In this article, Eshika Phadke who is currently pursuing M.A. IN BUSINESS LAWS, from NUJS, Kolkata, discusses How to know if your company is ready for an IPO.

The Companies Act, 2013 regulates the incorporation of a company in India. It also regulates the responsibilities of the company, its directors and its dissolution. There are primarily two types of companies in India- Private Limited Company and Public Limited Company- both limited by shares. With Limited Liability the legal responsibility for the debts of the company are limited to the extent of the face value of the shares held and therefore, the liability of the members in the case of winding-up is limited to the amount unpaid and due on the shares held.

Table1: Difference between a Public and a Private Company

Source: The Company Act, 2013

Advantages of a Private Limited company over a Public Limited company

As an entrepreneur or a start-up, working within the structure of a private limited company can yield several benefits. As can be seen in the table, there are several advantages to starting a company as a private company. It is said to be combining the privacy of a partnership with the permanence of the corporate constitution.

To begin with, it can be started with a minimum paid up share capital of Rs. 1, 00, 000, against Rs. 5 lakh for a Public Company. As against the requirement of a minimum of seven persons to incorporate a Public Company, a Private Company can be formed by just two persons. (Section 3(1)(iii))

According to Section 81, a Private Company can issue shares to any person, in any manner as it thinks best, in its own interest. This is especially relevant when Venture Capitalists invest in the company. This provision aids the investment as well as the divestment. As per Section 85-90 a Private Company may issue share capital of any kind, with no stipulations as to the extent of voting rights. A Public Company, on the other hand, has to adhere to provisions regarding the kinds of share capital, proportion of voting rights to paid-up capital, and restrictions on excessive voting rights.

A private Company can commence business immediately subsequent to obtaining the Certificate of Incorporation, which is issued by the Registrar of Companies. The Certificate of Commencement of Business, required by a Public Company is not needed.

Unlike a Public Company, a Private Company is not required to hold statutory meetings or to prepare any statutory reports. The Private Company can itself make provisions in its Articles regarding the length of Notice for calling a General Meeting, content and manner of Service of Notices, Explanatory statements, Chairman and Quorum for meetings, voting rights etc.

When these advantages start seeming like limitations or when the limitations outweigh the advantages-you know that it is time for your Private Limited Company to go public.

Is your Private Limited Company ready for the process required to go Public?

Why do you need an IPO?

When the company plans to acquire, expand or diversify it needs to raise capital. It may also need finances for working capital or to retire an old debt. It could need to give existing shareholders, including venture capitalists, a route to exit the company’s shareholding partially or fully. Or provide promoters an opportunity to dilute their holding.

In each of these cases, the company requires to raise capital by making a public offering. When a company that is not listed at any stock exchange makes a fresh issue of shares and/or makes an offer for sale of its existing shares, to the public, for the first time- it is called an Initial Public Offering (IPO). It is an offer for the sale of shares and for new investors to enter its shareholding family. This IPO is an invitation to offer, which is a precursor to a contract, and must meet the requirements laid down under S.11 of The Indian Contract Act, 1872.

The price of the share is determined, in consultation with its investment bankers, by the promoters of the company. The proceeds of the share issue go to the shareholders- often venture capitalists and promoters- if it is undertaken as a method to let them dilute their holding or to exit the company’s shareholding. If the share issue has been undertaken to raise finance- it is called a fresh issue of capital- and the proceeds of the issue go to the company. When the IPO is completed the company’s shares are listed. Which means that the securities are now admitted to dealings on a recognised stock exchange and can be traded at the designated stock exchange.

Listing has several benefits and it adds to a company’s prestige. It becomes an effective route for the company to raise more capital from both the domestic as well as the overseas markets. It simplifies the process of acquisition since the company can now use shares as currency. And, it lends liquidity to the stock, making it a more viable way to attract top talent by offering employee stock ownership plans. Apart from achieving these objectives of mobilising savings for economic development and providing liquidity met, it is imperative that the interests of the investors are also protected through full disclosures.

How to have an IPO

The Securities and Exchange Board of India (SEBI), established in 1992, was started ‘to protect the interests of investors in securities and to promote the development of, and to regulate the securities market’. The regulations governing the listing of securities are laid down in the SEBI (Disclosure and Investor Protection) Regulations, 2009. It has issued a set of guidelines applicable for public issues by listed and unlisted companies, all offers for sale and rights by listed companies, except rights issues where the average value of the shares offered does not exceed Rs. 50, 00, 000. (Clause 1.4 of the DIP Guidelines)

Your unlisted company is eligible for a public issue if its pre-issue net worth is above Rs. 1 crore in the last 3 years out of the last 5 years. With the minimum net worth having to meet the Rs. 1 crore requirement in the immediately preceding 2 years. And it should have had distributable profits for at least three out of the preceding five years.

As per Clause 1.2.1 of the DIP Guidelines, the net worth is the average value of the paid up equity capital and free reserves, not including the reserves created out of revaluation, minus the average value of the accumulated losses and deferred expenditure not written off.  Further, the offer size, through offer document, firm allotment, promoter’s contribution cannot exceed five times its pre-issue net worth.

If your unlisted company does not satisfy the criterion, the IPO can be made only through the Book Building process. In this process, sixty percent of the issue size must be allotted to the Qualified Institutional Buyers (QIBs)-which include public financial institutions, scheduled commercial banks, mutual funds, venture capital investors registered with the SEBI and foreign venture capital investors registered with SEBI. If this is not fulfilled the full subscription money will have to be refunded.

Book Building, as defined by the SEBI Guidelines, is the process undertaken by which a demand for the securities proposed to be issued by a corporate body is elicited and built up. Further, the price of such securities is assessed for the determination of the quantum of such securities to be issued by means of a notice, circular, advertisement, document or information memoranda or offer document.

The minimum post-issue paid-up capital will need to be Rs. 10 crores for IPOs and the minimum issue size would have to Rs. 10 crores. The market capitalisation, which is calculated by multiplying the post-issue paid-up number of equity shares with the issue price, would have to be at least Rs. 25 crores.

Regarding the paid-up capital and market capitalisation, your company would require to include a disclaimer clause which states that the securities would not be listed if the market capitalisation requirement is not met. This disclaimer needs to be part of the offer document.

Your company- the applicant, promoters and/or group companies- should be in compliance with all the requirements of the listing agreement. This will be in addition to compliance with the guidance and regulations applicable to listing from:

• Securities Contracts (Regulations) Act 1956
• Securities Contracts (Regulations) Rules 1957
• Securities and Exchange Board of India Act 1992
• Any other circular, clarifications, guidelines issued by the appropriate authority
• Companies Act 1956[i]

Your company also has to offer at least 20% of the post issue capital. In case of any issue to the public the minimum contribution of promoters will be locked in for a period of three years. And if the promoters’ contribution in the issue exceeds the minimum contribution, the excess contribution will be locked in for a period of one year.

If your company is seeking listing of its securities on BSE it is required to submit a Letter of Application to all the stock exchanges where it proposes to have its securities listed. This has to be done before filing the prospectus with the Registrar of Companies.

Your company is also required to complete the allotment of securities offered to the public within 30 days of the date of closure of the subscription list. Then, it has to approach the Designated Stock Exchange for approval of the basis of allotment.
It needs to be noted that in case of Book Building issues, allotment shall be made not later than 15 days from the closure of the issue. Failing this, interest at the rate of 15% shall be paid to the investors.

Your company will also have to get Trading Permission. As per SEBI Guidelines, your company should complete the formalities for trading at all the stock exchanges where the securities are to be listed within 7 working days of finalization of the basis of allotment.
Your company should scrupulously adhere to this time limit- as specified in SEBI (Disclosure and Investor Protection) Guidelines 2000- for allotment of all securities and dispatch of allotment letters/share certificates/credit in depository accounts and refund orders and for obtaining the listing permissions of all the exchanges whose names are stated in its prospectus or offer document.

If listing permission to your company had ever been denied by any stock exchange where an application for listing of securities had been made, your company cannot proceed with the allotment of shares. However, the company may file an appeal before SEBI under Section 22 of the Securities Contracts (Regulation) Act, 1956.

Your company would also have to be ready with paying 1% security fee, since companies making public/rights issues are required to deposit 1% of the issue amount with the Designated Stock Exchange. This has to be done before the issue opens. In the event of the company not resolving the complaints of investors- regarding delay in sending refund orders/share certificates, non-payment of commission to underwriters, brokers, etc.- this amount is liable to be forfeited.

Your company would require to pay Listing Fees

One more aspect that your company would have to be ready for is of the Compliance with the Listing Agreement. Your company would have to enter into an agreement with BSE called the Listing Agreement. Under this you are required to make certain disclosures and perform certain acts, failing which your company may face some disciplinary action, including suspension/delisting of securities.

This Listing Agreement is of great importance and will be executed under the common seal of your company. Under this Listing Agreement, your company would undertake, amongst other things:

• to provide facilities for prompt transfer, registration, sub-division and consolidation of securities;
• to give proper notice of closure of transfer books and record dates,
• to forward 6 copies of unabridged Annual Reports, Balance Sheets and Profit and Loss Accounts to the stock exchange,
• to file shareholding patterns and financial results on a quarterly basis;
• to intimate promptly to the stock exchange the happenings which are likely to materially affect the financial performance of the Company and its stock prices,
• to comply with the conditions of Corporate Governance, etc.

The Listing Department of the stock exchange monitors the compliance by the companies with the provisions of the Listing Agreement. This is especially so with regard to timely payment of annual listing fees, submission of results, shareholding patterns and corporate governance reports on a quarterly basis. Do note that penal action is taken against any defaulting companies.

If you are a start-up, SEBI has shrunk the IPO timeline to 6 days and eased rules for start-ups. Now start-ups will be allowed to raise funds from institutional investors under new rules approved by the regulator. Applications Supported by Blocked Amount (ASBA) will be made mandatory for all classes of IPO investors.

 Now according to SEBI, only qualified institutional buyers and non- institutional investors will be allowed to invest in your company through institutional trading platform.

If your company is technology intensive such as intellectual property, biotechnology, nano-technology you will be allowed to list. This is provided 25 per cent of pre-issue capital is through QIB. In case of any other company at least 50 per cent of the pre-issue capital should be held by QIBs.

According to the SEBI rules, the lock-in for the entire pre-issue capital will be for six months. The minimum investment in such companies has been set at Rs 10 lakh.

Also, SEBI has introduced a policy framework which re-classifies promoters in listed firms to public shareholders. Now, if your company becomes professionally managed it will not need to have any identifiable promoter, and no person in the company can hold more than 1 per cent shares of the company. Moreover, an outgoing promoter cannot hold more than 10 per cent of the shares of the company or have any direct or indirect control over the company and possess any special rights.

In the case of an IPO, the promoters must contribute at least twenty percent (20%) of the post issue capital. The term promoter includes any such person(s) who are in overall control of the company; or any person(s) who are instrumental in the formulation of a plan or program pursuant to which the securities are offered to the public; and also persons named in the prospectus as promoters. It must be noted that any person acting as a director or officer of the issuer company merely in a professional capacity is not included in the definition of promoter.

Your company would also have to be ready to adhere to Prospectus Requirements. The offer, or prospectus document would have to contain true and sufficient information to enable the investor to make an informed decision while investing in the offered securities. This is as specified Clause 6.1 of the DIP Guidelines. The prospectus must, inter alia, provide information relating to risk factors, project costs, means of financing, appraisal, issue schedule, details of the managerial personnel, capital structure of the company, terms of the issue, financial information of company and group companies, basis for issue price and details of the products, machinery and technology.

Are you ready to make the IPO feasible?

The first thing any company should consider when thinking about an IPO is this: is an IPO even feasible?

Apart from regulatory guidelines, you must also consider good business sense. This is especially relevant to growth stage entrepreneurs. It must be kept top of mind that going public is by no means the final step to long term success, although it’s certainly a big step in the process.

Timing is key- completing an IPO too early can have disastrous effects on the future health of your business and waiting for too long can allow a competitor to steal your thunder.

Your business requires predictability so ensure that this predictability has been achieved. Although last year your venture capitalist may have been happy when your business hit 97% of the plan, it will be different after an IPO.  But when your company goes public if you fall short of analysts’ expectations by even a small margin, your stock will likely plummet. The stakes are higher when your company goes public.

Your business needs to be aware of its underlying growth potential. You should have a game plan for growth after the IPO, else the markets will respond negatively.

You should have undertaken a Risk Analysis and ensured that there is no single point of failure. Appropriate risk mitigation should be in place to ensure that threats, in the form of market forces that can upset the business, are addressed.

Going public can bring numerous benefits to your company. However, before a company starts to prepare for an IPO you should have considered to what extent your company is ready for an IPO.  Are there valid strategic objectives it wants to achieve upon choosing the IPO route? Is the company ready to undertake steps required to be perceived favourably by prospective investors? This is vital to be able to operate as a Public Company.

Consider how big the market for your product or service is.  The bigger the market, the more likely you are to make money. The more money you can make the faster you can grow. Your company must have a huge market and room to grow. You are answerable to your investors.

Also consider how disruptive your product is. If your product a new way of doing something? The more disruptive your product the better. It helps to make you stand out- to get a larger share of the market.

Consider how predictable your business model is. Public market investors are partial to predictable earnings. If you can prove to investors that your company will succeed, investors will buy your story, but more importantly, your stock.

Finally, consider how much competitive advantage you have.  Consider what asset your company controls that will afford it more leverage over rivals as it grows.  If you’ve got a real advantage, then you have the final solution to the IPO equation. The more leverage you have or can create, the better it is.

If you have considered all the above aspects and chosen to have an IPO you can be positive that the markets will respond also respond positively- in the short term, the medium term as well as the long term.

Bibliography

http://iepf.gov.in/IEPF/IPO_In_off.html

http://www.sebi.gov.in/faq/pubissuefaq.html

[i] http://www.bseindia.com/Static/about/listsec.aspx?expandable=2