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BOTTOMLINE: SEBI lens on new age IPOs overlooks issue of irrational valuations

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SEBI has taken note of many issues around new age IPOs, but what about valuations? It is bizarre that companies looking to tap the public market, Paytm being a big case in point, don’t provide any basis for valuation of their shares, despite rules requiring them to get an independent valuation done.

BOTTOMLINE: SEBI lens on new age IPOs overlooks issue of irrational valuations
The Securities & Exchange Board of India is keeping a hawk-eye on the primary market, especially with IPOs of new age companies like Zomato and Paytm raising hefty sums. To address some of the problem areas, it has proposed changes to existing rules for public offers. Strangely, there is nary a mention of valuations, which is the most burning issue after the Paytm listing mishap.
So, what is SEBI concerned about? Let’s look at some of these issues before getting to the absurdity of valuations.
ON SEBI’S RADAR
There are four areas that SEBI is focusing on in its consultation paper.
a) Objects of the issue – where it is acquisitions / strategic investment
b) Conditions for Offer for Sale
c) Lock-in of shares for anchor investors
d) Monitoring of general corporate purpose amount
And on these four, it has proposed the following:
OBJECTS OF THE ISSUE
Prescribe limit of 35 percent for inorganic growth & general corporate purposes
Cos can already earmark 25 percent of offer for general corporate purposes
This limit will apply where inorganic opportunities are unidentified
OFS BY SIGNIFICANT SHAREHOLDERS
Sale via OFS for significant shareholders capped at 50 percent of pre-offer holding
Proposes 6-month lock-in post IPO for Significant holders selling via OFS
Significant shareholders are those with >20 percent pre-offer stake
Rule to apply where there are no identifiable promoters
Rule more relevant where companies are loss-making
LOCK-IN FOR ANCHOR INVESTORS
50 percent of anchor book should be allotted to those accepting >90 days lock-in
Other option: extend lock-in for all anchor investors beyond 30 days
MONITORING GENERAL CORPORATE PURPOSE
Proceeds earmarked under GCP (up to 25 percent of offer) to be monitored
Utilisation of GCP amount to be disclosed in quarterly Monitoring Agency report
Let’s put these proposed measures in context. SEBI seems concerned with lack of clarity on use of funds by new age issuers who earmark large sums for “inorganic growth” or “strategic investments” without providing any specifics. Also, given the large sums being raised, thousands of crores of rupees are designated for “general corporate purposes”, for which there is little management accountability. These are genuine concerns and it is good that SEBI is taking note of them, and is proposing a cap on such allocation along with suggesting monitoring of such funds use.
The other area of concern is large venture / private equity investors with substantial stakes looking to significantly exit these businesses via the offer for sale (OFS) route. To ensure skin in the game, the regulator is proposing a cap of 50 percent on sale of pre-offer stake by a shareholder with >20 percent stake. And to prevent the post 30-day exit by anchor investors, it is weighing a longer lock-in for all or a big chunk of such allocation.
These are all well-meaning proposals and one hopes they will, perhaps with a few tweaks, be implemented soon.
Regulatory gap on valuations
It just seems bizarre that companies looking to tap the public market, Paytm being a big case in point, don’t provide any basis for valuation of their shares. Is this a rabbit and hat trick? Is it a lucky draw number? The proposed argument that valuations are decided by merchant bankers and investors without revealing the basis doesn’t wash.
What’s more appalling, is that when the law of the land requires valuation of shares for any corporate issuance, how can these companies get away without offering an explanation?
For those not familiar with Company Law or Income Tax rules in this respect, companies can’t just price shares as they please. They need to get an independent valuation done each time they issue shares.
In the case of many new age companies that were till recently unlisted, the norms for issue of unquoted equity shares would have applied. Here is a small extract of the regulations:
Companies Act
Further issue of Share Capital:
To any persons, if it is authorised by a special resolution, whether or not those persons include the persons referred to in clause (a) or clause (b), either for cash or for a consideration other than cash, if the price of such shares is determined by the valuation report
Pricing of Sweat Equity Shares:
The price of sweat equity shares to be issued to employees and directors shall be at a fair price calculated by an independent valuer.
Income Tax Act
Valuation for Fresh issue of Share Capital:
Either discounted cash flow or intrinsic value or any other method at the option of the Assessee, on the basis of valuation report by Merchant Banker
Valuation for Transfer of Shares:
Intrinsic Value as defined in rules, on the basis of valuation report by Merchant Banker or Chartered Accountant
It follows, therefore, that if an independent valuation report is prepared for filing with MCA or for Income Tax purposes, why can’t such information be made available to the public that is investing hard-earned savings to subscribe to the offers of these companies?
Do note than an income tax officer can impose tax if there appears to be a gap between fair valuation and the pricing of shares by an unlisted issuer. But in the public market, there seems to be no check on mispricing.
Smart investors not stupid
The argument that large, marquee investors are investing in a new age IPO and hence the pricing is fair, is far stretched, especially when there is little information provided to judge this “fairness”.
In my many years of being associated and engaged with public and private markets, I have never come across a start-up deck that has an “ask” for fund raise, but no numbers to justify this “ask” and valuations for the raise. No investor worth their salt will put in money without a clear investment rationale and return expectation. And if such information is made available to marquee investors, why not to the public?
One knows for a fact that start-ups share significant details in their monthly / quarterly updates with venture and private investors, many of whom also have board positions. Given this, the attitude towards public disclosures by several such companies is hardly comforting.
Valuations for many new age IPOs may be irrational, or not, but there is an information asymmetry that prevents the lesser investors from making that assessment. And that needs to change.
This is one area SEBI hasn’t looked at closely enough, and it is about time it did, before more uninformed investors burn their fingers.
You are public, not private
What seems to be a general sense one’s getting from the way many of the new age public companies engage, is that they are not very open to sharing information. While this may be for competitive reasons, it is in stark contrast to how most publicly listed companies engage.
There is one simple fact that the listed new age companies need to come to terms with quickly, for their own good, and it is that they are now publicly listed and not private. And if they wish to remain so, they will need to recognize and appreciate their accountability to public shareholders and enhance disclosures to gain their confidence.
These are early days for new age businesses in the public market, and one hopes these companies and the public shareholders will get to better appreciate the compulsions on both sides, so that long-term wealth is created for the promoters, private investors and the public.
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