In the unicorn craze and IPO valuations, don’t take retail investors for a ride


Unicorns are strange creatures: trained in private markets, they now roam public markets. Almost all loss-making Unicorns that have been listed in the recent past quote below their listing price. The only exception is Nykaa launched by a former investment banker.

Unicorns are companies that “achieve” their billion-plus valuations by flipping stock into a cozy club of private equity investors. A few investors trading stocks with each other to increase the value of each other’s portfolios is a proven technique for increasing valuation at every turn. This is possible in private markets, but if these investors were to do the same in public markets, it would be called circular trading or market manipulation. Such activity is expressly prohibited and considered fraudulent in public procurement. This dichotomy between what is encouraged or accepted as practice in private markets and prohibited or frowned upon in public markets is what Unicorns, its promoters and its shareholders need to understand.

Private equity investors, when they take these shares public, ultimately flip them over to retail investors, who ultimately end up owning the box. Again, this time-tested technique, called the “biggest fool theory,” has been perfected by investment bankers, developers, and private equity investors.

Varun Sood, a journalist, recently tweeted: “On December 22, Morgan Stanley’s research arm issued an overweight rating on Paytm, giving a target price of Rs 1875. In the quarter ended December, Morgan Stanely ( sic), who was the leader. banker and lead investor, sells the maximum number of Paytm shares. On January 22, Paytm is at Rs 959 per share. While the research arm claims to be independent from the merchant banking unit, the fact is that they all seem to be involved in promoting the IPO price.

The old warning of buyer beware or caveat emptor is often invoked to defend this practice. Yes, buyer beware and the Draft IPO Prospectus (DHRP) provides information. However, each DHRP contains 700 to 1,000 pages in tiny, hard-to-read fonts written by smart investment bankers. As is the case with wordy documents, this deluge of information neither explains nor clarifies and only confuses the retail investor.

Moreover, “buyer beware” is a loose interpretation to justify the absence of proactive regulation. This basically gives license to a clever alec to fool retail investors and protect themselves under the argument that fools get fooled, and it’s up to the retail investor not to be fooled into the flipping game .

This does not mean that the valuation should be determined by the regulator. It only means that regulators must approach IPOs through their lens of consumer protection – not only must the buyer beware, but the seller must also ensure that a reasonably educated and intelligent person can take a call. reasoned about the product/service sold.

Another way is to insist that those who determine the valuation have more skin in the game. Starting with the investment bankers, who are part of the team that defines the book building of the IPO. The fees of these merchant banking companies can be paid through shares of the company with a lock-up of six months to one year. This will ensure that they are more careful about how they price the stock. If investment banks also want their employees to be sincere, they can even pay them bonuses via stock options. This will ensure that the game skin is complete down to the last investment banker employee.

The second stage is the pre-IPO placement. This is where justification for the price range is provided by asking “friends” in institutional investment firms to invest money. “Blue-blooded institutional investors are courted by investment bankers, promising high listing gains and creating artificial demand” for stocks. The claimed rationale is to stabilize the price range, but this is outright rigging. This step requires much greater scrutiny, transparency and oversight.

Especially, if mutual funds are investing money at this point. The mutual fund manager must see this as an exceptional decision, because any loss or profit must be anchored at the level of the AMC (asset management company) and not only at the level of the fund. Once the AMC is involved in the decision of the fund manager, its participation in this decision will be higher and frivolous investments will be avoided. Additionally, institutional investors should not be allowed to leverage a pre-IPO through borrowing.

Merchant banks, which are part of an NBFC, actually develop easy financing schemes for institutional investors, pushing them towards large investments in the pre-IPO allocation phase. Even if they don’t, there is enough easy money in the system to borrow to fund the pre-IPO placement or even the IPO itself. This is what the founder of BharatPe was discussing with the Kotak employee on that famous audio clip that Kotak failed to fund his IPO investment to the tune of Rs 500 crore.

What is a conflict of interest in public procurement

Recently, IPOs have used proceeds from the IPO to acquire other loss-making internet companies. There’s nothing wrong with the acquisition itself, if that’s the purpose of the IPO and if it’s disclosed properly. But very often the promoters of these newly listed companies are also angel investors in the acquired companies. Such an acquisition is a clear conflict of interest in public markets and is considered hostile to public shareholders. This is akin to front running promoters acquiring shares of a target listed company, clearly a fraudulent exercise and punishable under SEBI regulations.

New age companies are used to subverting traditional practices of self-regulation. But such conflicts are evidence of poor corporate governance. This may not matter in private markets, but it does in public companies.

Role of credit rating agencies

SEBI, in its revised standards released in December 2021, said credit rating agencies will monitor the end use of IPO proceeds for a period of one year. In the past, too, rating agencies have been criticized for the conflict of interest that arises when they are paid by a client they are supposed to oversee. This conflict of interest can be avoided if the credit rating agencies are remunerated by the investor protection fund under the aegis of the SEBI or by such a fund managed by the stock exchanges. They may then have a greater interest in ensuring that the proceeds of IPO funds are better controlled.

Second, credit rating agencies can be paid by the investor protection fund to also issue a rating on the risk they perceive in the assessment of loss-making companies. This will ensure that retail investors are at least risk aware in advance and that investment bankers are also aware that too high a valuation can invite riskier rating.

There have been criticisms of SEBI’s revised standards as reminiscent of the ICC price control days of the 1980s. invested. If retail investors abandon primary issues, it will do more harm to fundraising than good. The balance between protection and development is a role that a regulator must play; it cannot be too oriented towards development to the detriment of individual investors. In addition, there are enough stakeholders interested in the development of the market, SEBI is the only entity to protect the interests of retail investors.

The author is CEO of the Center for Public Policy Innovation. The opinions expressed in this article are those of the author and do not represent the position of this publication.

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