SEBI proposes rules on Pricing of IPOs
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India’s watchdog SEBI plans to ask advanced-age automated companies to account for the pricing of shares for their initial public offerings to ensure transparency after massive disappointment in stocks of some companies that eroded billions of dollars in investor wealth.
A discussion paper issued on 18th February, 2022 by the Securities and Exchange Board of India (SEBI) has fixed March 5th, 2022 as the time limit for public to submit the observations and comments.
Shares of some advanced age tech firms such as Paytm and Zomato have tumbled since their listings.
The watchdog wants latest tech firms to elaborate comprehensively how pricing of the shares have happened for initial public offerings (IPO), in comparison to pre-IPO share sales and publish all pre-IPO investor presentations to help investors make right and knowledgeable decisions.
SEBI noticed that many of these companies that don’t have a demonstrated track record of profitable operations for at least three years are launching IPOs. Such companies have usually been loss-making for an extended period before achieving break-even as they opted for scale over profits during the growth phase.
Some amongst them made the public debut in the past year, hoping to capitalize on a record rally in the stock markets. However, most are currently trading at discounted levels. At the moment, companies only disclose earnings per share (EPS), price to earnings (P/E), return on net worth (RoNW), and net asset value (NAV), as well as comparisons of these accounting ratios with the competitive part, i.e., companies of similar size in the same industry.
Such conventional framework, SEBI said, cannot be applied to the updated tech companies. It said disclosures in the ‘Basis of Issue Price’ section, specifically for a loss-making company, must be augmented with non-traditional parameters such as key performance indicators (KPIs) and disclosure of certain additional criterion such as valuation based on past transactions/fund-raising.
Advanced age startups listing shares is not like usual traditional businesses, and this move is much necessitated because most startups are losing money. Before filing offer documents, such companies are required to disclose valuations based on new share issuance and acquisitions during the preceding 18 months. Current metrics may stand inadequate to provide investors a crystal clear picture of a company’s financial statistics. These newly proposed reporting framework will help investors in making right and knowledge backed investment decisions when it comes to the tech companies.
In its six-page paper, SEBI said such companies should reveal all material KPIs shared with any pre-IPO investor in the three years before an IPO.
However, for KPIs that the issuer company deems irrelevant for a proposed IPO, the issuer shall provide adequate explanation for considering those KPIs as irrelevant with proper cross-reference to a table disclosing the said KPIs, according to SEBI. KPIs stated by the advanced age companies should be defined distinctly, consistently and precisely. KPIs should not be misleading in any manner.
Additionally, these KPIs shall be certified or audited by statutory auditors. The issuer company also is required to draw a comparison of KPIs with Indian-listed peer companies or globally-listed peers, while comparisons of KPIs over time also will have to be justified.
IPO-bound companies will be mandated to report in their draft prospectus the cost at which shares were sold in secondary and primary agreements in the previous 18 months if it has resulted in the dilution of over 5% stake.
The “Basis of Issue Price" section was scrutinized by a sub-group of the Primary Market Advisory Committee (PMAC) of SEBI. The recommendations of the sub-group were discussed in a meeting of PMAC, which were then proposed to the regulator through the discussion paper.
Key performance indicators will help in valuing loss making start-ups. With a large number of new age technology companies planning to make public debut on stock exchanges, SEBI proposed to make it compulsory to list out KPI in addition to the financial ratios while making disclosures in ‘Basis of Issue Price’ section?of the offer document.
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Under existing rules, companies planning for an IPO are?required to make revelations of critical accounting?ratios including?earnings per share (EPS), price to earnings (P/E), return on net worth?(RoNW), and net asset value (NAV) with?a comparison of such?accounting ratios with its peers i.e., companies of comparable size in the same industry.
It is noticed that the above parameters are typically descriptive of companies which are profit-making and does not relate to a company issuer that is loss-making.?Thus, these parameters may not help investors in taking investment decision w.r.t. loss-making issuers, SEBI said in a consultation paper issued on Friday (18th February, 2022)
This assumes significant in the light of large number of start-ups?filing of offer documents for IPOs.
Many such companies do not?have?track record of operating profit in preceding three years.?
Advanced age tech companies usually tend to remain loss making for an extensive time?period before achieving break-even as these companies in their growth phase opt for gaining scale over profits. Investors are on boarded on these companies on the premise?of future potential, and correspondingly the company strives for long-term market leadership?rather than short-term profitability considerations. The growth in such businesses?comes from expansion into untapped micro-markets and adding or acquiring new?customer base/companies/tech etc.
Globally, IPOs follow a disclosure based regime and prohibit any future projections for?marketing of the issue. Thus, basis of issue price is based on traditional parameters such as P/E ratio, NAV etc. trends in KPIs over the past years; valuations done at the earlier rounds of fund raising; and?market conditions.
In India, present requirement for the ‘Basis of Issue Price’ section in offer document covers?only disclosure of traditional parameters such as disclosure of key accounting ratios.
“It is obvious that disclosures in ‘Basis of Issue Price’ section, particularly for a loss-making?company, are required to be supplemented with non-traditional parameters like key?performance indicators and disclosure of certain additional parameters such as valuation based on past transactions/fund raising by issuer company,” SEBI said.
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