Startups can list without IPOs but angel funds can invest only in startups up to 3 years old: SEBI

Securities market regulator SEBI has come with significant guidelines for the startup ecosystem in India, boosting liquidity prospects for early stage investors by allowing startups to list without IPOs but has proposed certain restrictions on angel funds which may affect their investments.

The proposals, some of which have been talked about for a while, were cleared in a board meeting of SEBI on Tuesday. However, SEBI did not give a timeline for the implementation of the new decisions.

Startup listing

SEBI noted that lack of exit opportunities for the existing investors and restricted access to new investors is one of the problems faced by startups and SMEs. To provide liquidity for angel investors, VC firms and others, it approved the proposal to amend regulations to permit listing of startups and SMEs in a separate Institutional Trading platform (ITP) without having to file for IPOs.

This would be different from the existing SME exchange platforms of BSE and NSE which allow firms to list with relatively laxer regulations.

SEBI said such firms shall be accessible for investment to the 'informed investors' only and it marked the minimum amount for trading or investment on the ITP as Rs 10 lakh. These companies shall also be exempted from the requirements to offer up to 25 per cent of their stake to public through an offer document in order to get listed. This would allow such firms to list without IPOs and do away with the expenses associated with it.

However, SEBI added that such companies will be able to only make private placements and not public issues. This would create an institutional trading market for shares and other convertibles of startups, which can potentially bring more investors beyond angel investors and VC firms who have access to investments in such firms.

Standardised norms of entry for companies, eligibility criteria, continuous disclosure requirements, simplified exit rules and corporate governance norms will be prescribed separately, SEBI said.

According to Sanjay Vijayakumar, an angel investor and co-founder of MobMe Wireless (which is in the process of listing in an SME exchange), the decisions will help bring in more financial discipline much early on for entrepreneurs.

"In my opinion, along with HNIs, the platform should be open to working professionals as well since there are many young professionals who understand the Internet/mobile medium but are not HNIs. The next generation of youth has a higher risk appetite and they would be willing to invest under Rs 5 lakh in a startup," he said.

Vijayakumar said the current SME exchanges call for 25 per cent of equity dilution which was a dampener. "In most cases, the startups would want to dilute less, raise what is needed, increase the valuation and then raise more money," he said.

Vijayakumar explained that a positive spin to listing is that it can assign a market cap for the company and the shares can then be used as collateral as well. "This will help in unlocking value of shares in early stage itself as government funds give out loans at soft interest rates with shares as collateral, he said.

One of the key features of an IPO-less listing would be cost saving from the process of going through an IPO. This additional platform may also put pressure on the associated costs of listing on an SME exchange.

Mahesh Murthy of Seedfund said, in theory the SEBI proposal to allow startups and SMEs to list on an ITP without an IPO is great as it allows firms to divest less than 25 per cent and discover a price for their stock so that raising the next round though private placement will have fewer debates on pricing and valuation.

"But in practice, I'd like to see this market of HNIs and others on the ITP. I am not sure it's a big market of buyers right now. For an ecosystem to work it needs not just sellers but buyers too. There will be hundreds of sellers. But where are the buyers?," he asked.

Angel funds

The market regulator also came up with guidelines for angel funds and angel pools, bringing them under the ambit of Alternative Investment Funds (AIF) regulations. Given the smaller size of such funds compared with other VC firms, it categorised them as separate from VC firms but put such early stage investment funds under category I of AIF regulations.

SEBI said individual angel investors shall be required to have early stage investment experience/experience as serial entrepreneurs/be senior management professionals with 10 year experience. They shall also be required to have net tangible assets of at least Rs 2 crore ($330,000) while the corporate angel investors shall be required to have Rs 10 crore net worth or be a registered AIF/VCF.

For angel funds, the regulator prescribed a minimum corpus of at least Rs 10 crore (against Rs 20 crore for other AIFs) and minimum investment by an investor into that fund to be Rs 25 lakh (may be accepted over a maximum period of three years) against Rs 1 crore for other AIFs (such as larger VC firms and private equity firms). It added that the continuing interest by sponsor/manager in the Angel Fund shall be not less than 2.5 per cent of the total corpus or Rs 50 lakh, whichever is lesser.

SEBI also put separate riders for angel investments: they shall invest in firms incorporated in India and are not more than three years old; have a turnover not exceeding Rs 25 crore ($4.2 million); are unlisted, not promoted, sponsored or related to an industrial group whose turnover is in excess of Rs 300 crore and have no family connection with the investors proposing to invest in the company.

Further, investment in an investee company by an angel fund shall be not less than Rs 50 lakh and not more than Rs 5 crore and shall be required to be held for a period of at least 3 years.

This makes the guidelines restrictive which may affect such investments. This is especially so with respect to the requirement that angel funds to limit their investments to firms which are up to three years old. Though much of such investments happen in the early life cycle of a firm, it would take out access to such angel funds by firms whose founders managed to bootstrap for the initial years. Such startups would need to pitch to larger VC firms.

(Edited by Joby Puthuparampil Johnson)