SEBI seeks to tighten IPO rules for new age companies

Prabhat Nigam

28 Mar, 2022

The share prices of the new age technology companies such as Nykaa (FSN E-Commerce), Paytm (One97), Zomato have crashed recently after the stock market corrections. Investors who purchased these shares at the time of their IPOs have suffered huge losses since their shares have plummeted by 35-50 percent. The investors blame these companies for their losses because of their irrational valuations and in response to this, the capital market regulator, the Securities and Exchange Board of India (SEBI seeks to tighten IPO rules for these new age technology companies.   

Reason behind crashing of shares of these technology companies

The recent tensions between the Russia-Ukraine have sent shock waves to the global stock markets and because of this reason the value of equity of investors in these technology companies has significantly dropped. Nykaa and Zomato which showed significant results at the time of their listing reaching gains at 78% and 53% respectively have been at receiving end because of this situation.

The stock market experts have attributed this lowering of tax to the irrationally high valuations and the investors are not in the mood for investing in new-age technology companies.

The investors expect to get higher returns on their investments with the amount of risk they bear for these technology companies. It is on record that many of these technology companies have not been in profits for a very long period of time and instead facing losses. They have not shown even signs of break-even. This track record of the companies does not in any way justify the sky-high valuations. This is the result why many investors have dumped their equity. This is the main reason why SEBI seeks to tighten IPO rules.

In order to control the rising inflation in USA, their Central Bank will soon be taking steps to control the interest rates. Coupled with low interest rates, the geopolitical tensions prevailing in the market the market is not expected to rise for a sometime. These developments are scaring the investors which will force them to sell their stock in these companies and try to make an exit before the market crashes.

How does SEBI seek to tighten IPO rules?

Following are the ways by which SEBI seeks to tighten IPO rules:

1. Transparent mechanism for IPO pricing: The initial step by which SEBI seeks to tighten IPO rules is by setting up a mechanism of transparent pricing for these technology companies. In furtherance of this measure, SEBI has issued some proposals in its discussion paper and asked the public for their comments by 5^th of March, 2022.
2. Seek justification of pricing: Therefore, after receiving these proposals, SEBI will approve the best of them and form a mechanism where it will ask these technology companies to justify the pricing of their issue and how did they arrive at it. This has come in response to SEBI’s observation that many companies at the time of filing their document for IPO under Regulation 6(2) of ICDR Regulations do not reflect the track record of profits in the past three years of their operations.
3. Disclosures from these companies: Another measure through which SEBI seeks to tighten IPO rules is by asking these companies to furnish their non-traditional information such as Key Performance Indicators of their past to justify the prospects of future profitability. Other information such as company’s past fundraising rounds, presentations made by the company to its investors before the IPO and a comparison of the share sales before the IPO.

All this information of the companies will help SEBI determine whether the price sought by the company from the investors is justified or not.

Why does SEBI seek to tighten IPO rules?  

The current laid down by SEBI related to IPO require the companies to make disclosure related to return on net worth (RoNW), earnings per share (EPS), net asset value (NAV), price to earnings (P/E). Since these new tech based companies are already reeling under losses, they are not able to comply with these rules.

Most of these companies are already under losses and have launched their IPOs taking the advantage of the stock market in the upswing. However, after the market corrections, these companies are being traded at discounted levels.

SEBI wants these companies to identify the Key Performance Indicators and get them certified by statutory auditors. These indicators have to be compared by the issuer from its listed peers both within and outside India.

Many of these technology companies do not provide any basis of their pricing or valuation of their shares. All that they state is that the valuation has been arrived by the investors and merchant bankers. SEBI^[1] now wants these companies to justify their share price valuations similar to how shares for corporate issuances are valued.

Conclusion

The investors in order to save themselves from the losses due to falling share prices of these new companies are adopting the strategy of averaging out their share price by buying the shares when the market is down so as to cover the loss made by investing in them initially. However, the market experts have advised against in investing in these companies since these companies are not expected to make profits in near future.  So to prevent the investors from making huge losses by investing in already loss making companies, SEBI seeks to tighten IPO rules for these new companies.

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