Eligibility Criteria for Initial Public Offers

1.0

Objective
This memorandum seeks to modify the eligibility criteria for Initial Public Offers
(IPOs) namely (i) enabling IPOs through Offer for Sale (OFS) when more than 50%
of net tangible assets are held in monetary assets (based on a reference from
Department of Disinvestment, Government of India) (ii) profitability criteria to be met
on both stand alone and consolidated basis, thus making it more stringent.

2.0

Present Requirement

2.1

Regulation 26 of SEBI (Issue of Capital and Disclosure Requirements) Regulations,

2009 (hereinafter referred to as ICDRR) lists out the conditions for IPOs. There are
5 sub-regulations to Regulation 26. An issuer has to satisfy all 5 conditions to be
eligible to make an IPO under this regulation (profitability route) and if not, the issuer
is required to make the issue under Regulation 26 (2) through compulsory book built
or appraisal route. The compulsory book built route requires at least 50%
subscription by Qualified Institutional Buyers and the appraisal route requires 15%
participation in the project by scheduled commercial banks or public financial
institutions.

2.2

Relevant extract of Regulation 26 of ICDRR prescribing eligibility conditions for

issuer companies to come out with IPOs is placed at Annexure. Regulation 26(1) (a)
is about net tangible assets requirement and Regulation 26 (1) (b) is about track
record of profitability. The proposal is to amend these two sub-regulations which
are discussed below.

3.0
3.1

Net tangible assets requirement

Regulation 26 (1) (a) provides that an issuer should have net tangible assets of at
least Rs.3 crore in each of the preceding three full years of which not more than
50% are held in monetary assets. Proviso to Regulation 26(1)(a) requires that if
more than 50% of the net tangible assets are held in monetary assets, the issuer
ought to have firm commitments to utilize such excess monetary assets in its
business or project.

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3.2

The rationale behind regulation 26(1) (a) is that if a company has unutilised
monetary assets on its books which is not earmarked for specific use, it must first
utilise those monetary assets to fund its requirements, before venturing to raise
money through a public issue. This may hold good in case of IPO through issuance
of fresh equities where the issue proceeds go to the issuer who is already cash
rich.

3.3

Whereas, in an IPO through pure offer for sale (OFS), issue proceeds go to the
selling shareholders. The present provisions do not differentiate between IPOs
through fresh issue of equities and IPOs through pure OFS with the result a
company which is otherwise eligible under regulation 26 except for the limit on
monetary assets has to necessarily follow Regulation 26(2) which interalia
requires atleast 50% allotment to QIBs. This, limits the issuers ability to reserve
more than 35% of the issue size to retail individual investors.

3.4

Proposal for consideration

In view of the above, it is proposed to amend to Regulation 26(1)(a) suitably to
enable IPOs through OFS even if more than 50% of net tangible assets are held in
monetary assets.

4.0

Track record of profitability

4.1

Regulation 26(1)(b) of SEBI (ICDR) Regulations provides that an issuer may make
an IPO if it has a track record of distributable profits in terms of Section 205 of the
Companies Act, 1956, for atleast three out of the immediately preceding five years,
provided that extra-ordinary items shall not be considered for calculating
distributable profits. The Regulations are silent on whether the said profitability
criterion is to be applied on stand alone or consolidated basis.

4.2

The offer document requires disclosure of financials on both stand alone and
consolidated basis. From the said disclosures, it was observed that some
companies are able to satisfy the profitability criteria on standalone basis but show
huge losses on a consolidated basis. Since the regulations are silent, such issuers

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claim eligibility for making an issue via voluntary book built route [Regulation 26
(1)].

4.3

Whereas if a view is taken that issuer companies should satisfy profitability criteria
on both stand alone and consolidated basis, they would be eligible to make an
issue only under mandatory book built route [Regulation 26(2)], which require that
at least 50% of the offer is to be allotted to QIBs. The rationale behind the said
requirement is that QIBs being large, well-informed investors are better equipped to
analyze the financial credentials of such companies and when they repose faith by
subscribing to at least fifty percent of the issue despite the issuer not satisfying
profitability track record, it gives some guidance to retail investors. It was, therefore,
felt that the application of the criterion under Regulation 26(1) needs to be more
stringent.

4.4

Consideration by SCODA
The issue was deliberated by SCODA. After deliberations, SCODA recommended
that the eligibility condition may be modified to provide that the issuer company
shall have net profits on consolidated basis also for atleast three out of the
immediately preceding five years; in cases where the company did not have
subsidiaries in all the immediately preceding five years but had subsidiary/
subsidiaries for a period lesser than five years, then it shall have net profits on a
consolidated basis in atleast one or more of the years for which consolidated
accounts are prepared.

4.5

SEBIs views and proposal for consideration

The above recommendation of the SCODA intends to make the eligibility criteria
for issuer companies coming out with IPOs more stringent by mandating that the
track record of profitability be complied with by companies on stand-alone as well
as consolidated basis. It is, therefore, proposed that the recommendation of
SCODA be accepted.

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5.0

Proposal
The Board is requested to o consider and approve the proposal contained in Para 3.4 and 4.5 of the
memorandum.
o authorize the Chairman to take necessary steps to give effect to the decisions
by making suitable amendments to the SEBI (ICDR) Regulations.

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Annexure
26. (1) An issuer may make an initial public offer, if:
(a) it has net tangible assets of at least three crore rupees in each of the preceding three
full years (of twelve months each), of which not more than fifty per cent. are held in
monetary assets:
Provided that if more than fifty per cent. of the net tangible assets are held in monetary
assets, the issuer has made firm commitments to utilise such excess monetary assets
in its business or project;
(b) it has a track record of distributable profits in terms of section 205 of the Companies
Act, 1956, for at least three out of the immediately preceding five years:
Provided that extraordinary items shall not be considered for calculating distributable
profits;
(c) it has a net worth of at least one crore rupees in each of the preceding three full years
(of twelve months each);
(d) the aggregate of the proposed issue and all previous issues made in the same
financial year in terms of issue size does not exceed five times its pre-issue net worth
as per the audited balance sheet of the preceding financial year;
(e) if it has changed its name within the last one year, at least fifty per cent. of the revenue
for the preceding one full year has been earned by it from the activity indicated by the
new name.
(2) An issuer not satisfying any of the conditions stipulated in sub-regulation (1) may
make an initial public offer if:
(a) (i) the issue is made through the book building process and the issuer undertakes to
allot at least fifty per cent. of the net offer to public to qualified institutional buyers
and to refund full subscription monies if it fails to make allotment to the qualified
institutional buyers ;
or
(ii) at least fifteen per cent. of the cost of the project is contributed by scheduled
commercial banks or public financial institutions, of which not less than ten per cent.
shall come from the appraisers and the issuer undertakes to allot at least ten per
cent. of the net offer to public to qualified institutional buyers and to refund full
subscription monies if it fails to make the allotment to the qualified institutional
buyers;
(b) (i) the minimum post-issue face value capital of the issuer is ten crore rupees;
or
(ii) the issuer undertakes to provide market-making for at least two years from the date
of listing of the specified securities, subject to the following:

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(A) the market makers offer buy and sell quotes for a minimum depth of three
hundred specified securities and ensure that the bid-ask spread for their quotes
does not, at any time, exceed ten per cent.;
(B) the inventory of the market makers, as on the date of allotment of the specified
securities, shall be at least five per cent. of the proposed issue.
(3) An issuer may make an initial public offer of convertible debt instruments without
making a prior public issue of its equity shares and listing thereof.
(4) An issuer shall not make an allotment pursuant to a public issue if the number of
prospective allottees is less than one thousand.
(5) No issuer shall make an initial public offer if 12[as on the date of registering the
prospectus with the Registrar of Companies] there are any outstanding convertible
securities or any other right which would entitle any person any option to receive equity
shares after the initial public offer:
Provided that the provisions of this sub-regulation shall not apply to:
(a) a public issue made during the currency of convertible debt instruments which
were issued through an earlier initial public offer, if the conversion price of such
convertible debt instruments was determined and disclosed in the prospectus of the
earlier issue of convertible debt instruments;
(b) outstanding options granted to employees pursuant to an employee stock option
scheme framed in accordance with the relevant Guidance Note or Accounting
Standards, if any, issued by the Institute of Chartered Accountants of India in this
regard.
(6) Subject to provisions of the Companies Act, 1956 and these regulations, equity shares
may be offered for sale to public if such equity shares have been held by the sellers for a
period of at least one year prior to the filing of draft offer document with the Board in
accordance with sub regulation (1) of regulation 6:
Provided that in case equity shares received on conversion or exchange of fully paid-up
compulsorily convertible securities including depository receipts are being offered for sale,
the holding period of such convertible securities as well as that of resultant equity shares
together shall be considered for the purpose of calculation of one year period referred in
this sub-regulation:
Provided further that the requirement of holding equity shares for a period of one year
shall not apply:
(a) in case of an offer for sale of specified securities of a government company or
statutory authority or corporation or any special purpose vehicle set up and controlled
by any one or more of them, which is engaged in infrastructure sector;
(b) if the specified securities offered for sale were acquired pursuant to any scheme
approved by a High Court under sections 391-394 of the Companies Act, 1956, in
lieu of business and
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invested capital which had been in existence for a period of more than one year
prior to such approval.
(7) No issuer shall make an initial public offer, unless as on the date of registering
prospectus or red herring prospectus with the Registrar of Companies, the issuer has
obtained grading for the initial public offer from at least one credit rating agency
registered with the Board.

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