Startups will pull up stunts but it is for venture capitalists to call their bluffs. But in India public has to be protected from loss-the-harbinger-of-profits glib mantra
The recent conviction of Elizabeth Homes the founder of the startup in perpetuity, Theranos, on charges of cheating, by a San Jose jury is sending chill down the spines of startup founders in the US, some of whom blithely ride their luck, setting store by the most audacious fund-raising model—fake-it-till-you-make-it. A conman doesn’t push the envelope uttering the same lie many times lest he is caught in the act by someone made of sterner stuff or less credulous.
But Elizabeth had the gall to persist with her smug bluff and bluster that teething problems were being addressed all through the two decades her company was trying to perfect a contraption capable of drawing a drop of blood with a prick and carrying out as many as seventy tests in a jiffy, as it were, thus fast-tracking diagnosis and medication. Venture capitalists and angel investors were falling over themselves to get a sliver of its equity in their delusional pursuit of a mirage.
Back home, in India the dubious fund-raising model—loss-is-harbinger-of-profits—is less audacious and cunning but a lot more brazen. This model, strangely countenanced by our market regulator, the SEBI, is more dangerous than the American startup model because while the American model bilks the deep-pocketed venture capitalists, the Indian model targets mutual funds and small investors for whom there is a reservation of 35 percent in IPOs.
To be sure, SEBI insists on track record of profits for a company wanting to go public but in a manner of double take allows untrammeled access to public funds if the funds are raised through the 100 percent book building route in the facile belief that if institutional investors give their thumbs up, the small investors have no reason to demur.
The centerpiece, the livewire, of the 100 percent book-built IPO is a swinging merchant banker. Indeed, his appointment is a must as per the SEBI norms in such an exercise. In the vastly informative and lively novel the Billion Dollars sure thing, Paul Erdman throws a barb at merchant bankers with an apocryphal story of a hungry shark tamely swimming past a drowning merchant banker citing professional etiquette—a shark cannot harm another shark!!—for not making a meal of the drowning merchant banker.
Levity aside, in the Indian IPO scene, it is the merchant banker all the way. Get hold of a good and resourceful merchant banker and it would be a breeze is the refrain of those in the know. Thus, the exception to the track-record-of-profits rule has alas become the norm. Be that as it may but such a powerful mover and shaker should be made to have some skin in the game. Fifty precent of his fees by way of shares of the company, locked in for a year at least, plus a substantial underwriting obligation would meet the ends of justice and have a sobering effect on aggressive pricing.
There has been a clamor for IPO reforms in India but what the SEBI did last week in response was half-hearted and ephemeral. Offer for sale (OFS) has been allowed to ride piggyback on IPOs so much so that it is invariably IPO-cum-OFS. It is the worst form of conflict of interest as it encourages promoters to fix the IPO price unrealistically and unreasonably high in collusion with merchant bankers with a view to profiting themselves while dismounting. The SEBI has addressed this partially and half-heartedly by allowing promoters to unload only 50 percent of their holdings through this piggyback ride. It ought to have read the riot act to them—disinvestment must be only through the stock exchange platform, period.
Its continued and tacit endorsement of loss-is-harbinger-of-profit brazenness is shocking. Public must be insulated from loss-making companies. To be sure they have to take losses in their stride should a profitable company they are already shareholders of strike a bad patch but to entice them in an IPO with a loss overhang amounts to a wanton disregard for the tender finances of small investors.
Unwittingly therefore in India public are cast in the role of venture capitalists. The SEBI in May 2018 unceremoniously cast asunder the optional safety net it had flung for the small investors under which they could get the IPO price they had paid from the promoters on a maximum of 1000 shares should the market pride dip below the IPO price during the first six months after listing. It should restore it making it mandatory with the merchant banker too standing guard with the safety net alongside the promoters.
— S. Murlidharan is a CA by qualification and writes on economic issues, fiscal and commercial laws. The views expressed in the article are his own.
Read his other columns here
(Edited by : Ajay Vaishnav)
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