IPOs as an Exit

In recent times, the Indian venture capital ecosystem is witnessing a large number of IPOs or “initial public offerings” by unicorns or otherwise profitable investee companies. Commencing with Zomato and Paytm to Nykaa, Policybazaar and Mobikwik, all of whom are successful Indian start-up companies, we can expect more profitable investee companies to join the IPO bandwagon.

IPOs are an initial listing of a company’s shares on a stock exchange thus making the said company’s shares available to the public for subscription. IPOs are an established mechanism for providing the venture capital or private equity investors in an investee company with an exit from the company by listing the shares held by them on a stock exchange.

IPOs are regulated in India by the Securities and Exchange Board of India (“SEBI”) and are governed by the Securities Exchange Board (Listing Obligations and Disclosure Requirements) Regulations 2015 (“LODR Regulations”). The listing of the shares of an investee company is also governed by the terms pertaining to exits contained in an investment agreement.

This article will examine the terms of standard investment agreements pertaining to providing investors with an exit through an IPO.

Firstly, the investment agreement will specify that the IPO of the Company has to be a “Qualified IPO” in order to fall within the ambit of an “exit” to the investors. A “Qualified IPO” is one which (i) necessarily requires the Company to list on a recognised stock exchange; (ii) gives the Company specified minimum proceeds from the IPO; and (iii) is at a share price which is a specified multiple of the investor subscription price per share. The investee company will therefore work towards fulfilling all the aforesaid requirements when it goes for an IPO in order to provide the investors with an exit. Proceeding to a qualified IPO is also an affirmative vote item which means that investor consent would be required for making a confirmed decision to proceed with an IPO.

The IPO can be through a fresh issuance of shares or vide a secondary sale of the shares held by the existing shareholders. The investors should be able to offer 100% of their shareholding for listing in the IPO. Further, the investment agreement will specify that the investors will not be treated as “promoters” for the purposes of the LODR Regulations. This is to avoid the lock in requirements of 3 years on shares held by Promoters when a company goes for initial listing[Regulation 4.11 of the LODR]

Additionally, the investment agreement will also provide that the appointment of the merchant banker for the IPO is an affirmative vote item i.e., an item which requires the investors’ consent. The investors also have to approve the valuation of the company when going for the qualified IPO and the red herring prospectus prior to it being filed with the SEBI. All the costs pertaining to the IPO will have to be borne by the investee company.

From an investor perspective a qualified IPO may be the best exit possible given the high valuation of a company however an IPO may not necessarily be the best option for the promoters of the company. Firstly, their shares are locked in for a period of 3 years which means they cannot exit the company for that period. Secondly, and more importantly once a company lists on a stock exchange it is governed by the listing agreement of the concerned stock exchange and various SEBI regulations including the LODR Regulations. The rigours of being a listed public company may not always seem attractive to the promoters.

Therefore, in our view, the pros and cons of proceeding with listing should be weighed carefully by any investee company before proceeding with an IPO.

This article examines the requirements of an exit via an Initial Public Offer (IPO) for companies with investment from PE or VC investors.