For several years, India’s startup ecosystem had produced many large companies with rapidly-increasing valuations, but retail investors had to wait and watch from the sidelines — these startups couldn’t list on the stock markets because they were largely loss-making. SEBI regulations prohibited loss-making companies from being listed on stock markets. So how are loss-making startups now suddenly queuing up to go public?
SEBI rules for profitable companies to go public
SEBI has two separate categories about companies who wish to IPO. One route, which is more popular, is for profitable companies. These are the requirements of companies to go public if they’re profitable:
a) Net tangible assets of at least Rs. 3 crore in each of the preceding three full years of which not more than 50% are held in monetary assets. However, the limit of 50% on monetary assets shall not be applicable in case the public offer is made entirely through offer for sale.
b) Minimum of Rs. 15 crore as average pre-tax operating profit in at least three years of the immediately preceding five years.
c) Net worth of at least Rs. 1 crore in each of the preceding three full years.
d) If there has been a change in the company’s name, at least 50% of the revenue for preceding one year should be from the new activity denoted by the new name
e) The issue size should not exceed 5 times the pre-issue net worth
Most Indian startups, though, make losses, and don’t fulfil the condition of having Rs. 15 crore in profit for three years. They can, therefore, not IPO through this route. There is, however, another way for these companies to go public.
SEBI rules for loss-making companies to go public
SEBI has introduced a new set of guidelines for loss-making companies to go public. The guideline states:
Issue shall be through book building route, with at least 75% of net offer to the public to be mandatory allotted to the Qualified Institutional Buyers (QIBs). The company shall refund the subscription money if the minimum subscription of QIBs is not attained.
Differences in requirements between profitable and loss-making companies while going public
The difference in requirements between profitable and loss-making companies while going public is in the way the shares can be offered to the public.
When a profitable company goes public, this is how shares are allocated:
Qualified Institutional Buyers – 50%
High Net worth Individuals – 15%
Retail – 35%
When a loss-making company goes public, this is how shares are allocated
Qualified Institutional Buyers – 75%
High Net worth Individuals – 15%
Retail – 10%
The biggest difference between profitable and loss-making companies going public is the amount of shares available to retail investors — while profitable companies can offer 35% of their shares to retail investors, loss-making companies can offer only 10% of their shares to retail investors.
Why are IPO rules different for loss-making companies?
It’s often hard to value a loss-making business, because there’s no way to evaluate free cash flows, and other financial ratios like the P/E ratio. As such, SEBI, with its different guidelines for loss-making companies, tries to protect retail investors by letting them have a smaller fraction of the issue available to access. SEBI seems to reckon that Qualified Institutional Buyers, which includes entities like Mutual Funds, commercial banks, insurance companies, etc, have the required expertise to value these companies, and allocates them a larger chunk of the issue. Retail investors, who might not have the skills to evaluate loss-making companies, are protected by giving them a smaller fraction of shares.
Loss making companies which have gone public
There are several companies which have used the loss-making route to have their stocks listed on the stock markets. Among them are Burger King, Barbeque Nation and Macrotech Developers. Zomato most famously listed on the stock market in July while having never made a profit in its 12 years of history. Going forward, loss-making companies including Paytm, Mobikwik and Oyo Rooms are also expected to list on the stock markets.