How Loss-Making Companies Still Launch IPOs

Synopsis: With a wave of IPOs that have entered the Indian market, not all companies have been consistently profitable, so how are they allowed to be listed? Let us find out in this article.

An Initial Public Offering (IPO) is the process by which a company offers its shares to the public for the first time, thereby becoming a publicly traded company. The trend for IPOs has been increasing year by year for both the companies and our retail investors. 

Companies now find it very easy to gather capital through IPOs even if they have not been generating any profits, but there’s a catch: certain regulations have to be met which are given by SEBI before applying for an IPO; they are as follows:

There are two entry norms that the issuer needs to fulfil; they are:

Entry Norm 1, also known as the Profitability Route:

This route applies to companies that are already profitable with a strong financial foundation. To qualify, the company must:

• Have net tangible assets of at least Rs. 3 crore for each of the past three full years, with no more than 50% of these assets held in cash or equivalent. This 50% limit doesn’t apply if the entire IPO is through an offer for sale.
• Achieve an average pre-tax operating profit of Rs. 15 crore or more in at least three out of the last five years.
• Maintain a net worth of at least Rs. 1 crore for each of the preceding 3 full years.
• If the company changed its name within the last year, it should have earned at least 50% of its revenue in the previous year from the activities related to the new name.
• Ensure that the total size of the proposed IPO issue, combined with previous issues in the same financial year, doesn’t exceed five times its net worth before the issue, based on the latest audited balance sheet.

This route ensures that companies with consistent profits and assets can access public markets confidently.

Entry Norm 2, also known as the QIB route. 

For companies that don’t meet the profitability criteria, SEBI provides an alternative. The criteria of this route are:

• The IPO must be conducted through a book-building process, where bids from investors determine the price.
• At least 75% of the net shares offered must be allocated to qualified institutional buyers, such as mutual funds, insurance companies, or banks.
• If this minimum subscription from QIBs isn’t achieved, the IPO is cancelled, and subscribers get their money back.

This route offers companies, especially those still growing or currently loss-making, the ability to raise funds by relying mainly on sophisticated institutional investors who can take higher risks.

This is how the companies still under loss can bring about an issue. With this being known, it is very important for the retail investors to analyse the issue properly; by reading all KPIs and by considering their risk-bearing capacity, a retail investor should take a bet. 

Written by Leon Mendonca. 

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