SEBI’s Restrictions on usage of IPO funds

SEBI’s Restrictions on usage of IPO funds

Recently in the year 2021, many start-ups went public by launching their Initial Public Offerings (IPOs), raising funds of more than 1.1 trillion rupees. With such a market frenzy in the market related to IPOs, the SEBI came across certain gaps in the regulatory framework regarding the usage of funds raised through IPO by the founders. Therefore, SEBI has come up with a slew of amendments to fill these gaps and see to it that the investor’s money is not squandered by the founders. 

What is an IPO?

The acronym of IPO stands for Initial Public Offering. Whenever a company extends ownership to the public in exchange for capital by listing its shares on the Stock Exchange, it is referred to as an IPO. It is a type of public issue where the company offers its shares for the first time to the public in order to gain liquidity and for achieving higher valuations for the company.

This type of public issue is underwritten by an underwriter and the process of trading of company’s shares on the stock exchange begins. 

Regulation of IPO funds by the founders

The SEBI was concerned about the existing state of affairs where the start-ups without a track record of profitability and the founders having very low stakes involved in the company were coming out with their IPOs.

Restrictions on Large Shareholders

The new rules have been framed to maintain the investors’ confidence by restricting complete exit of the large shareholders in the companies who have not shown a record of profit.

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Till date, the large shareholders had the option of exiting completely from the company by selling their entire shareholdings on the day of listing via Offer for Sale (OFS) route. Now, the SEBI rules restrict the large shareholders having more than 20 percent stake in the company, from disposing of 50 percent of their shareholding in the company on the listing day of the IPO.

Restrictions on Unidentified Acquisitions

The new rules restrict the companies from using more than 25 percent of the IPO proceeds in making unidentified acquisitions. A similar cap of 35 percent has been put on the spending of IPO proceeds on these very unidentified acquisitions by the companies. Further, their actions will also be monitored by the Credit Rating Agencies (CRAs).

Increased Lock-in period for Anchor Investors

Anchor Investors belong to that category of investors who are approached by the companies before rolling out their IPOs so that buying of shares in bulk by these investors will help in generating confidence and increase popularity among the retail investors. For these anchor investors the lock-in period has been increased to 90 days from the earlier 30 days.

These steps have been taken by the SEBI[1] with the hope of reducing volatility in the market and the retail investors are affected adversely because of the actions of these large shareholders. However, these amendments will be applicable from April 2022 onwards and will not be applicable to more than half of anchor investors.

Reduction in Lock-in period for non-promoter investors

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The SEBI has also reduced the lock-in period from 12 months to 6 months in cases of non-promoter investors in a preferential issue of equity shares. The rules also suggest that in case there is a change in the control of the company as a result of preferential issue, then a panel of independent directors will give a report on the said preferential issue and about its pricing.

Submission of report in allotment of shares

The company coming out with its IPO has to furnish a report delineating the reasons for allotting more than 5 percent of its share to any entity.

Changes in Price Band Norms

The new amendments have set a difference of minimum 5 percent between the floor price and ceiling limit of the price band.

In cases of issues made through the book building process, the minimum price band has been set at 105 percent of the floor price and shall be applicable to the issues launched after these amendments come into force.

Changes in Reservation of quota

The new rules force the companies coming up with their IPOs to reserve one-third size of the retail investor quota for the retail investors having application size ranging between 2 lakh to 10 lakh. And other two-third of the retail investor quota for the investors having application size more than rupees 10 lakh.

Regulations on Mutual Funds (MF) schemes

Unit holder’s consent for winding up of Mutual Fund schemes

The new amendments mandate that in case a Mutual Fund wishes to wind up any of its schemes, then it is not allowed to take such decision arbitrarily. The MF has to take permission from the unit holders though a voting process before proceeding further with the winding up process. Now, the MF needs to publish the voting result within a minimum of 45 days before publication of the notice explaining the reasons for closing of such scheme. 

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The practice of complete exit from the company by the major shareholders on the very day of listing of the IPO has the propensity to send poor impression about the investment sentiments in the market. Therefore, to curb the consequences of volatility in the market and protecting the investors’ money, the SEBI has come out with these amendments. These amendments will not only foster the responsibility of the founders and major shareholders towards the company but enforce the investors’ confidence regarding the investments they will be making in these companies.

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