Contributed by Vanshika Tandon

The conventional understanding that the Initial Public Offering (“IPO”) constitutes the sole mechanism for market exit strategy ought to be reassessed in the wake alternatives such as direct listing and formation of a special purpose acquisition company (“SPAC”). There has been a growing nexus between complex ‘public offering’ requirements and the number of companies willing to stay private. Therefore, the complicated and expensive IPO processes arguably provided an impetus for the companies to seek alternatives for “going public”.

The recent trends exhibited by Spotify in April, 2018 and Slack Technologies in September 2021 illustrate direct listings as an ‘efficiency story’. It is also recognised that the operational concerns are minimised under the direct listing process owing to its inexpensive nature and less cumbersome procedure. Within the Indian capital markets, the growing fascination with the process of direct listing is an apparent manifestation of ever-more strict governance norms.

The article aims at analysing if the Indian regulatory framework allows the process of direct listing to be conceived as an alternative to the challenges posed by the IPO procedure. Further, Securities and Exchange Board of India (“SEBI”), as a response to various scams has tightened its grip around the functionalities of the securities and capital market. These stringent norms are notified as pillars of transparency. Thus, it is also analysed if the notional implication of direct listing satisfies the transparency and vigilance standards set forth.

Direct Listing: a feasible alternative to IPO?

The process of direct listing is marked by the sale of shares by the existing shareholders on the stock exchanges. However, the process is neither premised on the cornerstone of issuing new shares, nor does it seek any lock-up commitments from the existing shareholders. Further, the existing shares are sold on the national stock exchange without any role played by the Investment Banks in the capacity of underwriters. The route of direct listing, to this end, exemplifies the nullified aspect of “road show” of securities to attract investors and ultimately sell the securities to the public. Thus, direct listing is a distinct facet of “going public”.

The adoption of one model of “going public” over the other is dependent upon company’s motivation behind going public. For instance, post initial rounds of funding (Series A, Series B etc.), two possibilities arise—firstly, the company raises maximum funds and becomes profitable, thereby pushing the company towards an IPO to seek subscription of new shares; secondly, the company struggles to raise funds through private placements, thereby moving towards public stock exchanges to fulfil the capital requirements.   

Direct listing becomes the foremost choice for the start-ups or businesses enjoying good public reputation unwilling to undertake the costs of IPO. Moreover, IPO is also understood to provide an exit strategy for the promoters and initial investors. The tech-unicorns and other start-ups however lack the incentive to go public at a later stage owing to their varied subscription model, capital expenditure and infrastructural expectations. Direct listing in this regard is enabled as an alternative to the IPO process for exit strategies.

It is also evident that direct listing results in automatic anti-dilution of the shareholder rights because the existing shares are merely sold through national stock exchanges, rather than seeking new subscriptions. The prices of these shares can be traced back to the popularity of the businesses going public. Thus, the price of each share, dependents on the market demand.  These nuances supplant the case for direct listing over the long-drawn process of IPO.

Direct Listing in India: Slacking-off SEBI’s Control?

The story of Indian corporate and securities’ governance is weaved around maintaining air tight norms to avoid corporate mismanagement and frauds. The present landscape is a consequence to various scams ranging from Mundhra Scam to Satyam Scam and the Sahara India scam. Thus, it becomes essential to examine if the present regime allows the adoption of direct listing over the traditional IPO process to go public; if direct listing can be construed to remain at par with the disclosure requirements

Direct listing is not an alien concept to India. The process is envisaged through the introduction of Institutional Trading Platform (“ITP”). It was introduced by SEBI as a stock-exchange window, for the medium and small business to attract potential investors. This platform serves as an important way-out for the early shareholders of the start-up rather than following the conventional IPO process.

The Spotify story while lays ground for an innovative process of “going public”, it is imperative to examine if such story would have sustained in India. The equity market of India is advancing but the growth stories are limited due to the restrictive regulatory measures. For instance, unlike the Securities Exchange Commission (“SEC”), SEBI mandates three-years of consecutive profits for a company before going public. This directly translates into better investor participation in the innovative business model in US. It was consequently reported that ‘since most start-up stories revolve around postponing profits in order to gain market share and expand, most Indian investors are essentially denied the chance to demonstrate their support for novel business concepts.’

Over the last two-years, India witnessed some of the biggest IPO failures. While the companies such as Paytm, Zomato and Reliance were speculated with high valuations, the IPO triggered downfall of the share value. On the other hand, the start-up ecosystem of India is also hit by the corporate misgovernance trend. For instance, the recent turmoil caused in the ed-tech sector by Byju’s case which followed the BharatPe case and the GoMechanisc case, reignited the unease caused by corporate mismanagement. These cases were labelled as “direct result of misreporting of financial statements and investors’ serenity towards conducting due diligence”. The failure of these companies is attributed to management conflicts and decisions thereof.

It is true that the regulation by SEBI takes a back seat when the companies are still private, which culminates into various frauds and scams. Arguably, if the companies were under the radar of SEBI, their financial management would have been more transparent and thus appropriate. It is inferred that, start-ups and unicorn companies lack the incentive to go public owing to the slow gaining profitability and failure to raise capital through placement offers. The traditional costs attached to the IPO process moreover divests interests of these companies to go public. This results in companies wanting to stay private and par take in mismanagement schemes to somehow make available the funds and capital, in-order to grow.

The study of the recent cases and failed IPO in India also reveal that decisions resulting in mismanagement and corporate misgovernance is also attributable to the displeasure associated with the immediate cash need by growing businesses. The process of IPO while seems promising towards raising funds which remained a far cry during initial rounds of funding, it does not warrant profitability or faster liquidity. The lock-in period mandates a restriction on sale of shares by the existing shareholders for certain duration of time. Moreover, the additional sale of shares by the shareholders outside the scope of IPO is restricted which again does not satisfy the need for immediate cash flow.

The direct listing process envisages an innovative mechanism to deal with the mentioned concerns of start-ups in India. Here, the shares of a company are sold to retail and institutional investors through stock exchanges. Essentially, the shareholders are provided an immediate exit strategy and the company with liquidity. The process moreover, envisions a much broader pool of interested shareholders (sellers) and investors (buyers) thereby enabling price determination by the market forces of demand and supply. Due to widened scope of stock market, the market-driven price represents a truer picture. Thus, direct listing in the light of failed IPOs and recent scams promises an easy way of “going public” to the start-ups. By the virtue of  selling stock on the stock exchange, the companies fall within the radar of SEBI as public companies. The regulation by SEBI, to this end would result in transparency.

Conclusion

In the light of foregoing discussion, a case has been made that the process of direct listing offers potential as an alternative to the IPO process. Within India, direct listing can be considered towards enabling a market exit for the shareholders unicorns and start-ups without indulging in expensive IPO process. In this sense, direct listing can even be enforced as a corporate governance strategy, ensuring transparency through SEBI mandated requirements as soon as the company gets listed as public. The SEC, put-forth a detailed mechanism to ensure transparency of the companies pursuing direct listing but it is evident that within India, the regulations must be adopted to better suit the capital market needs. A blind adoption could perhaps conclude in alienation from regulatory framework owing to varies equity landscape. Moreover, SEBI acknowledged that the direct listing by Spotify marks an efficient and transparent process. Thus, certain adjustments can be expected by the regulator to place direct listing as an enforcement if not as an alternative to IPO.