[Suchisubhra Sarkar, a graduate of the West Bengal National University of Juridical Sciences, is a capital markets practitioner with over four years of experience at leading law firms.]
In the aftermath of poor post-listing performance by technology companies, the Securities and Exchange Board of India (“SEBI”) took cognizance of the need to standardize and disclose valuation metrics. In particular, companies with limited operating and financial histories tended to rely on growth metrics that were opaque to retail investors, prompting consultation by SEBI on the subject matter and subsequent introduction of the SEBI (Issue of Capital and Disclosure Requirements) (Fourth Amendment) Regulations, 2022, (“November 2022 Amendment”). The November 2022 Amendment introduced detailed disclosure requirements in Initial Public Offering (“IPO”) documents in connection with Key Performance Indicators (“KPIs”), which are quantifiable metrics through which a company’s performance can be gauged. KPIs play a key role in IPO valuation and in determining the issue price at which equity shares are made available to investors. As the November 2022 Amendment closes on a year, this post analyses its key successes and indicates areas that have raised challenges for capital markets stakeholders.
Prior to the November 2022 Amendment, the “Basis for Issue Price” section in the draft red herring prospectus, red herring prospectus, and prospectus (collectively, the “Offer Documents”) required disclosure of specified key ratios, along with a comparison of such ratios with companies in the issuer’s line of business. Any additional metric that the issuer and underwriters deemed a KPI is reflected in the “Our Business” section of Offer Documents, and any peer comparisons deemed relevant is reflected in the “Industry Overview” section. However, there was no obligation to disclose KPI comparisons with the issuer’s peers to assess its performance.
Interestingly, in the event there were no comparable listed peers in India, Offer Documents could state so and avoid including information on any peer ratios.
The November 2022 Amendment, without defining what precisely constitutes KPIs, introduced the following requirements:
SEBI mandated that identified KPIs would need to be explained in the “Definitions and Abbreviations” section of Offer Documents, using simple English to enable ease of understanding. Any technical terms used would need to be clarified further in simple terms. In addition, an explanation would need to be included for how each KPI was used historically by the management to analyse and monitor the issuer’s operational or financial performance.
The author believes this has been critical to retail investors’ engagement with Offer Documents. Prior to the November 2022 Amendment, practitioners, as a matter of good order and for SEBI’s clarity, would attempt to provide definitions for KPIs where possible. However, such definitions would often presume a degree of familiarity with the issuer’s industry, and would not necessarily include an explanation for each KPI. The requirement to simplistically define KPIs and provide a clear explanation for each KPI at the outset has placed a regulatory onus on underwriters and counsels to ensure that retail investors are able to comprehend these metrics on the basis of which pricing is determined, and investments are made.
Institutional investors have a greater degree of familiarity with the nature of industry-specific KPIs, their explanation, calculation methodology, and any nuances in their reliability as a metric for assessment of a company’s performance. In comparison, without an analysis of how a KPI was historically used to track performance, retail investors would face opaque valuations, without an understanding of an issuer’s growth trajectory and potential. In the course of implementing the November 2022 Amendment and simplifying technical KPIs, Offer Documents are progressively bridging the information asymmetry between the two categories of investors.
KPIs for three years, with peer comparison
The November 2022 Amendment clarified that KPIs for the issuer would need to be disclosed for the same period for which financial statements are included in the Offer Document, being three financial years and any applicable interim period. It also mandated that KPIs be compared with listed Indian peers and/or global listed peers. In the absence of precise comparisons, appropriate notes would need to be included to explain the differences.
Inclusion of KPIs for a period of choice (usually the most recent and favourable), prior to the November 2022 Amendment, allowed for skewed portrayals of an issuer’s results of operations. In comparison, disclosure of data for three financial years and a stub period presents a more realistic picture of the company’s growth and performance, giving investors context to the company’s journey and pipeline. This is aided further by including corresponding data for the same periods for the peer group as well. While an issuer may attempt to explain any downward trends as a result of external factors, investors now have readily accessible data for other industry players to understand whether such trends are a result of industry circumstances or those unique to the issuer. Further, the ease of access to this data provides a framework for less initiated investors to understand the relative positioning of a company within the industry, as well as any limitation to the scope for growth. From the issuer’s perspective as well, if certain KPIs demonstrate muted trends compared to other industries, as is the case with profitability metrics in technology companies, it is now possible to efficiently demonstrate these to retail investors as an industry phenomenon.
While a global peer may not be exactly comparable owing to differences in market, customers, and other nuances, the November 2022 Amendment has compelled issuers and underwriters to carefully assess the global market in a particular industry in the absence of Indian listed peers, instead of simply stating the impossibility of a comparison.
Certification/Comfort on the KPIs
As per the November 2022 Amendment, KPIs disclosed in Offer Documents are required to be certified by any of the statutory auditors of the issuer, peer-reviewed chartered accountants, or peer-reviewed cost accountants.
In practice, financial information across Offer Documents is ‘comforted’, meaning they are verified and confirmed, by the statutory auditors of the issuer. This is driven by the fact that the statutory auditors are also responsible for preparing the financial statements included in Offer Documents, and have undertaken the required procedures to provide ‘comfort’ on financial information. Accordingly, financial metrics such as revenue from operations, profit after tax, return on equity, and EBITDA, which are a combination of numbers either directly stemming from the financial statements, or derived through the application of formulae thereon, are ‘comforted’ in Offer Documents by statutory auditors.
In April 2023, the Institute of Chartered Accountants of India issued its ‘Technical Guide on Disclosure and Reporting of KPIs in Offer Document’, (“Guidance”) to guide accountants on the methodology for certifying KPIs to comply with the November 2022 Amendment. While the Guidance states that the report on KPIs is within the domain of ‘practitioners’, which includes the statutory auditors of an issuer, certain auditors have taken the view that they will not be placed to provide any ‘comfort’ on the KPIs included in the “Basis for Issue Price” section. Such comfort is not necessarily required from the statutory auditors and can also be provided by peer-reviewed cost or chartered accountants appointed otherwise. Consequently, however, certain financial metrics stemming directly from the financials of the issuer – also identified as KPIs in the “Basis for Issue Price” section – are comforted by such auditors in all but one section of the Offer Document. Given that the statutory auditors take on liability for the financial statements, the lack of comfort provided to financial metrics, which are also deemed KPIs, creates a dichotomy in Offer Documents.
Identifying ‘investors’ in the three preceding years
The November 2022 Amendment states that all the KPIs which have been disclosed to the issuer’s investors at any time during the three preceding years are to be included in the Offer Documents.
The intention is to disclose information that investors may have potentially deemed material in their decision on whether to invest in a company. However, there is uncertainty on whether ‘investor’ includes (i) those who did not eventually make an investment in the issuer but may have undertaken diligence and accessed KPIs, (ii) shareholders such as promoters, who may have access to day-to-day operations of the company and are exposed to multiple financial and operational metrics, which may not all be material. In the absence of a definition of KPIs in the November 2022 Amendment or the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018, underwriters have sought ad hoc guidance from SEBI on these questions.
In conclusion, the November 2022 Amendment has been successful in its aim of bridging information asymmetry and creating more empowered investors. The challenges faced in the last year stem from practical implementation, which, with the issuance of formal clarification from SEBI, will be adequate to address the primary goals of the amendment.
– Suchisubhra Sarkar