Introduction

The Securities and Exchange Board of India (‘SEBI’) has significantly overhauled its capital-raising regulations through the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) (Amendment) Regulations, 2024 (‘Amending Regulation’), effective from May 18, 2024. The Amending Regulation, by virtue of the amendments it makes to the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘ICDR Regulations’), aims to simplify the capital-raising process, particularly for startups and small and medium enterprises (‘SMEs’).

Relaxation of Minimum Promoter’s Contribution

Pre-Amendment Landscape

Historically, under Regulation 14 of the ICDR Regulations, promoters of companies undertaking an Initial Public Offering (‘IPO’) were required to hold at least 20% (twenty- percent) of the post-IPO share capital, termed as the Minimum Promoter’s Contribution (‘MPC’). This requirement, under Regulation 16 of the ICDR Regulations, had a lock-in period of 18 (eighteen) months or 3 (three) years (depending on the use of IPO proceeds) post-allotment.

However, in most startups, founders often end up getting significantly diluted, being left with only a small percentage of equity shares after having raised funds through venture capitalists and/or private equity and venture capital funds who end up holding a substantial chunk of the equity in such companies. In such instances, shareholders other than the founders had to step up and provide some of their equity shares to fulfil the MPC requirements. It is pertinent to mention herein that prior to the Amending Regulation, only specified categories of investors (alternative investment funds, public financial institutions, foreign venture capital investors, banks and insurance companies) could contribute towards the MPC requirements without being categorised as promoters. Further, such investors were not generally shareholders on the cap tables of most startups.

This stringent MPC requirement posed significant challenges for startups and early-stage companies, often necessitating complex financial engineering to comply with the MPC requirements. The rigid framework hindered the ability of these companies to attract diverse investors and optimize their capital structure.

Post-Amendment Landscape

The Amending Regulation has relaxed this stringent MPC requirement. Now, non-individual public shareholders holding between 5% (five percent) and 10% (ten percent) of the post-issue capital, along with entities within the promoter group, can contribute towards the MPC. This expansion aims to broaden the investor base and their contribution to the company in order to facilitate capital raising for companies, especially those in their early stages. By prescribing the aforementioned threshold, the Amending Regulation also provides an assurance to the public investors that such shareholders will continue to remain invested in the company post-listing.

This relaxation is particularly beneficial for startups and new-age tech firms, which often undergo multiple funding rounds leading to dilution of promoter holdings. By easing the MPC requirements, SEBI has addressed a key challenge faced by these businesses.

Inclusion of Compulsorily Convertible Securities for calculation of MPC

Another pivotal change is the inclusion of Compulsorily Convertible Securities (‘CCS’) for the MPC calculation. The Amending Regulation provides that CCS held for more than 1 (one) year prior to filing of the DRHP will be included in the MPC, as long as appropriate disclosures of the terms of conversion are made in the DRHP and such CCS are converted into equity shares prior to filing of the red herring prospectus.

This move recognizes the evolving financing landscape, particularly in sectors characterized by high growth potential and a reliance on convertible securities. While the ICDR Regulations do not define the term “CCS”, it defines a “convertible security”. In terms of Regulation 2(1)(k), a “convertible security” means “a security which is convertible into or exchangeable with equity shares of the issuer at a later date, with or without the option of the holder of such security and includes convertible debt instrument and convertible preference shares”.  Therefore, CCS essentially is a financial instrument that carries a mandatory conversion feature into equity shares after a specified period or under certain conditions. By treating CCS as equity for MPC purposes, SEBI has provided a more practical framework for companies to manage their capital structure.

This amendment is likely to encourage investment in start-ups, where convertible securities are commonly used as a financing tool.  Convertible securities offer a flexible financing option as start-ups can raise equity funding without diluting ownership immediately. By allowing CCS to be included in the MPC calculation, SEBI has made it more attractive for investors to participate in start-ups and has created a more conducive environment for companies to access capital and fuel growth.

Streamlining the Capital-Raising Process – Revised thresholds for refiling of Draft Red Herring Prospectus

To expedite the capital-raising process, SEBI has introduced a rupee value-based threshold for determining the need to re-file the DRHP. The “rupee value-based threshold” refers to a specific monetary value that determines whether a change in the estimated issue size requires a re-filing of the DRHP. The Amending Regulation has clarified that for a fresh issue, any change in the estimated issue size by more than 20% (twenty percent) would trigger a refiling of the DRHP. This means that if a company plans to issue new shares and the total amount it expects to raise changes by more than 20% (twenty percent) from their initial estimate, it must submit a revised DRHP to the regulatory authorities. On the other hand, for an offer for sale (‘OFS’), where existing shareholders are selling their shares, the rule is different. In such cases, the change that necessitates the need for refiling the DRHP should be at least 50% (fifty percent) of the unit value of the shares being sold.

Previously, there was no such specific threshold, and any change in the issue size would typically necessitate a re-filing. The introduction of a rupee value-based threshold simplifies the process and reduces administrative burdens for issuers thereby reducing the time and cost associated with the capital-raising process.

Additionally, the elimination of the security deposit requirement further streamlines the process. Previously, a refundable security deposit of 1% (one percent) of the issue size was required to be deposited with the designated stock exchange. This requirement led to numerous customer complaints concerning the refund process of this deposit.

Further, the minimum days for which the bidding can be extended in case of force majeure, banking strike or similar circumstances has been revised from 3 (three) working days to 1 (one) working day. This change can significantly reduce uncertainty and delays in the bidding process. By allowing the process to resume more quickly, it leads to a more efficient overall process. Minimizing downtime also helps in the quicker completion of the bidding cycle, ensuring that the market remains active and functional even in the face of disruptions. Another advantage is the potential for improved market stability. Shorter extensions mean less prolonged uncertainty, which can often lead to market fluctuations. By resuming the bidding process sooner, the market is likely to experience less volatility, contributing to a more stable investment environment. Investors are likely to feel more confident knowing that disruptions will be promptly addressed, reinforcing their trust in the market’s resilience and operational efficiency.

These measures are expected to largely benefit companies of all sizes, but particularly startups and SMEs that often face resource constraints by reducing bureaucratic hurdles, which refer to the administrative challenges faced by companies during the capital-raising process. These challenges included time-consuming procedures, multiple filings, and other regulatory complexities.

With the introduction of a rupee value-based threshold for DRHP re-filing and the elimination of the security deposit requirement, SEBI has created a more efficient capital-raising ecosystem.

Conclusion

SEBI’s amendments to the ICDR Regulations represent a significant step towards creating a more conducive business environment. By addressing the challenges faced by companies, particularly startups and SMEs, the regulator has taken steps to simplify the capital-raising process and enhance investor confidence. The relaxation of the MPC requirements, the inclusion of CCS towards MPC, and the streamlining of the DRHP filing process are expected to stimulate entrepreneurship and innovation, contributing to the overall growth of the Indian economy.

While the full impact of these changes will unfold over time, they undoubtedly mark a positive development for the Indian capital markets.

Written By Nidhi Arora (Partner) and Manan Kapoor (Senior Associate)