In this blog post, Meghana Bhargava, a Bangalore-based Lawyer with an Independent Practice and a student pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, lists and describes the pre-conditions that have to be taken into account before doing an IPO in India for a start-up. 

Introduction

The Start-up India initiative launched on 16^th January 2016 released a Start-up India Action Plan[1]that defines Start-up as an entity, less than five years old and having an annual turnover of less than INR 25 crore in any of the preceding financial years, working towards innovation, development or commercialization of new products and services generally technology driven.

The general understanding of the term Start-up is a young venture usually a small company, initially funded and operated by its founders, typically offering products or services that are innovative. One of the biggest markers for a Start-up is that the product or services offered are unique enough and which have huge market potential. Start-ups are usually technology or intellectual property driven with innovation at their core and in order to expand quickly, look for investments and funding from angels, venture capitalists or through a public offer.

Governing Laws

1. Companies Act, 2013 ( read with Rules as applicable)
2. SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR Regulations)

Discussion

Structural change of the Start-up

Most Start-ups in India are either Private Limited Companies or Limited Liability Partnerships and in a few cases Partnership Firms. To do an IPO, the business is required to be a Public Company, i.e., authorised by its constitutional documents to have more than fifty shareholders and have no restrictions on the transferability of its shares. Therefore the first step towards an IPO is to restructure the company into a Public Company.

Private Company to a Public Company

Conversion of a Private company into a Public company involves alteration of memorandum and article of association of the company[2]. Upon completion of formalities, the Registrar shall consider the application for change in class of company, close the existing registration and issue a fresh certificate of incorporation.[3]

Partnership firm or Limited Liability Partnership (LLP)  to a Public Company

A Partnership firm or an LLP that wishes to convert into a Public company can incorporate a company which can take over the business of the firm or LLP under the provisions of Part 1 of Chapter XXI of the Companies Act and Companies (Authorised to Register) Rules, 2014.Upon completion of formalities, the Registrar shall consider the application and objections if any, if the registrar is satisfied that the company should be registered, the Registrar shall issue a certificate of incorporation.[4]It is noteworthy that all applicable sections and rules under the Companies Act, 2013 regarding this have been notified and are in force.

However, depending on the company and structural complexities, there may be some ground difficulties. Therefore the other option would be to incorporate a new company to take over the business and dissolve the old entity.

The Pre-conditions to doing an IPO

The eligibility criteria to doing an IPO is specified in the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR Regulations). Start-ups, therefore, have to ensure that they are compliant with the regulations or satisfy the pre-conditions before making an IPO.

Chapter II and Chapter III, Part I of the ICDR Regulation list the conditions that the company has to satisfy at the time of filing offer document for public issue, here below is a summary of the same:

1. Ensure that, if the company is in existence for less than three years or does not meet certain financial strength tests, allot at least 50% of the shares forming part of the IPO to retail and institutional investors.
2. Ensure that neither the company nor its affiliates are barred from accessing the capital market by SEBI or any other authorities; and none of the promoters[5], directors or persons in control of the company were or are a promoter, director or person in control of any other company which is barred from accessing the capital market, under any order or directions made by SEBI.[6]
3. Ensure to make an application for listing of the specified securities in at least one recognised stock exchange having nationwide trading terminals.
4. Ensure to appoint one or more merchant bankers, at least one of whom shall be a lead merchant banker and shall also appoint other intermediaries, in consultation with the lead merchant banker, to carry out the obligations relating to the issue.[7]
5. Ensure that it shall not make an allotment under a public issue if the number of prospective allottees is less than 1000.
6. Ensure to enter into an agreement with a depository for dematerialisation of specified securities already issued or proposed to be issued.
7. Ensure all existing partly paid-up equity shares of the company have either been fully paid up or forfeited.[8]
8. Ensure that there are no outstanding convertible securities or any other right which would entitle any person with any option to receive equity shares excluding convertible debt instruments issued through an earlier initial public offer, ESOPs and or fully paid-up outstanding convertible securities that are to be converted on or before filing the red herring prospectus.[9]
9. Ensure equity shares offered for sale to public have been held by the sellers for a period of at least one year prior to the filing of draft offer document with the Board subject to exemptions as provided in Regulation 26 (6) of the ICDR Regulations, 2009.
10. Ensure that it satisfies all five sub-regulations to Regulation 26 so as to be eligible to make an IPO under this regulation (Profitability route)[10], summarily listed here:
11. Net tangible assets of at least INR 3 crore for three full years.
12. Distributable profits in at least three years.
13. The net worth of at least INR 1 crore in three years.
14. The issue size should not exceed five times the pre-issue net worth.
15. If there has been a change in the company’s name, at least 50 per cent of the revenue for preceding one year should be from the new activity denoted by the new name.
16. Where the company fails to meet the financial criteria, it is required to make the issue under Regulation 26 (2) through compulsory book built or Appraisal route. The compulsory book-built route requires at least 50% subscription by Qualified Institutional Buyers, and the appraisal route requires 15% participation in the project by scheduled commercial banks or public financial.
17. Ensure that the promoters contribute 20 percent of the total capital. This is known as ‘minimum promoter’s contribution’ and is locked-in for three years.[11]
18. Ensure that the contribution of non-promoter entities, e.g. investors, is locked-in for a period of 1 year. However, VCs registered with SEBI are exempt from this requirement of lock-in.[12]
19. Obtain grading for the IPO from one or more credit rating agencies registered with SEBI.
20. Ensure corporate governance compliances are met as required under clause 49 of the listing agreement.

Once the above compliance requirements are met, the Start-up has to submit a registration statement to SEBI with the details of its finances as well as its business plan. SEBI will scrutinize these documents and conduct its investigation / background checks and call for further documentation as required. When SEBI is satisfied with the documents, it gives a go ahead for the IPO to happen.

Conclusion

As one can see, the regulation requirements and procedures are extremely complicated and lengthy and do not differentiate between regular companies and Start-ups with regard to the pre- conditions to doing an IPO.

However, it is worthy to note that Start-ups have another option, rather than the regular route, they can list on the Institutional Trading Platform (ITP). SEBI has relaxed several norms governing IPO with regard to listing on the ITP. For instance, on the ITP the lock-in period for the promoter’s capital is six months as opposed to three years for the normal IPO, the disclosure requirements are less stringent, this might appeal where Start-ups are hesitant to make public several company information and also the ITP gives investors an easier exit from the Start-up.

That said, on ground, the fact remains that even as on 25^th May 2016, according to the SEBI Chairman UK Sinha, no Start-ups had so far listed on the ITP[13], Start-ups preferring to raise private equity capital rather than going in for public issue.

References:

[1] Also defined via Ministry of Commerce and Industry ( Department of Industrial Policy and Promotion) notification dated 17-02-2016

[2]Sec 13 and Sec 14. Alteration of articles of the Companies Act, 2013 read with Rule 33 of the Companies (Incorporation) Rules, 2014.

[3]Section 18 of the Companies Act, 2013.

[4]Form no. INC 11

[5] As defined under 2(za) of the ICDR Regulation, 2009

[6]Regulation 4 of the ICDR Regulation, 2009

[7]Regulation 5 of the ICDR Regulation, 2009

[8]Regulation 4 of the ICDR Regulation, 2009

[9]Regulation 26 (5) (a) to (c) of the ICDR Regulation, 2009

[10]Regulation 26(1) (a) to (e) of the ICDR Regulation, 2009

[11]Regulation 36 of the ICDR Regulation, 2009

[12]Regulation 36 of the ICDR Regulation, 2009

[13]http://m.thehindubusinessline.com/markets/stock-markets/sebi-to-tweak-guidelines-for-listing-of-startups/article8646330.ece