Listing of Small and Medium Enterprises (SMEs) and Start-Up Companies on SME platform without making an Initial Public Offer.

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1 Listing of Small and Medium Enterprises (SMEs) and Start-Up Companies on SME platform without making an Initial Public Offer. 1.0 Objective The Finance Minister in his budget speech on Feb 28, 2013 announced that "Small and Medium Enterprises (SMEs), including start-up companies, will be permitted to list on the SME exchange without being required to make an initial public offer (IPO), but the participation will be restricted to informed investors. This will be in addition to the existing SME platform in which listing can be done through an IPO and with wider investor participation" This memorandum seeks to place before the Board, our proposals regarding implementing the said budget announcement. 2.0 Background 2.1 Considering the role of SMEs in nation building and their potential in terms of generating employment and income as well as fostering innovation and enterprise, it is imperative that necessary enabling environment is provided for these enterprises to flourish. However the risk of failure for a Start-Up or an SME is quiet high as compared to companies which have already grown larger. The investors in these early stage companies are also constrained by the limited options when it comes to exiting the company. Buy back by the promoter or scouting for another buyer are the normal options and in such situations the terms of exit may not be very favourable to the investor. Consequently, Start-Ups and SMEs find it harder to raise capital compared to larger companies due to their higher risk profile. 2.2 Providing an efficient framework to bring together Start-Ups and SMEs seeking capital and investors capable of assuming the risks and challenges of investing in an early stage company (the potential of immense returns as well as total loss of invested capital is high in such companies) can help hasten the growth of these enterprises and help them contribute towards the national economy. Generally informed investors like Venture Capital Funds (VCFs), Angel Investors or such Alternate Investment Funds, (AIFs), who are able to

2 assess the risk return profile of these companies and make an investment with a clear idea of the risks involved, are the potential investors in Start-Ups and SMEs. Apart from assuming the risk of business failure, the risk of their investment being locked-in for very long durations is also one of the constraints faced by these investors in investing in Start-Ups and SMEs which drive up the cost of capital. This is due to the limited marketability of unlisted securities and the absence of a structured market place where all interested investors could look-in for possible investments and exit options. 2.3 In this context, if the securities of a company were listed, it would give it better visibility and thereby wider reach to investors. With a structured market for investors, existing investors in an SME or a Start-Up are more likely to find an alternate buyer than if they search for a buyer using their own network of contacts in the investment community. Standardized norms of entry for issuers and continuous disclosure thereafter will also attract more informed investors to participate in this segment. Of the several risks faced by these informed investors who invest in start-ups and SMEs some of the risks involving both internal business operations as well as external environment can be mitigated to a certain extent by such listing which will require companies to make proper disclosures as part of regulatory requirements. The investors will be in a better position to decide the extent of their exposure depending on their risk appetite. Further, listing of the securities would also mitigate the exit risk and such risk reduction will automatically result in a lower cost of capital as well as easy flow of more capital into this segment. 2.4 However, present regulatory provisions require an unlisted company to make an Initial Public Offer (IPO) and offer upto 25% of its shareholding to public through an offer document in-order to get listed, even on the SME platform. Making an IPO involves, appointing intermediaries like Merchant Bankers for due-diligence, marketing the issue and overall issue management, bankers to an issue for collection of funds, syndicate members for distribution and collection of application. The procedural and economic cost of making an IPO including cost of distribution, advertising and other intermediary fees, are too high to be absorbed by the Start-Ups and SMEs. Further, the promoters are normally not interested in diluting 25% of the shareholding in the company to

3 public at early stage of the company's lifecycle as the obtainable valuations are low at this stage. 3.0 Proposed Concept: Listing without IPO 3.1 As identified above, the major factors which hold back Start-Ups and SMEs from listing are cost and procedures for IPO and the requirements of dilution of equity capital by the promoters. Therefore a platform on which only informed investors participate may address all these issues as the regulatory requirements can be relaxed and customized to fit the profile of informed investors. Such investors have the wherewithal to undertake such duediligence process and analysis on their own and arrive at an informed investment decision, be it in the primary market or secondary. With such customized norms for informed investors, small companies like Start-Ups and SMEs may find it easier to get listed on this platform. We can, therefore, consider enabling Start-Ups and SMEs to list on a separate SME platform accessible only to informed investors without having to make an Initial Public Offer (IPO). 3.2 Such a market for only informed investors may have the following characteristics a. Listing without making a public offer or raising capital from the public. b. Company to meet entry norms specific to this segment to qualify for such listing without IPO. c. Company disallowed to make a public offer at the time of listing or while listed on this platform. d. Further capital raising to be done only through preferential allotment and rights issue route. There shall not be an option for renunciation of rights in such rights issue to limit public participation. e. The emphasis shall be on providing visibility to companies before investors and a structured platform for investors for easy entry and exit. f. Considering that only informed investors would be present in this market, the company need not be treated as a target company under the SAST regulations.

4 g. Since the market is accessible only to informed investors, exit procedure may be customized to suit the investor profile with emphasis on approval of non-promoter shareholders rather than promoter having to provide exit to all other shareholders and therefore delisting regulations of SEBI would not apply. 3.3 SEBI had formed an Expert committee constituting of representatives from various stakeholders including, Ministry of Finance, Ministry of MSME, Industry associations, Stock Exchanges, Angel investors, Association of Venture Capital Funds, Brokers and trading members, Merchant bankers, Investor associations, Law firms and Consultancy firms to examine how the above said concept can be implemented. The committee discussed the same in detail and based on the inputs received from the Expert Committee the manner of implementing the above said concept of permitting listing of Start- Ups and SMEs without having to make IPO, is presented below for consideration. 4.0 Enabling Listing without IPO for Start-Ups and SMEs 4.1 Eligibility: In-order to preserve the credibility of the proposed platform so that it develops into a successful market where start-ups and SMEs can list and where the informed investors can find suitable companies to invest in, an eligibility criteria for entry into the platform may be kept. The possible eligibility routes may include a minimum investment in the equity of the company by, either registered Venture capital funds, Alternate investment funds, Merchant banks, Qualified institutional buyers or specialized international multilateral agency or domestic agency like SIDBI, NABARD, or a PFI under Sec 4A of Companies Act and other approved categories of investors/ lenders. Receiving project financing or working capital financing from scheduled banks during the last 3 years may also be considered as one of the eligibility routes. Apart from qualifying any of these, the company should additionally meet other conditions including, itself, its promoters and directors group companies etc. not being named in the wilful defaulters list on CIBIL, the company, its group companies and subsidiaries not having been referred to BIFR in the past 5 years, or any regulatory actions against the company, promoters or its directors in the past 5 years etc. Further to ensure that this platform is

5 restricted only to start-ups and SMEs, it may be required that companies seeking to list on this platform are not older than 10 years or having revenues more than 100 crores or paid up capital more than 25 crores. Stock Exchanges would examine the compliance with the eligibility norms before permitting listing in this platform. 4.2 Regulations Enabling Listing without IPO: Under Rule 19 of Securities Contracts (Regulation) Rules 1957 [SC(R)R 1957] Requirements with respect to the listing of securities on a recognised stock exchange are specified. Of these requirements, Rule 19(2)(b) requires that "at least twenty five per cent. of each class or kind of equity shares or debentures convertible into equity shares issued by the company was offered and allotted to public in terms of an offer document.". Since most promoters would not wish to dilute a significant part of their company at an early stage at relatively lower valuations, this requirement for dilution would be a major road block in preventing start-ups and SMEs from considering the listing route for capital raising. However Rule 19(7) of SC(R)R 1957 states that SEBI may, at its own discretion or on the recommendation of a recognised stock exchange, waive or relax the strict enforcement of any or all of the requirements with respect to listing prescribed by these rules. In view of this, it is proposed that we may waive compliance with rule 19(2)(b) for all companies that have received inprinciple approval for listing by the relevant stock exchanges on this proposed platform. This may be provided in the regulations and accordingly the stock exchanges would be able to permit listing of eligible start-ups and SMEs without having to make an IPO However, whenever these companies wish to migrate to main board or present SME platform where there is wider participation of investors, they would be required to offer shares to public through an IPO and comply with other conditions for listing and raising capital as applicable to the respective platforms. 4.3 Corporate Governance and Continuous Disclosures. In-order to maintain high standards of corporate practices, it is proposed that corporate governance norms as it applies to present SME exchange and main board may apply to companies listed on this proposed platform. As in the case of main board and SME exchange, such corporate governance norms would apply to a company

6 with a paid up capital of 3 crore or above. It is proposed that the following areas may be kept as continuous disclosure requirements. a) Disclose Shareholding pattern on half yearly basis. b) Disclose abridged Financial Results on half yearly basis. c) Comply with Corporate Governance requirements as prescribed for the SME platform. d) Disclose Corporate Actions where corporate benefits are involved (like dividend, split, buyback, bonus, rights). e) Intimation of Board Meeting where specific agenda disclosure shall be required (although not all board meeting intimation would be required) and their outcome. f) Disclose and intimate to stock exchanges, all the notices sent to shareholders and their outcome. g) Disclose details related to further raising of funds. h) Any change in Management Team. i) Disclose Price Sensitive Information. j) Payment of listing fees. 4.4 Ring-fencing the market for informed investors only. Presently market lot for main market listed securities is 1 security each and for those on SME Exchange is 100,000 each. SEBI (ICDR) defines a retail investor as one who applies or bids for securities for a value of not more than 200,000. It is proposed that we may mandate a market lot of 10,00,000 so that only informed investors trade in this platform. 4.5 Continued Commitment by the promoter: In-order to ensure that the promoters continue to remain committed to the company even after listing, it is proposed that on similar lines to main market and existing SME exchange the promoters shareholding be put under 3 years lock-in to the extent of 20% of shares held by him at time of listing. 4.6 Raising Capital: It is proposed that the companies that seek listing on this platform shall not be allowed to raise capital at time of listing. However post listing they may raise capital through private placement under the extant

7 regulations in this regard or through rights issue without the option to renunciation of rights. 4.7 Information memorandum and Liability for mis-statements in the information memorandum: While only informed investors would be accessing this platform, it is important that they are provided with pertinent information to make their investment decision. Accordingly the companies who seek listing on this platform be required to file an information memorandum on the stock exchange which shall be made public for 21 days before the company is listed. We may specify that any mis-statements in such information memorandum shall invite regulatory action in accordance with the provisions of SEBI Act 1992 or rules and regulations made there under. 4.8 Migration / Exit from proposed platform: Exit: If companies which get listed on this platform continue to be listed on it even after it has achieved a certain size, it may end up disproportionately consuming the capital which otherwise would go to other start-ups and SMEs. Therefore in-order to encourage companies which have grown beyond a size since listing to move to Main market or the existing SME market where there is wider investor participation and more capital available, it is proposed that we may incorporate suitable provisions that companies which exceed 25Crore in capital or revenues or market capitalization as prescribed from time to time be required to exit the platform within a period of 18 months. Also companies which have remained listed on this platform for 10 years may also be required to compulsorily exit the platform after such period Voluntary Exit: Since the investors in these companies are informed investors, their presence during shareholder meetings would be of considerable importance in managing the affairs of the company. It is proposed that a company be permitted to delist its shares from this proposed trading platform if its shareholders approve such delisting by passing a special resolution through postal ballot with 90% of total votes and the majority of non-promoter votes have been cast in favor of the proposal Compulsory Exit resulting from non-compliance: In-order to encourage timely compliance with continuous listing norms and corporate governance requirements, it may also be provided that companies which fail to comply

8 with such requirements on this platform for more than a year shall be permanently removed from the platform. 5.0 The board is requested to consider and approve the proposals at para 3.0 and 4.0 above and authorize the Chairman to take suitable measures including amendments to the relevant regulations to give effect to these proposals. ***********