IPO Safety Net

The idea of an IPO Safety Net is being discussed since the past couple of months or so and there were some news articles that said SEBI might even make it mandatory, but even before that Sai Silks came out with an IPO last week, and included the safety net scheme in that.

Under this scheme, if the share price fell below the IPO price at any time within 6 months from the issue of shares, the promoters will buy back shares from retail investors at the IPO price. Sai Silks put a limit of 1,000 shares per investor under this scheme. This of course only applies to the original allottee and if you bought the share from the stock market after it listed then you won’t be covered under this safety net.

This is not the first time a company has done this, and about 7 years ago – Usher Agro had also come out with a safety net.

I don’t see the point of this scheme and feel that if made mandatory it will be counter productive to its good intentions which is to protect the small investors against IPOs that fall very badly after listing.

Most small investors who invest in the IPO market have no intention of holding the stock for more than a few days and sell it if they can make a small gain. You can’t and you shouldn’t protect against this type of mentality. People should understand that equity is risky, and people should only speculate if they can stomach losing money.

If the idea is to kick start the IPO market again, then this will not solve it because the IPO market has slowed down due to the fact that there are hardly any good companies that have listed with a reasonable price. Till such time that good companies list in the market at a reasonable price, the IPO market won’t get started again, and this step, if made mandatory, creates a disincentive for good companies to list.

The promoters part with their stake in the company, and if the share falls due to a broader fall in the market, they have to now make good losses of the retail investors as well. So, first they part with their stake, and then they part with their money?

I think this creates an disincentive for good companies to list, or list their stocks at a considerable discount to what they feel is the intrinsic value which will in turn give rise to an IPO pop at the day of listing, and people will be busy selling within a few hours. This will also mean that a lot more people apply for shares and get only a handful shares at subscription. There is no benefit of being in this situation either.

I feel this is a bad idea and if a company wants to create such a safety net then they are free to do so but forcing it on all companies creates perverse incentives in the market, and won’t contribue to an environment where a healthy capital market can flourish.

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