INDIA BUSINESS WORLD - OCTOBER 2006
THE MONTH THAT WAS...

BAR ON STAKE SALE BY VCS & PES TO HIT PRE-IPO MARKET

 The Securities Exchange Board of India (Sebi) has put the venture capital and private equity (PE) firms in a bind by removing the provision that allowed them to sell stake in a company after its initial public offering. Now, only those firms that have invested more than a year before the company goes public can sell their shares on listing. This is likely to affect the late stage and pre-IPO deal market, given that fact that more than 80 companies have filed Red Herring prospectus required to go public. Sebi has not clarified whether any or some of these issues will be affected by the change in norms.

   Venture funds are trying to persuade Sebi to accept its suggestions. The industry has asked Sebi to consider two modifications. The first is regarding convertibles. A convertible operates like a debt and turns into equity at a pre-specified price later. Many venture capital and PE firms use convertibles to invest in companies. They want Sebi to take the start of the convertible as the date of investment, and not when it converts into equity, in the company. Sebi has accepted this. The second modification is regarding the investment into a subsidiary. The industry wants Sebi to consider the date of investment into a subsidiary as the starting date of investment, essentially what IDFC did in GMR's power company. Sebi has not accepted this.

A fortnight after Sebi put out a circular, most venture funds they had received a notice to this effect from their share custodians. Till now, Sebi allowed venture capital and private equity firms to sell their stake on listing irrespective how close to the IPO they had invested; however, the promoters and other institutional investors in the company which is making the offering could only sell their shares a year after the listing. The ostensible reason for this is to prevent pre-IPO ‘flipping' — buying shares in company just prior to its listing and selling them on listing for quick gains if the share price rises.

   According to sources, a key factor for Sebi to change guidelines is the huge interest shown by the broking community to set up PE funds. Almost 15 top brokers in India have expressed interest and a large bullish operator wants to set up a $1-billion PE fund based out of Mauritius.

   SEBI is worried that these brokers will invest in an IPO through their PE Funds, use their market moving prowess to push up the stock and then cash out of the stock through the PE fund,” says a source.

   The venture capital industry is not convinced by Sebi's thinking. “Most venture capital and PE firms are longterm investors and rarely make a quick exit after the IPO,” says a partner at a US-based PE firm. For the time being, the venture industry is taking it on the chin and asked for some clarifications in the order. The strange thing about this amendment is that no change has been made to the Sebi guidelines on the venture capital industry. “They have brought in this amendment by modifying the disclosure and investor protection guidelines instead,” says Punit Shah, head, financial services practice, RSM, an accounting firm.

   The immediate impact of this decision will be to reduce the attractiveness of late-stage and pre-IPO deals. “This will have an adverse impact on the venture capital and private equity industry,” says Shah. Though data on pre-IPO deals is hard to come by, late stage deals have increased quite sharply this year. According to Arun Natarajan at Venture Intelligence, a venture investment monitoring company, late stage deals in the first nine months of the 2006 stood at $1.8 billion — 34% of total deal value — as compared with $0.346 billion — 26% of total deal value — during the same period in 2005.