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Background
In the last couple of years, the startup market in India has considerably heated up. It is now said to be the second largest startup market in the world after the U.S. Startups are an important driver of economic growth. These enterprises bring in new products and services, or new ways in which existing products and services are marketed. The energy and enthusiasm unleashed by these ventures can significantly enhance economic growth. Even when these enterprises fail, they perform a service, in enabling other eager entrepreneurs to learn lessons from such failures. In the broader interests of the economy, it is desirable to create an ecosystem where such enterprises strike roots, bloom and prosper. In India such a system has come into existence in many parts of the country such as Karnataka, Kerala, the National Capital Region and Maharashtra, and the movement is now spreading across the country.
"There is an exuberance in the start-up deal space and if these clauses of the companies act are relaxed, a more vibrant start-up ecosystem can be created," says Rajiv Dadlani of Mumbai Angels, an investor group. (6th May Livemint)
Capital Short
A common thread that runs through these enterprises is that they are all looking to raise capital from the public to fund their businesses. These ventures are often promoted by first time entrepreneurs, college drop outs and anybody else with a good idea. They seek to target investments from venture capital funds and 'angel investors'. It is a vital necessity for these companies to raise capital from the markets in order to finance their business plans.
Many of these enterprises deal in knowledge based products and services. The nature, utility and worth of these products and services are not widely understood or appreciated by many of the traditional investors. Making things worse, these enterprises do not make profits in the first years or even later, even though their sales growth is rapid and the companies show potential to become really big. It may be noted that Amazon, a giant of the internet business model, is still not profitable, even though its valuation in the stock markets is sky high.
SEBI Steps In
In an effort to remedy the situation, SEBI has come out with a draft proposal easing the norms under which such new companies can raise money on the markets. It has proposed a modified institutional platform, where capital can be raised, subject to certain modifications in the current regulatory framework that may include relaxation on restrictions on fund raising, minimum investment from certain category of investors, etc.
Companies operating in the area of software product development, e-commerce, new-age companies having innovative business models, which create new business opportunities or which serve to improve efficiency in existing business activities, will be eligible to use the new platform.
Existing rules
Under the existing ICDR Regulations, promoters are required to offer a minimum of 20% of post issue capital as lock-in for a period of 3 years. The lock-in provision ensures that promoters' interest continues to remain in the business for a period of at least 3 years.
However, many start-up companies that have flourished in recent times and several of which have also achieved scale, have lower founding members' holding (often less than 20%) and large share holdings by institutional investors. Founding members of such companies are not in a position to offer the shares for lock-in. Further such companies are often loss-making and belong to sectors where comparative financial ratios are not available.
Currently, detailed disclosure on objects of the issue and basis for the issue price has to be made to justify the price for the shares. The amount collected has to be utilized for the stated purpose. This is done to protect the interest of investors and to prevent unscrupulous operators from exploiting retail investors.
New Rules
New-age companies having innovative business models and belonging to the knowledge-based technology sector, where no person (individually or collectively with persons acting in concert) holds 25% or more of the pre-issue share capital, may be considered as professionally managed companies and access capital through the said institutional platform. In other words, companies where any person (individually or collectively with persons acting in concert) holds 25% or more of the pre-issue share capital shall access capital through the existing main board. (SEBI draft paper). The lock in period would be for six months only.
The proposed platform will have two categories of investors, Qualified Institutional Buyers (QIB) and Non-Institutional Investors (NII). No QIB shall be allotted more than 5% of the issue size.
The minimum application size in case of such issues shall be Rs. 10 lakhs. The minimum number of allottees in such issues shall be 500. The minimum trading lot on the said platform shall be of Rs. 5 lakhs. There is also a suggestion that this threshold limit on the trading lot be lowered for sale of shares by the employees who have been granted ESOPs.
The listing on institutional platform shall be for a period of at least 1 year. After one year the company will have the option to migrate to the main board if they comply with the eligibility requirements of the Stock Exchanges.
Disclosure regarding group companies will be restricted to such companies as covered under Accounting Standard 18. Existing regulations stipulate that the names of parties to whom amounts exceeding Rs. 1, 00,000 and outstanding for more than thirty days, should be disclosed. The new regulation says that the disclosure should be based on materiality thresholds as defined in the offer document and that internet links to the company's webpage should be provided for accessing such details.
Conclusion
This initiative by SEBI is a welcome one. India is home to nearly 3000 startups - and the number grows with every passing day - and this move will prevent them from going abroad in search of capital. The move will add much needed depth and zest to Indian markets. It also fits in nicely with the NDA government's promise to improve 'ease of doing business', in India. When the move fructifies, it will have significant positive long term effects on the economy. It will put India on par with other nations like the U.S.A. and China which encourage innovation in a big way.
For HNI investors, there will now be a regulated crowdfunding platform which they can access to make investments in ideas that excite them. Informal crowdfunding exists even today - however, with no regulations, no transparency and little information, risks are heightened. A well regulated platform promises to provide a much better manner in which HNIs can participate meaningfully in this exciting new investment option. And for advisors serving HNIs, there is one more set of investment avenues to keep abreast of, and offer valuable inputs on alpha opportunities.
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