bets but the term “risky” shouldn’t deter the regulator. SEBI can mandate better disclosures and IPO ratings to ensure investors are well-aware of what they are getting into. However, it would simply be a dumb regulation which penalizes interested investors with good risk-appetite in order to protect those on the other side of the fence. With five out of seven companies which got listed this year trading below their IPO price as on 19 June, it is no brainer that SEBI’s existing rules are no good at containing greed and mispricing. As such, it remains doubtful if exclusions, stringent regulations are real solutions.

Contrary to SEBI’s belief, retail investors seem to have matured if their response to MEP Infrastructure, PNC Infratech and Ortel Communications IPOs is any indicator. Broadbrushing retail investors as intellectually incapable of understanding risks associated with start-ups would be a big mistake. In fact, this should have been a showpiece in the regulator’s long list of endeavors to bring retail investors into the market. Poor and even disastrous listings are the bitter truths of the market which can’t be eliminated by exclusions. It is only when such setbacks are offset by good IPOs that investors’ faith in the market can be restored.

This is quite ironical that the regulator is making small investors deprived of the very same growth prospects which have forced it to put together the e-IPO norms.

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