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Regulatory Safeguards for Fund Allocation: Navigating Variations in Objects of the Issue - MMJC
Object of the Issue: Commitment to purpose
When companies raise funds through an Initial Public Offering (IPO) or other public issuance, they commit to specific goals for the use of these funds, known as the “Objects of the Issue.” According to Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) regulations, 2018 (‘ICDR’)[i] companies planning to conduct an IPO must clearly disclose the object of the issue in the offer document. This means that the company is required to provide detailed information about the specific purpose for which the funds raised through the IPO will be utilized.Effective monitoring of funds raised through public issues is essential to ensure alignment with the object of the issue stated in offer documents. However, companies often face unforeseen circumstances or strategic shifts that necessitate deviations from their original plans.
Below are few case studies where companies had to deviate from the slated objects as specified in DRHP due to some unforeseen circumstances:
A. Unforeseen Changes in Circumstances:
Unexpected situations often compel companies to reallocate funds to address operational or market challenges. These changes, though unplanned, highlight the importance of adaptability in achieving organizational goals.
1. Company A – Construction and Equipment Delays
Allocation to Object Clause as per DRHP:
₹82.70 crores were allocated for constructing a new manufacturing facility in Panchla, West Bengal, with a planned completion in FY 2023.
Variation and Reason:
Due to construction delays, the company has extended its timeline for the completion of the Panchla facility construction from the fiscal year 2023 to fiscal year 2024. The company reallocated ₹30.78 crores for civil work, clean room costs, and equipment by introducing a new funding sub-category, “Machines & Moulds,”. This adjustment ensured that the project stayed within budget while addressing unforeseen delays.
2. Company B – Market Adaptation and Flexibility
Allocation to Object Clause as per DRHP:
₹234.55 million was earmarked for capital expenditure from the ₹5,000 million raised through its IPO.
Variation and Reason:
By FY 2023, only ₹149.18 million was utilized, and the remaining ₹85.37 million was deferred to FY 2024 and FY 2025. The company revised its retail strategy, prioritizing Multi-Brand Outlets (MBOs) over Exclusive Brand Outlets (EBOs) due to difficulties in securing affordable rental spaces. This flexibility enabled the company to navigate market conditions effectively.
3. Company C – Shift from Capital to Operational Expenditure
Allocation to Object Clause in DRHP:
₹34.65 crores were allocated for machinery and equipment to upgrade existing data centre infrastructure of company.
Variation and Reason:
The company initially allocated the funds to upgrade the existing data centre infrastructure as it neared the end of its lifecycle, but only ₹1.41 crores out of ₹34.65 crores were spent in FY 2022 on current data centre infrastructure, and the remaining funds were reallocated to migrate operations to Amazon Web Services (AWS) Cloud which is a scalable and resilient infrastructure, which can adapt to the company’s evolving needs without the limitations of physical infrastructure. Migrating to AWS Cloud allows the Company to avoid the periodic, significant investments required for upgrading physical data centre equipment every five years. This shift from capital to operational expenditure reduced infrastructure costs, improved scalability, and introduced a predictable cost structure.
B. Strategic Goal Revisions or Lack of Clarity
Some reallocation decisions happen because of changes in the company’s overall strategy or a better understanding of its goals. While these changes reflect the company’s priorities, they might sometimes seem unclear or not fully explained.
1. Company A – Operational Efficiency and Strategic Alignment
Allocation to Object Clause as per DRHP:
The IPO funds were allocated for the expansion of “Nashik Manufacturing Facility I.”
Variation and Reason:
Company Allocated the funds for the expansion of the “Nashik Manufacturing Facility II” in Trishala, Nashik. This development of new facility intended to improve operational efficiency and take advantage of new opportunities at the site. This change aligns with the companies updated growth strategy and boosts production capacity.
Due to delays in the project, the company needs more time to fully utilize the remaining IPO funds. Originally, these funds were to be used by the end of FY 2024-25, but the Board of Directors proposes extending the deadline to FY 2028-29
2. Company B – Debt Repayment and Financial Restructuring
Allocation to Object Clause as per DRHP:
To utilise ₹448.83 million out of the IPO Proceeds towards funding the capital expenditure of the Company’s wholly owned subsidiary company for the purpose of setting up a manufacturing facility at plot in SEZ Aerospace Park, Devanahalli, Bengaluru, for Electronic Manufacturing Services (“EMS Facility”)
Variation and Reason:
The company used internal funds for setting up the EMS facility and reallocated IPO proceeds for debt repayment and corporate expenses. Such repayment and/or pre-payment will help reduce company’s outstanding indebtedness, reduce debt servicing costs, improve debt-to-equity ratio and enable the utilisation of company’s accruals for further investment in company’s future business growth and expansion plans.
Process of Changing Object of the issue:
As is seen above companies sometimes need to change their object of the issue. This may include change in timelines of use of issue proceeds, reallocation of IPO proceeds. In that process as prescribed under Section 27 of the Companies Act, 2013 and Rule 7 of Companies (Prospectus and Allotment of Securities) Rules, 2014 needs to be followed. The process begins with the Board of Directors approving the proposed change and preparing a detailed notice for shareholders. This is followed by seeking shareholder approval through a special resolution requiring 75% consent via a general meeting or postal ballot. The notice must clearly outline the original objects of the issue, funds raised, utilization status, proposed changes, reasons, and associated risks. Key details of the resolution should then be advertised in one English and one vernacular newspaper. Dissenting shareholders must be provided an exit offer in line with SEBI guidelines. Finally, the company must notify stock exchanges, upload relevant details on its website, and report the changes in the annual Director’s Report.
What care should be taken while drafting object clause?
In order to avoid change in objects of the issue care needs to be taken in drafting the objects clause. As is seen from above examples some of the variations are due to unavoidable circumstances, while other deviations reflect a strategic realignment, where companies have proactively chosen to redirect funds to align with broader growth objectives or emerging business needs. These adjustments highlight a need for flexibility in fund utilization. Such deviations from the original object of the issue raise concerns about the company board’s long-term strategic vision, potentially leading shareholders to question the reliability of their investment.
To avoid such deviations from the stated purpose of the issue, companies should carefully consider and refine their plans before including them in the prospectus that will ultimately be presented to shareholders. Only well-thought-out and realistic objectives should be listed to ensure alignment with long-term strategy and to build shareholder trust.
When defining the object of the issue, companies should ensure,
- Alignment with long-term strategy.
- Set realistic and achievable goals.
- Anticipate market conditions to maintain flexibility.
- Each use of funds should have a clear, transparent justification, and contingency planning should be in place to manage any unforeseen obstacles.
- Objectives should also align with the company’s financial health, especially regarding debt repayment or operational expansions.
By focusing on these aspects, companies can build shareholder trust and reduce the likelihood of deviations.
Choosing the right key partners, such as merchant bankers, monitoring agents, statutory auditors, legal counsel is crucial for a company. These professionals are responsible for ensuring that the company sticks to its stated objectives and complies with all legal and regulatory requirements. For example, merchant bankers and monitoring agents play a vital role in overseeing the proper use of funds, helping to prevent deviations from the object clause. Statutory auditors and legal counsel ensure that everything is transparent and legally sound, while registrars manage the issuance process and investor records. By carefully selecting these partners, companies can minimize the risk of straying from their original plans, protecting shareholder interests and maintaining the integrity of their operations.
[i]Chapter II Regulation 24 (2) (b) of Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) regulations, 2018 (‘ICDR’)
This article is published on Taxmann
This article is written by Animesh Joshi – Associate– animeshjoshi@mmjc.in