SEBI is keeping a strict watch on usage of proceeds from initial public offerings (IPO) to detect possible fraud as many small and medium enterprises companies are flocking to the primary markets to ostensibly meet their working capital needs.
Unlike funds raised for capital expenditure, the use of working capital can be mismanaged, and it is very difficult to trace the final benefit of its usage, experts say.
Key concern
S Venkat, Founder of business consulting firm Practus, said while it is justified for companies to allocate some portion of IPO proceeds for working capital requirements, very high allocations could potentially be a red flag.
Late last year, SEBI cancelled the IPO of Trafiksol ITS Technologies and ordered it to refund ₹45 crore raised. The issue, priced at ₹70 a share, was oversubscribed 346 times. One of the objects of the issue was to purchase software from a third-party vendor which turned out to be shell company with fabricated profiles and forged financial statements. The SEBI order was post a probe triggered by a complaint regarding the use of issue proceeds and wrongful disclosures.
Similarly, SEBI banned Mishtann Foods from equity markets after it found negligible fixed assets on its books and negative cash flow from its operating activity. The company raised ₹50 crore out of which ₹37 crore was to be used to meet working capital requirements.
Funds raised
Of the overall ₹8,822 crore raised by 242 companies through SME IPO last year, about 35 per cent or ₹3,091 crore were for meeting working capital requirements, according to data collated by AIF manager Finavenue, from NSE Emerge and BSE SME.
Funds raised for capex at ₹2,447 crore accounted for 27 per cent while that of general corporate purpose added up to ₹1,456 crore or 16 per cent, the data showed.
Abhishek Jaiswal, Fund Manager, Finavenue said while SEBI has put 15 per cent cap on fund raised for general corporate purpose in SME IPOs, a similar upper limit for raising working capital will protect investors’ interest.
A warning sign
While excessive reliance on working capital funding can be a warning sign, he said investors can examine the consistency of reported figures across income statements to spot discrepancies or sudden spikes in working capital requirements.
In the case of Mishtann Foods, it was found to have very low inventory as compared to its sizeable sale figures during the investigation period and were prima facie found to be fictitious, involving a circular flow of funds.
When companies scale, they need working capital to finance higher levels of receivables and inventory. This incremental working capital is effectively ‘locked’ in the business for the long term and hence using equity to finance working capital can be justified to an extent, Venkat qualified.