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Confidential Pre-filing of Offer Documents: Dawn of a New Era for IPOs?

The authors are Shivam Bhattacharya and Mahadev Nair, fourth year students at Gujarat National Law University (GNLU), Gandhinagar.


Introduction


On 21st November 2022, the ‘Securities and Exchange Board of India’ (‘SEBI’) amended the provisions of ‘SEBI (Issue of Capital and Disclosure Requirement) Regulations, 2018’, wherein it introduced the concept of ‘confidential pre-filing of IPO documents’. This amendment came pursuant to a board meeting which had taken place on 30th September, wherein the proposal was first mooted. Within this mechanism, the information in the ‘Draft Red Herring Prospectus’ (‘DRHP’) would be made available only to SEBI and the stock exchanges, thereby allowing the potential IPO-bound companies to keep their business-sensitive information private and away from their competitors.


This decision came in light of several high-profile IPOs such as those of Paytm, Zomato, Nazara Technologies etc. falling soon after it opened to public subscription. It has been one of the several steps which the market regulator, SEBI has taken in recent times to protect investors from high valuations within the market, which is already witnessing increasing uncertainty and unpredictability.


Moreover, with SEBI keeping this as an optional mechanism for the companies to utilise, thereby providing them with both flexibility and security in keeping their vital business information private, it is expected that several corporate entities are likely to make use of this new amendment before launching their IPO.


Keeping this as the backdrop, the present article highlights the reasons for introducing this optional scheme by SEBI, it’s working in the Indian securities market and provides a holistic overview of its implications and significance on the market in India in light of the rising challenges, including of over-valuation which the market faces today.


Need for an alternative mechanism of pre-filing


The common notion that having a high amount of capital would help a company to grow its business and help it to survive in tough market conditions has proven to be untrue in the light of recent ‘weak post-listing performance’ by several companies. The year 2021 in particular saw huge sums of capital being flown freely into the securities markets with India witnessing one of its biggest bull markets, however soon thereafter a number of factors including over-valuation led to a failed listing of major IPOs, including Paytm, Zomato, Nazara Technologies etc. To safeguard the wealth of the market investors from these overvalued IPOs, SEBI decided to come out with this optional policy.


Moreover, a report carried out last year provided that only 23 of the first 100 unicorns of India are profitable, thereby highlighting the high number of over-valued entities getting listed on the stock exchanges. This has led the primary market regulator, SEBI to undertake measures for ensuring that this trend of over-valued companies being listed is reduced, and ensuring that stability and transparency are maintained in the market. Additionally, it has been felt by several experts that since there is no guarantee that a company after submitting its DRHP would go for an IPO, making confidential information public at the first instance would prove to be detrimental to their business interests since competitors are likely to take undue benefits of these disclosures.


At the same time, it is critical to consider that in addition to the timing of entering the stock market, the high-valuation of the companies entering the securities market without any adequate justification has led to the failed listing of several companies. In this regard, the optional mechanism of pre-filing would allow both the corporate entity and the stock exchanges to undertake the necessary safety measures before the company decides to go public. In addition to that, the utility of this mechanism has been tested in countries such as the USA and Canada, and several companies therein are preferring this alternative scheme before filing for an IPO.


Pre-Filing Mechanism and its working in the Indian securities market


For understanding the working of this optional scheme in the Indian market, it is essential to look at its mechanism. Similar to the standard process for filing an IPO, under this pre-filing mechanism the company would need to follow a number of steps as well, which include converting to a public company, obtaining the signed consents from the auditors and the need to comply with the appropriate corporate governance requirements. Then, the offer documents of the company would have to be submitted to SEBI for comments and recommendations, based on which the company can decide whether to go IPO or not.


If it decides to go for an IPO, it would have to ensure that it has incorporated all the comments and suggestions received and based on that prepare an updated DRHP. Thereafter, the updated DRHP would be made available for a time period of 21 days to the public for an ‘initial period of scrutiny’.


Even though this optional mechanism was notified just a few months back, ‘Tata Play’ became the first company in India to have filed a confidential pre-filing of offer documents in November last year. It has set in motion a process wherein more companies would be utilising this mechanism to assess the market conditions before entering into it. That is, there would be no additional pressure on a company to go for an IPO. This is expected to change the way companies look at IPOs and thus, is likely to be more flexible, stable and transparent in the securities markets since the potential IPO-bound companies would be able to gauge the market sentiments and conditions, before filing to go public.


Significance of this mechanism and implications on the securities market


This optional ‘pre-filing’ mechanism for companies has been one of the several steps which SEBI has taken to counter the effects of overvalued start-ups being listed. Even as more and more investors including both domestic and foreign are taking interest in the stock market, it has become even more crucial to keep the valuations of companies about to be listed, in check.


The main objective behind the introduction of this scheme by SEBI is that it would allow the companies planning on launching IPOs to withhold sensitive and confidential information relating to its business and financial metrics from their competing entities. This would provide the company with more flexibility and would allow them to make the necessary changes to their DRHP, before making it available for public scrutiny. Both the company and the public are expected to greatly benefit from this, which in turn would reduce the instances of overvalued start-ups entering the market.


Moreover, with a number of external factors affecting the markets in recent times, it has become imperative from the perspective of an investor to select the right corporate entity to invest in and infuse capital at the correct time. Even though investors are being increasingly cautious and selective about investing their money in companies looking for IPOs, this step is likely to go a long way in assuaging their concerns.


From the perspective of the companies, they would be free to act on the recommendations and suggestions given by SEBI and incorporate the same before opening their shares for subscription, without worrying about sensitive information being disclosed. The comments and suggestions being given on the draft DRHP would ensure that all the factors including the interests of the investors, prevailing market conditions, determination of valuations etc. are all taken into consideration before the offer documents are made public.


Conclusion


The above mechanism introduced by SEBI strives to create a balance between the various stakeholders involved in the securities market including the companies, investors, regulatory bodies and the general public. By limiting the extent of information which is disclosed publicly at the first instance, companies would be able to safeguard sensitive business information. This amendment has been met with increased optimism as it has presented an opportunity to the new-age companies and start-ups that are planning on launching their IPOs in the future.


In addition to that, the process remains uncomplicated and direct, similar to the one followed for filing for IPO papers, except that the details regarding the IPO are made available to the public at a later date. With this optional ‘pre-filing mechanism’ being simple and beneficial, it represents a positive step for the Indian securities market. As more Indian companies are planning to launch their IPO this year, including major ones such as Oyo, Swiggy, Mamaearth etc., it is expected that this optional mechanism would be utilised by the companies to their advantage. It is also a welcome measure for new investors who had been wary of investing ever since the valuations of major IPOs plummeted in recent times.


Thus, overall it is expected that this alternative mechanism would go a long way in protecting the companies from the rising volatility in the market and more importantly countering the challenge of over-valued corporate entities entering the market.







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