How SEBI’s proposed guidelines and DVRs can translate into hyper-growth for tech startups

Even as India ranks second in the number of IPOs worldwide, the year-on-year drop at 78 percent is ridden with many growth challenges. SEBI’s new guidelines could fuel Startup India’s prospects to shine.

On the face of it, the Indian business ecosystem seems to be booming. In fact, the country’s stock exchanges ranked second in the world in terms of the number of IPOs (initial public offerings) for the period between January 2018 to November 2018.

A deeper look into the system, however, reveals a less positive picture. There was an astounding year-on-year drop of 78 per cent in the number of IPOs in the country between Q4 2017 and Q4 2018. More alarmingly, the last quarter of the previous year saw a 33 per cent quarter-on-quarter drop, indicating major growth challenges for home-grown businesses.

In just June 2019, three tech unicorns in the US – Lyft, Uber, and Pinterest – have gone public. The Indian startup landscape, on the other hand, is awaiting a similar turnaround in fortunes. The lack of depth in the capital market, inflexible regulations, and a few catches in the IPO process have been restricting the transition of Indian unicorns into publically-listed companies.

However, the recent guideline changes proposed by the Securities Exchange Board of India (SEBI) – especially around the issuance of shares with Differential Voting Rights (DVRs) for tech startups – could potentially change this. These new norms for buyback and pledging of shares by promoters can be a fertile ground for startups to flourish in.

Look at the basics, understand the whole picture

Why an IPO? What’s the catch?

A company decides to go public to raise capital and further expand its operations. Apart from a strengthened capital base, acquisitions become easier, ownership gets diversified and the company’s prestige increases. However, all of these benefits come at a cost.

By undergoing an IPO, the percentage of shares of the company with the public increases, and the voting rights of outside shareholders (as per their respective equity investment) become more significant. This implies higher restrictions on management and trading, and forces disclosure to the public. The situation becomes even more complicated for tech entrepreneurs, who usually end up having to significantly dilute their equity in order to secure capital investment and drive hyper-growth.

Tech entrepreneurs, as a result, have lesser and lesser control over the decision-making process vital to the company’s continued growth. Often, such dilution of equity takes the company off its intended long-term vision, and leads to a significant churn – at senior management level, the employee base, and its business performance. This has been a major deterrent for Indian tech startups in realising the dream of going public.

The DVR framework and its potential benefits

SEBI has made the scenario more conducive for startups eyeing IPOs by proposing relaxed regulations for listing of startups on the stock exchanges. More importantly, it has defined a Differential Voting Rights (DVRs) framework that can favourably upturn the game for tech startups to raise funds without diluting control over their business.

This framework allows only the founders, promoters, and those holding executive positions within the company the eligibility to be its superior shareholders, and have superior voting rights (SR).

While this framework goes against the principle of “one vote, one share,” it can allow tech companies to retain their long-term vision even as regular equity base expands. The company’s long-term vision and business strategy can now remain in the hands of their promoters and founders. This will facilitate tech entrepreneurs to pursue institutional investments and drive hyper-growth for their ventures without the fear of diluting their equity stakes.

Apart from the DVRs, the following are some of the proposed guidelines by SEBI, which can highly benefit companies:

  • It aims to bring down the holding of qualified institutional investors in the startups from 50 percent to 25 percent.
  • It recommends scrapping the restrictions on the person(s) individually, or collectively holding 25 percent or more of the post-issue capital, as an eligibility criteria for the entity to list on ITP. It nullifies all separate provisions to cap post-IPO shareholding.
  • It has revised the minimum application size from Rs 10 lakh to Rs 2 lakh, and in multiples thereof.
  • The official body has also proposed ramping up disclosure for auditors of listed companies. In addition to this, they have also proposed a format for disclosing reasons when the auditor of a listed entity or one of its material units resigns, including details of information the auditor failed to get from the company.

These regulations are more in sync with the current environment and can transform the business ecosystem of the country. With these, the Government can pave the way for easier listing of startups on the stock exchanges in India, thereby taking the country higher on the ease of doing business index.

(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)

(Edited by Suruchi Kapur)


Updates from around the world