Liberalize India’s IPO regulations

There are decades where nothing happens, and there are weeks where decades happen.” This line, misattributed to the Russian communist Vladimir Lenin, has often been invoked in world affairs to stamp the import of history-turning events that unfold over a short time frame. It would also apply to what India’s venture ecosystem witnessed in recent months.

In the first half of May, Walmart acquired a controlling stake in Flipkart for $17 billion (over ₹ 1 trillion). Around the same time, a small New Delhi-based cloud computing company called E2E Networks had its initial public offering (IPO) over-subscribed by 70 times. E2E Networks was holding an IPO to raise ₹ 22 crore, targeting a market capitalization of ₹ 81 crore—it saw demand for over ₹ 1,400 crore. The scale of the two events in monetary terms is vastly different, but the two represent something very new in India. An acquisition of the scale achieved by Flipkart and a small IPO of a venture-backed technology company like E2E Networks have both been elusive for years.

Some commentators shortsightedly portrayed Flipkart’s sale to Walmart as a sellout and a tragedy, as if it were a moral outrage that an American company acquired an Indian business. What these critics do not appreciate is that openness is a two-way street— today, it is an American corporate giant buying India’s largest technology start-up.

With a fast-growing base of over 250 million 4G users and Indian telecom companies preparing to launch next-generation 5G services at the same time as the advanced economies, India’s digital services market is set to explode over the next decade. Tomorrow there will be a day when an Indian company buys out a global technology market leader in the US.

This possibility doesn’t occur to the critics and betrays a defensive, mentally colonized mindset that cannot fathom the rise of India. In the league of liberal democracies, India’s openness to trade and investment, a stark contrast to China’s digital mercantilism, is a strategic strength.

Between the two ends of the spectrum of a mega-acquisition and a micro cap IPO, there is a wide gulf to be bridged. There is space for listed small capitalization and middle-market technology businesses that might grow into substantial entities as listed companies. This requires addressing regulatory bottlenecks that prevent pre-revenue Indian technology ventures from going public.

Owing to a legacy of stock market scams through the 1990s, capital markets regulator Securities and Exchange Board of India’s (Sebi’s) impulse has been to protect retail investors at all cost. As the business and stock market landscape have altered unrecognizably over the past two decades, the cost that such protection exacts today may exceed the benefits.

The public equities asset class has grown by leaps and bounds over the past decade. The number of demat accounts in India climbed from 10.07 million in September 2007 to 21.83 million in March 2014. The savings financialization drive of the Narendra Modi government has since increased the number to 31.61 million as of February. Investment in equities through systematic investment plans rocketed from ₹ 43,921 crore in 2016-17 to ₹ 67,190 crore in 2017-18, with systematic investment plan flows hitting an all-time record ₹ 7,304 crore in May. The number of mutual fund folios clocked in at ₹ 7.13 crore in March, up from ₹ 5.53 crore in March 2017. According to one study published in October 2017, 60,000 new investors were entering the stock market every single day, up three times from the monthly average of the previous three years.

The rise of financial digital media platforms, specialist investment portals and even social media is not acknowledged for the role they play in parsing and disseminating company information as well as in providing investor education. These information utilities simply did not exist in the pre-internet era.

It is safe to say that both the awareness and appetite of the Indian retail investor has increased manifold. The principal barrier to listing of technology companies lies in the regulatory criteria that fixes arbitrary thresholds for net tangible assets and average operating profit. Additionally, the requirement of a minimum 20% promoter holding typically cannot be met by companies that have accepted multiple rounds of private equity funding. Expecting financial investors to classify themselves as promoters, with these investors locking up an investment for three more years after going public when they may have already held it for a number of years, makes an Indian listing very challenging.

There is a case to reduce or remove the promoter holding requirement. The correct lever to ensure corporate governance is to fix accountability and commensurate consequences for maladministration at the level of the company’s executive management and the board of directors. Requiring a minimum promoter holding is in fact a tacit admission that the board of directors doesn’t matter.

The growth of India’s equity capital markets and retail investor base has matched the evolution of the venture ecosystem that seeks to tap public markets for expansion capital. Dated regulations are a wall between entrepreneurs and equity markets that drive Indian technology entrepreneurs to move offshore and pursue listings abroad. Equally, retail investors are denied the opportunity to invest in tomorrow’s technology champions. It is time this wall was brought down.

Rajeev Mantri is executive director of venture capital firm Navam Capital and co-founder of the India Enterprise Council.

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