Additional disclosures

Sebi's proposal on tech start-up IPOs will be useful for investors

The Securities and Exchange Board of India (Sebi) has released a discussion paper outlining proposed changes and additions to the mandatory disclosures in new public issues. While there are no changes to the disclosure norms for companies with three years of profitability, firms that are loss-making will have to make more detailed disclosures. As such, these new criteria will apply mainly to new-age technology companies (NATC), which tend to be loss-making. More disclosures should always be welcomed in the cause of transparency and especially so in this segment, given that there has been a series of loss-making start-ups accessing the primary market. Most of the current mandatory set of disclosures pertain to profitable companies and these metrics are meaningless in the case of loss-making businesses. The “basis of pricing” for an initial public offering (IPO) generally uses metrics such as the price-to-earnings multiples, earnings per share, and other financial ratios such as returns on net worth to justify the pricing.

None of these can be meaningfully applied to loss-making entities. Moreover, as the discussion paper points out, NATCs generally remain loss-making for a longer period before achieving break-even. The NATC business model favours scale and market share over profits. Investors need to be aware that they are betting on future potential and the possibility of long-term leadership in new business segments. This is certainly the case with NATC IPOs such as food delivery app Zomato, PolicyBazaar, and Paytm, which are loss-making, and Nykaa was only marginally profitable when it went public. The share prices of all these NATCs have corrected steeply post-IPO listing. While that is a risk that equity investors must always be prepared for, there has been criticism that it is hard to rationally set a valuation for a loss-making entity which is in a new business segment. As such, these IPOs may have been priced too high and investors did not possess enough relevant information to make a judgement call on the valuations.

After discussion by a sub-group of the Primary Market Advisory Committee (PMAC) of Sebi, the regulator has made several recommendations in this paper. The traditional financial ratios must be supplemented with key performance indicators (KPIs), and disclosure of valuations based on past transactions/fund raising by the issuer. In the offer documents, the company must share KPIs pertaining to business trends, including all KPIs disclosed to private investors at previous rounds of fund-raising over a look-back period of three years. Such KPIs and claims based on them should be audited. The company must explain why these KPIs help justify the valuations. If it deems certain KPIs irrelevant, it must also explain why. If comparison with global peers could be appropriate, the issue documents should also have such comparisons, and highlight the similarities and differences. This could be useful simply because the company may not have a local competitor, or peer. The issue documents should also append detailed explanations of the valuations at prior fund-raising in the past 18 months, and compare that to the issue price band. These details, to be sure, are not particularly onerous for NATCs to release, since private equity and venture capital investors would have asked for similar information in prior rounds of funding. These may give investors a better sense of the actual business dynamics in the case of loss-making start-ups.