Due diligence vital for start-ups

Sebi norms for listing of these entities require minimal disclosures and compliance

The Securities and Exchange Board of India (Sebi) has revolutionised the way start-ups and new-age companies access capital by clearing listing norms that make it easier for companies to find serious investors. While the norms are forward-looking and address the capital woes of new-age companies, these might lead to additional due-diligence requirements for even savvy investors such as private equity (PE) and venture capital (VC) players.

The final norms have diluted the requirements for compliance and disclosures for companies looking to come out with initial public offerings (IPOs) and trade on the Institutional Trading Platform. Experts say this could be a concern for those looking to invest in these companies.

Initially, Sebi had proposed listed start-ups spend only up to 25 per cent towards "general corporate purposes", expense which could include virtually everything. However, it has revised it to bring it on a par with global standards. Now, start-ups being listed can spend the entire sum on general corporate purposes; they can simply state that proceeds from the listing and selling of equity will be used for these purposes, without being too specific.

According to the new proposal by Sebi, start-ups on the Alternate Capital Raising Platform don't have to disclose all facts before listing. They aren't required to share the fact that they will raise funds, as small investors are anyway kept out and seasoned investors don't need this information.

On the issue of court cases, a declaration will purely depend on the latest update and developments. Originally, it was proposed that a start-up seeking to list on this platform disclose all court cases and regulatory orders. Additionally, they were mandated to inform the public at large that they would raise funds (common during the listing of traditional companies on stock exchanges).

As the stock market typically demands a lock-in period after the sale of equity shares, Sebi has mandated a lock-in period of six months for start-ups listing on this alternate platform.

Amit Rahane, executive director (fraud investigation & dispute services), EY India, says the new norms will increase reliance on forensic diligence. "Investors are extremely keen on India as a region and PE and VC firms are looking to tap the potential this market presents. Dealing with investing in the start-up space does, however, present a set of challenges, unlike larger companies, which have historical figures to draw a comparative against. Forensic diligence, therefore, becomes imperative, as key decision makers need to evaluate the reputation and integrity of the promoter, managing techniques and gauge the morale of employees compared to empirical data. We have been seeing an increased interest from PE/VC firms, to qualm their fears about their investee companies. These listing norms will serve as an impetus in this regard, as the reliance on forensic diligence will certainly increase because these will be unable to access the company's books and records," he says.

Another market player says investors will have to do their own homework before putting money in these IPOs, as such companies don't need enough disclosures.

Dinesh Anand, partner and leader (forensic services), PwC India, says, "While start-ups have their own inherent risks, safeguards in the form of minimum investment (Rs 10 lakh) have been put in place. The intent of the norms is to ensure only investors with adequate risk appetite and the ability to identify and understand the relevant risks are allowed to invest. At the same time, investors will have to conduct smarter due diligence to overcome the limitations they might face due to the diluted norms for disclosure. Overall, the fact that Sebi has brought out norms for listing of start-ups is a very positive step."

Another concern is companies have been given an option of migrating to the main stock exchanges after three years of listing. "A company could choose to keep trading with minimal disclosures," says a PE player.