Uniqus Insights

Shaping the regulatory and governance agenda

3, April 2023

Introduction

The Securities and Exchange Board of India (“SEBI”), in its board meeting held on September 30, 2022, which subsequently got notified in the official
gazette dated November 21, 2022, had approved certain key proposals, including:

Disclosure of Key Performance Indicators (KPIs);
Disclosure of price per share of Issuer based on past transactions and past fund raising from the investors; and
Introduction of pre-filling of offer documents as an optional alternative mechanism for the purpose of Initial Public Offer on the Main Board.

Our Analysis

A. Disclosure of KPIs

Background
Securities And Exchange Board of India (Issue of Capital And Disclosure Requirements) Regulations, 2018 (“ICDR regulations 2018”) provided a detailed
framework for disclosing financial information/ratios including the audited financial statements as part of the offer documents by the Issuers. However,
there was no specific requirement or a defined framework to disclose KPIs.

Whilst the Issuers disclosed the same on a discretionary manner to suit their purpose, the information disclosed was not required to be audited/
certified, defined consistently, explained or to be presented in a comprehensive manner. Further, disclosure of traditional financial parameters such as
earnings per share (EPS), price to earnings (P/E), average return on net worth (RoNW) and net asset value (NAV) in “Basis for Issue Price” section of offer
documents were not necessarily useful in cases where the Issuer was yet to turn profitable or had yet to reach break-even.

Summary of disclosure requirements

KPIs disclosed in the offer document and the terms used in KPIs shall be defined in the “Definitions and Abbreviations” section of the offer document and must be comprehensive.
KPIs disclosed in the offer document shall be approved by the Audit Committee of the Issuer.
Disclosure and confirmation from the Audit Committee that all KPIs that have been disclosed to its investors at any point of time during the three years preceding to the date of filing of offer document are disclosed in the offer document.
KPIs disclosed in the offer document shall be certified by the statutory auditors or independent Chartered Accountant/firm or Cost Accountants.
Certificate issued with respect to KPIs shall be included in the list of material documents, which should be available for inspection.
KPIs shall be provided for the period which should be co-terminus with the period for which the restated financial information is disclosed in the offer document.
Explanation shall be provided on how these KPIs have been used by the management historically to analyse, track, or monitor the operational and/ or financial performance of the Issuer.
Disclosure of any other relevant and material KPIs of the business can be made in consultation with the lead merchant banker.
Cross reference of KPIs disclosed in other sections of the offer document to be provided.
KPI comparison with Indian listed peer Companies and/ or global listed peer Companies will be required to be disclosed.
Issuers must at least annually disclose updates to KPIs disclosed in the “Basis of Offer Price” section, till the later of (a) one year from listing date or (b) full utilization of the IPO proceeds, with explanations for changes.

Our Analysis

a. Under the existing regulations, disclosure of key accounting ratios under the “Basis for offer/issue price section” provided information only of financial parameters, which had the following limitations:

Financial parameters help in assessing the financial performance of those Companies that are profitable and may not assist investors in taking
investment decision with respect to investing in an issue by a Company which is yet to break-even.
Prospective investors in new age technology Companies and startup Companies also consider non-financial parameters such as scale of operations,
long-term potential market leadership and similar other factors for making investment decisions, for which existing accounting ratios, which are
disclosed in the offer document, may not be relevant.
Basis for issue price is driven by many other non-financial factors including KPIs. Non-disclosure of such data in the offer document precludes
providing the investors with a comprehensive view about the Company’s operations.

Point of View

As seen in the above analysis, whilst the requirement to comply with the KPI guidance is mandatory, we note that in practice there has been a mixed
application of the regulation. Our recommendation is that the Issuers ensure absolute compliance with the above regulation, as non-compliance of
the same can result in significant litigation risk for the Issuer, its Key Managerial Personnel and Board of directors, including the independent
directors of the Issuer.

B. Disclosure of price per share of Issuer based on past transactions and past fund raising from the investors

Background
With the objective to provide comprehensive details to investors regarding past share issue transactions of Issuers under one particular section of the
offer document, SEBI, via ICDR Regulations 2022, has mandated the following disclosure under “Basis for Issue Price” section of offer documents for all
offer documents.

Summary of disclosure requirements under ‘Basis for issue price’ section

Disclose price per share of Issuer based on primary / new issue of shares, excluding share issued under ESOP/ ESOS and issuance of bonus shares
during the 18 months period prior to filing of DRHP/RHP, where such issuance is equal to or more than 5% of the fully diluted paid-up share capital of
the Issuer.
Disclose price per share of Issuer based on specified secondary sale / acquisition of shares, during the 18 months period prior to IPO, where such
issuance is equal to or more than 5% of the fully diluted paid-up share capital of the Issuer.
Disclose price per share of Issuer based on last five primary or secondary transactions, not older than three years prior to IPO, in case there are no
such transactions of primary / new issue of shares or specified secondary sale / acquisition of shares.
Disclose weighted average cost of acquisition (WACA) based on primary / new issue of shares and specified secondary sale / acquisition of shares and
last five primary or secondary transactions, with the floor price and cap price as being “X” times the WACA in the offer document and in the Price Band
Advertisement under ‘Risks to Investors’.

Our Analysis

It’s a welcome move from SEBI, as details of past transactions and past fund raising from investors will aid the future investors to take an informed
decision and assess the reasonableness of the issue price.
Considering the dynamic nature of business models, a look back period of 18 months appears to be adequate for all Issuers before making an
investment.
Based on the comments received by SEBI from various stakeholders, either the Issuers may not have access to the details of all pre-IPO secondary
transactions of its shares and details of transactions done by individual investors may not be subject to any pricing of shares by the Issuers. For this
purpose, SEBI has introduced the requirement to disclose only secondary transactions of promoter, promoter group, shareholders selling shares
through offer for sale in IPO and shareholder having nomination right(s).
Price per share details is to be given for transactions which equal to more than 5% of the fully diluted paid-up share capital of the Issuer. This
threshold will ensure that, only transactions which are significant in size are covered in the disclosure.
The intent of this disclosure is to capture the transactions which may cover the latest pricing of shares by the Issuer. If there are no primary/
secondary transactions in last 18 months, then disclosure shall be given for last 5 primary or secondary transactions, not older than 3 years prior to the
date of filing of the DRHP / RHP, irrespective of the size of transactions.
It is also expected that Issuers provide qualitative disclosures to compare offer price with WACA of past primary/ secondary transactions along with
comparison of Issuer KPIs/financial ratios.

Small and Medium Enterprises Platform (SMEs)

The amendment to disclose requirements on KPI is in Part A of Schedule VI, in paragraph (9) under the heading – (K) Basis for Issue Price (“this
section”). This schedule is also applicable for Initial public offers (IPOs) made on SMEs platforms as given in Chapter IV of Securities and Exchange
Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018.

Point of View

There is scope of improving adherence with and quality of these disclosures by Issuers, especially on the SME platform. Considering there is a very low compliance of KPI disclosure requirement in SME platform filings, we expect the Issuers to ensure compliance with the regulations in totality as non-compliance of the same can result in significant litigation risk for the Issuers, its Key Managerial Personnel and Board of directors, including the independent directors of the Issuers.

C. Introduction of pre-filling of offer documents as an optional alter- native mechanism for the purpose of Initial Public Offer on the Main Board

Background

Under the existing regulations, there is no concept of Pre-filing of Draft Red Herring Prospectus (PDRHP). In this amendment, the SEBI has introduced an optional alternative mechanism to facilitate public Companies desirous of an IPO listing on main board to file their draft offer document on a confidential basis. For this, a new chapter (Chapter II A) has been introduced in the SEBI ICDR Regulations, 2018.

Our Analysis

a. Under the existing process, following are the challenges faced by the Issuers:

– An Issuer exploring the possibility of an IPO will need to make disclosure of various sensitive information about its business in the DRHP at a time when there may not be certainty that the IPO would be executed or when it would be executed.

– There remains an apprehension in the mind of the Issuer that competitors might take undue advantage of the information disclosed by it in its DRHP.

– After filing DRHP by the Issuers, SEBI seeks clarification on the same and issues an Observation Letter. An Issuer can access the market within 1 year from the date of this Observation Letter. At times, due to volatility in market conditions or other factors, Issuers may defer the IPO. Consequently, the feedback received from potential institutional investors during the roadshows and observations from SEBI loses its recency when the Issuer re- approaches the market for its IPO.

– The RHP, which is quite comprehensive in information, and which has undergone regulatory review incorporating observations of SEBI, is available for investors only for a maximum period of 5 days as Issuers launch IPOs within 3-5 days of filing RHP with Registrar of Companies.

b. SEBI’s move on PDRHP- confidential filing, is a welcome change in India. Globally, it is seen that some jurisdictions such as UK, Canada and US have already permitted pre-filing of the offer document for review by the regulatory authorities.

Comparison with US-SEC regulations on confidential filings

– In US, with effect from July 10, 2017, voluntary draft registration statement (DRS) submissions for all Issuers for non-public review has been introduced to facilitate confidential filing and for Emerging Growth Companies (EGCs), the process of confidential filing was already in existence under the Jumpstart Our Business Startups (JOBS) Act.

Point of View

SEBI’s move on confidential filings will facilitate disclosure of an information rich document for investors to consume at an appropriate time when the Issuer is ready to proceed with its listing plans and at the same time will protect the interests of the Issuers who will also be required to disclose the market sensitive information only when its reasonably certain that they will proceed with their listing plans. However, there is not much adoption seen of this alternate mechanism, which may be attributable to the slow activity in IPO market over the last few months. If global experience is an indicator, we expect an increased usage of this mechanism by Issuers going forward.

Uniqus Point of View

The above mentioned amendments to the ICDR Regulations is expected to bring in greater transparency in the IPO process through increased
disclosures on aspects impacting the offer price of the Issuer.
The enhanced regulations also impose an onerous responsibility on independent directors and the Audit Committees, since the required disclosures are
required to be formally approved.
On the disclosures of KPIs, the SEBI, as a capital markets regulator has taken a lead in this area. Our analysis indicates that the capital markets regulators
of jurisdictions such as the US, UK and Canada, which are fairly deep in capital market activity and advanced in capital markets regulations, have still not
introduced the disclosures of the type proposed by the SEBI, which we believe is of relevance to the potential investors in taking investment decisions.
Similarly, the introduction of a pre- filing regime, which has been tried and tested successfully in overseas jurisdictions for some time now, puts the
Indian ecosystem on par with the global jurisdictions and will go a long way in making the capital raising process attractive to all types of Issuers.
The above regulations are a step in the right direction and will greatly benefit the Investors as well as the Issuers. However, for this to be of benefit to all stakeholders, it is imperative that Issuers apply the requirements of the regulations in its true spirit and in totality. More specifically:a. Issuers need to engage with their Audit Committee’s well in advance to educate them on their duties under this amendment to avoid any later
surprises in the IPO process.
b. Issuers should carefully evaluate what would be categorized as KPIs that best depicts their business performance and relevant peer companies’
benchmarks. This ought to be done in consultation with Audit Committee as this impacts the basis of issue price.
c. Issuers also have to weigh benefits of confidential filings with management and Audit Committee before concluding the mode of filing.

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