A RED HERRING PLEASE – HOW SEBI CAN HELP COMPANIES FILE FOR IPO SOONER

The primary regulations governing IPOs in India are called the SEBI Issue of Capital and Disclosure Requirement Regulations. Through these, SEBI has laid down the framework of a ‘somewhat’ disclosure-based regime for companies hoping to access public capital markets. From a regulatory review point of view, an IPO is largely divided into these six stages:

•       Stage 1: Draft red herring prospectus (DRHP) is filed with SEBI

•       Stage 2: SEBI reviews the DRHP and gives its comments

•       Stage 3: Company addresses these comments and files an updated DRHP (UDRHP) with SEBI

•       Stage 4: SEBI gives final comments/clearance

•       Stage 5: Company files the red herring prospectus (RHP) with registrar of companies

•       Stage 6: Company can launch the IPO, allot shares, and get listed

Once the RHP is filed with the registrar, the company can launch the IPO which then entails bidding by investors and eventual allotment and listing.

We say ‘somewhat’ disclosure-based because SEBI prescribes quite a few eligibility conditions which if unsatisfied, would preclude a company or a shareholder hoping to offload stake through an IPO, from accessing public markets. Among these, there are some which make complete sense - such as, a company or its promoters cannot undertake an IPO if they have been debarred by SEBI or are wilful defaulters or fugitive economic offenders. Then there are others which make sense from a policy point of view for SEBI. For example, SEBI requires a shareholder to hold shares for at least one year before it can sell those shares in the IPO. The idea behind this being that since pre-IPO valuations are lower, SEBI does not want someone to make a quick buck by investing just before the IPO and then off-loading its stake in the IPO at a relatively higher IPO valuation. Now some conditions, including this one, are required to be satisfied at the time of filing the DRHP with SEBI. So, a shareholder must have held shares for a minimum of one year at the time of filing the DRHP. There are of course certain exemptions to this rule, but the underlying requirement that capital must have been invested for at least a year remains.

Another condition, an indirect eligibility to undertake an IPO, is one which requires a promoter to have what is called the ‘minimum promoter’s contribution’ or MPC. MPC is 20% of the post IPO share capital held by a promoter that is locked-in for at least 18 months after the IPO. Not all shares held by a promoter are eligible for MPC. Whether shares are in fact eligible or not also depends on how long ago the promoter had acquired these shares. The duration of holding for this purpose again is calculated based the filing of the DRHP. For example, shares acquired within one year of filing DRHP are not eligible for calculating MPC, except in certain situations. Here again, the eligibility of shares for MPC is tested on how long the shares have been held prior to the DRHP filing.

In addition, SEBI has also recently been insisting on a couple of more time bound conditions being met at the time of filing DRHPs. One is where the law requires a cooling off period of six months after a company has undertaken a buyback before it raises further capital. A plain reading of this provision would mean that six months period must pass between the buyback and when the capital is actually raised, or maybe allotment is done, and not planning up an offering. Second is on conversion of warrants. Even though SEBI’s regulations allow ‘convertible securities’ to exist till RHP, SEBI has been taking a view that warrants, if any, should be converted prior to the filing of the DRHP.

The reason why SEBI at times insists that conditions or compliances required under its regulations be met or complied with at the DRHP stage itself, is because SEBI wants to review a document which is as close to being final as possible. That is the reason why of the six stages mentioned earlier, the run up to the DRHP often takes the longest with some companies starting work one to three years before they want to get listed. However, as is apparent, the conditions discussed above are very objective and require only passage of time to get satisfied. A shareholder who has acquired shares recently, for example, only has to keep holding its shares and they will eventually become eligible to be sold in the IPO. Same would also be true for shares acquired by a promoter not too long ago, which need to become eligible for MPC.

We have often seen issuers needing to wait to file DRHPs only because enough time has not passed for one or more of these requirements to get satisfied. A company which has undergone a recent re-structuring, for example, might have to wait for a year or six months, before filing DRHP to satisfy these conditions. Such delay often results in issuers not being ablet to tap the market at the right time, especially in times when launch windows are short and timing becomes important. It would be a good initiative on SEBI’s end to have re-look at such conditions and link them to filing of RHP (if not listing itself) and not DRHP. SEBI review process also would not be impacted if these time bound conditions are linked to RHP, which could let the process of review and passage of time, run parallelly. This will help issuers to time the launch, and since these requirements can be tested very objectively, nothing substantial will be pending for SEBI’s review of the DRHP.