Profit-sharing agreement norms may be a hurdle for PE-backed firms’ IPO plans2 min read . Updated: 30 Jan 2017, 09:24 AM IST
While Sebi's profit-sharing agreement norms apply only to listed companies to check for violations of corporate governance norms, it could have implications for IPOs as well
Mumbai: Initial public offerings (IPOs) of private equity-backed companies that have inked profit-sharing agreements may face hurdles with the markets regulator making it mandatory for listed companies to disclose and seek shareholders’ approval for all such agreements.
Profit-sharing or upside-sharing agreements between promoters, key managerial personnel and private equity investors are signed to encourage promoters or key employees to meet an agreed target. These agreements are often linked to the internal rate of return (IRR) that the private equity investor makes at the time of exit.
While the Sebi amendment in January ostensibly applies only to listed companies to check possible instances of violations of corporate governance norms, it could have implications for IPO-bound companies, according to legal experts.
“While the market regulator seems to be concerned of a possible conflict of interest of promoters or management teams taking measures to ensure stock appreciation in anticipation of higher profit sharing with an investor’s exit from a listed company, it needs to be seen how Sebi will practically apply provisions of this amendment to unlisted companies which may have upside sharing arrangements at the time of listing and exit post listing," said Aakash Choubey, a partner at law firm Khaitan and Co.
After seeking public comments, Sebi approved an amendment on 23 November to Listing Obligations and Disclosure Requirements Regulations 2015. The amendment was notified on 4 January.
Significantly, a Sebi show-cause notice in November last year asked PVR Ltd to explain a profit-sharing deal struck by its promoters with private equity investors that was not disclosed to its shareholders. The notice pointed to the violation of two norms: one related to a code of conduct for all board members and senior management and another to disclosure of events and information which are material.
According to the amendment, new upside-sharing agreements between an employee, including key managerial personnel or a director or promoter, and a shareholder or third party would require prior approval from the board of the listed company and shareholders of the listed company through an ordinary resolution.
Additionally, to remain valid and enforceable, existing agreements as on 4 January are required to be approved at the next meeting of the board and, thereafter, by the public shareholders of the listed company, the Sebi circular said. The circular does not explicitly mention how upside agreements in unlisted companies will be regulated on listing.
“The ambiguity is definitely going to cause some concern and confusion among private equity funds and promoters," said Nimesh Shah, managing director and co-founder of the Investment Banking Group at Nine Rivers Capital Advisors.
“Depending on what Sebi finally says on the matter, it could take away the incentive of listing a company altogether for PE investor, promoter or both in some cases," Shah added.
While an email sent to Sebi remained unanswered at the time of going to press, a senior official at the watchdog, who did not want to be named, confirmed that the market regulator is in receipt of some representations on the applicability of the recent amendments on companies that are planning to list.
“As long as the companies make a disclosure in their IPO prospectus, they would be compliant with Sebi regulations. With full disclosure, the investors will be able to make an informed decision," the official said. “Sebi will issue an FAQ (a list of frequently asked questions) to address these concerns," he added.