Raising Funds in Business through SME IPO – What role does Capital Structure play while filing DRHP

 

Capital Structure

Capital structure describes how a company funds its growth and operations using a mix of debt and equity. This mix greatly influences the company’s financial health, performance, investment decisions, and acquisition strategies. Factors that affect capital structure can differ based on the industry, the company’s stage of development, and financial regulations. There are various ways to raise funds through capital market through which a company can fuel its growth.

IPO (Initial Public Offer) is one of the means to raise funds for both small and matured businesses. One has to comply with various eligibility criteria for IPO and Capital structure is one of the regulatory requirements as discussed below. Here are some disclosures that will form part of capital structure in DRHP when a company considers raising capital though issuing shares

 

What role does IPO Advisors play in successful IPO?

IPO Advisors play an important role in successful launch of an IPO. Their advisory role from IPO readiness, selecting the best merchant banker in India for SME IPO, various due diligence activities and IPO valuation guides the company throughout the IPO Issue and listing process. IPO platform in India provides information on upcoming IPOs on NSE Emerge and BSE SME and list of merchant bankers and anchor investors. Role of IPO advisor is important in the success of the listings.

 

Regulatory Disclosure Requirement of Capital Structure in Filing DRHP for IPO:

• Disclosure of Shareholding Pattern

According to Regulation 31 of SEBI (LODR) Regulations, 2015; Shareholding Pattern must be disclosed in DRHP under the section of capital structure.

The shareholding pattern Pre-Issue and Post Issue is required to be disclosed by Issuer in DRHP.

It provides a snapshot of how a company's shares are allocated among various stakeholders, which is crucial for investors to understand the company’s financial stability and ownership distribution. This information is especially important when raising capital through IPO, as it helps investors make informed decisions about the company’s equity structure.

• Disclosure of Employee Stock Option Plan / Employee Stock Option Scheme

If a company has issued any type of ESOP / ESOS to their employees before IPO, the company is required to disclose this information in the DRHP. It clarifies the holding of the employees in the company in form of ESOP / ESOS.

ESOP / ESOS are the type of schemes which give employees some form of ownership in their company.

• Disclosure of Equity Shares Allotted in pursuant to Scheme under section 230 – 232 (Restructuring) of the company’s act, 2013.

This disclosure reveals how shares are allocated after restructuring (if any restructuring has taken place) providing investors in IPO, with key insights into the company’s financial health and ownership.

This disclosure ensures legal compliance and provides information on company’s valuation after restructuring.

In conclusion, disclosing equity shares allotted under Sections 230-232 of the Companies Act, 2013, is essential for upholding transparency, meeting regulatory standards, and giving potential IPO investors crucial insights.

• Disclosure of Issuance of Bonus Share to its promoters and Promoters Group

When a company raising funds in capital market issues bonus shares to its promoters and their group, this disclosure is required by SEBI (LODR) regulations and must be included in the Draft Red Herring Prospectus (DRHP). It shows how bonus shares are distributed among key stakeholders, providing investors with a clear view of ownership changes and their potential effects on the company. This transparency helps investors understand share distribution better and make informed decisions about the company going for IPO to raise capital.

Importance of Capital Structure for an SME IPO: SEBI LODR Perspective

A company can choose any method of raising fund from capital market like debt funding, equity funding or hybrid. A private limited company can choose to go public by listing on NSE or BSE through IPO. Listing can be done on either Mainboard or on SME platforms. (know the difference between Mainboard and SME IPO)

When preparing for an SME IPO, the capital structure of a company is crucial, especially from the perspective of the Securities and Exchange Board of India (SEBI) and the Listing Obligations and Disclosure Requirements (LODR). Here’s why:

1. Investor Perception: For SME IPO, how a company balances debt and equity affect investor perception. A balanced capital structure—outlined in the Draft Red Herring Prospectus (DRHP)—signals stability and reduces perceived risk. This is critical for attracting investors who rely on these signals to assess financial health and make investment decisions.

2. Cost of Capital: The mix of debt and equity affects the company’s overall cost of capital. A well-managed capital structure helps in minimizing this cost, which enhances profitability and improves the company’s ability to provide returns to shareholders.

For companies looking to raise capital, the Draft Red Herring Prospectus (DRHP) and SEBI regulations emphasize the importance of balancing debt and equity to ensure transparency and fair valuation. This balance is crucial for attracting investors and achieving a successful capital raising process.

3. Valuation: The capital structure is crucial in arriving at a company’s valuation during the initial public offering (IPO) capital raising process. High debt levels can increase financial risk and lower valuation, while a strong equity base supports higher valuations. Investors scrutinize this in the Draft Red Herring Prospectus (DRHP) to gauge the company's growth potential and stability, impacting the success of the IPO capital raising.

4. Financial Flexibility: A well-structured capital base enhances financial flexibility, allowing the company to respond effectively to market and economic changes. This flexibility is crucial for adapting to new opportunities or challenges, as noted in the SEBI LODR guidelines and the company’s listing disclosures.

5. Impact on IPO Pricing: The capital structure influences the pricing of the IPO and IPO valuations. Companies with high debt might need to offer shares at a lower price to attract investors, which can impact the initial and long-term performance of the stock. This dynamic is closely monitored in the DRHP and SEBI LODR documents to ensure accurate and fair pricing.

6. Risk Profile: The company’s risk profile is heavily influenced by its capital structure. High debt increases financial risk and can lead to higher interest expenses, affecting overall profitability. Investors evaluate these risks as detailed in the DRHP and SEBI LODR requirements to determine if the potential returns justify the investment.

7. Attracting Investors: A well-balanced capital structure makes an SME IPO more attractive. It demonstrates effective management and strategic financial planning, which are key to raising capital and ensuring a successful IPO to capital raising. This is highlighted in the DRHP and SEBI LODR documents to assure potential investors.

8. Long-Term Strategy: The capital structure reflects the company’s long-term strategy and growth plans. Investors seek a capital structure that aligns with the company’s strategic goals and supports sustainable growth. This alignment is crucial as per SEBI LODR guidelines and the company’s listing disclosures.

Conclusion

In summary, the capital structure is a fundamental aspect of SME IPO. It influences investor perception, cost of capital, company valuation, financial flexibility, IPO pricing, risk profile, and overall attractiveness. An optimal capital structure attracts many investors over a long period of time.

A well-planned capital structure, compliant with SEBI LODR guidelines, is crucial for a successful IPO and supports the company's long-term growth and stability. This approach also highlights effective ways to raise funds through the capital market, ensuring that the IPO process is both strategic and beneficial for the company’s future.