[Guest post by Rashmi Ramanath, who is a 5th year B.A., LL.B. (Hons.) student at Jindal Global Law School in Sonipat]
The Initial Public Offering (IPO) of SKS Microfinance was a first of its kind. It was for the first time that a group of four venture capitalists led by Sequoia Capital India were named as promoters to an issue. Vikram Akula, one of the company’s founders, owned a 6% stake in the company and failed to meet the requirements of a promoter for a public issue. The four investors replaced Akula as promoter of the firm. More recently in June 2017, the Prataap Snacks IPO was also backed by Sequoia. In fact, the company was made to refile its Draft Red Herring Prospectus naming Sequoia as a promoter to the issue after Sequoia’s conversion of preference shares led to an increase in their shareholding to 46.71%.
This trend of naming private equity investors as promoters to a public issue has raised two major concerns. The first is that private equity investors usually look at IPOs as a quick exit option. As promoters, they will be subject to various disclosure norms as well as a three-year lock in requirement. The second concern is with respect to the definition of “promoters” as any person who is in control of the issuer. The definition of control is still largely ambiguous under securities law.
Beginning with the first concern regarding exit options available to private equity investors, the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 (the ICDR Regulations) provide for a framework for all public issues. As per the regulation 2(za) of the ICDR Regulations, a “promoter” is any person who is in control of the issuer or instrumental in the formulation of the plan pursuant to which securities are offered to the public. A promoter is also anyone who is named in the offer document as a promoter.
The ICDR Regulations provide that in a public offer promoters to the issue must contribute at least 20% of the post issue paid up share capital, and this minimum contribution capital is subject to a lock in of three years from the date of allotment of the issue while anything in excess of 20% is subject to a lock in of one year from the date of allotment (see regulations 32 and 36 of the ICDR Regulations). Promoters are seen as anchors of the issue and usually have a high skin in the game. A lock in on the promoters’ shares is imposed to inspire confidence in the issue, and it is also a sign that the promoters are serious about the venture. In a situation where the company is professionally managed or where the promoters are not identifiable, the company can disclose the same in their offer document (see regulation 34 of the ICDR Regulations). As a result, the minimum promoter contribution requirement as well as the lock-in period requirement do not apply to these shares. The Ujjivan Financial Services Limited IPO as well as the Equitas Holding IPO had unidentifiable promoters.
Private equity and venture capital investors usually take the IPO route to exit from their investments. As promoters to the issue, a part of their investment gets locked in for a three-year period, which may be a highly undesirable option to those looking for an exit. In addition to the lock-in, promoters are also subject to a number of disclosure requirements under the ICDR Regulations. These include actions by all statutory and regulatory authorities, outstanding litigation, material developments among many others (see schedule VIII of the ICDR Regulations). This can get cumbersome for such investors and can also act as a deal breaker of sorts in attracting investment.
The second concern is with respect to the meaning of ‘control’. The definition of control in the ICDR Regulations is the same as under the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the Takeover Regulations). This opens a whole new can of worms. The definition of what constitutes control has been a topic of great debate and discussion. The Takeover Regulations state that control “includes the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholder’s agreements or voting agreements or in any other manner” (see regulation 2(1)(e) of the Takeover Regulations).
In 2015, the Securities and Exchange Board of India (SEBI) came out with a discussion paper and invited comments on the definition on control. The paper laid out the definition of control as prescribed under a number of legislative enactments and regulative instruments such as the Competition Act, 2002, the Consolidated FDI Policy, insurance laws and the like. Ultimately, SEBI stated that one regulatory agency may be guided by the findings of other regulatory agency on a particular issue only if the two laws are pari materia in their substance and are being applied on the same set of facts and circumstances. This was also discussed by SEBI in the Jet-Etihad case.
While in this scenario, both the ICDR Regulations and the Takeover Regulations are governed by the same regulatory body, i.e., SEBI, the Takeover Regulations apply entirely to listed entities while the ICDR Regulations lay down the framework for unlisted entities. The question that thus arises is whether the same definition of control can be applied under both regulations, given that the purpose of the two instruments are very different.
– Rashmi Ramanath