In the world of capital markets, credibility is currency. This is especially true when Small and Medium Enterprises (SMEs) seek to list their shares on the SME Platform through an Initial Public Offering (IPO). For investors to believe in the business, they must first believe that the promoters are committed. The backbone of any successful IPO lies in the confidence promoters show in their own company.

SEBI, the capital market regulator, addresses this concern through two key mechanisms:

1. Promoters’ Minimum Contribution, and
2. Lock-in Requirements.

These aren’t just legal terms. They’re designed to show investors that the promoters aren’t looking for a quick exit but are genuinely invested in the company’s long-term future.

What is Promoters’ Contribution?

Promoters’ Contribution refers to the minimum amount of shares that the promoters must invest and offer as part of the IPO. It shows the promoters’ confidence in the business and provides assurance to public investors. Simply put, promoters must hold at least 20% of the post-issue capital of the company. This is a regulatory requirement under Regulation 236(1) of SEBI’s ICDR Regulations.

For any company going public, promoters’ commitment remains the cornerstone of investor confidence. This ensures that promoters stand to gain or lose alongside public shareholders, reinforcing alignment of interests.

This 20% can be:

• Already held shares, provided they meet eligibility conditions
• Fresh subscription in the IPO, either in equity or convertible securities

In some cases, such as startups or professionally managed companies, promoters might not be able to hold 20%. SEBI allows trusted investors as mentioned below to step in and make up the shortfall (up to 10% of the post-issue capital):

• AIFs (Alternative Investment Funds)
• Foreign Venture Capital Investors
• Scheduled Commercial Banks
• Insurance Companies
• Public Financial Institutions
• Large non-promoter public shareholders (holding 5% or more)
• Promoter Group entities (other than the actual promoters)

And if a company doesn’t have an identifiable promoter, this 20% rule doesn’t apply at all.

How Can Promoters Contribute?

Promoters can contribute through:

• Equity shares
• Convertible securities (with a clear promise to convert into shares later)

If the conversion price isn’t fixed upfront, promoters must give a written commitment and disclose it in the IPO offer document.

In IPOs involving convertible debt instruments, the promoters must:

• Contribute at least 20% of the total project cost in equity
• Bring in at least 20% of the issue amount from their own funds

Also, the promoters must meet these funding requirements at least one day before the IPO opens.

What Can’t Be Counted as Promoters’ Contribution?

Not every share qualifies as valid promoter contribution. Regulation 237 of ICDR Regulations, 2018 list out certain securities that are ineligible for the promoter’s contribution:

• Shares received in the last 3 years for consideration other than cash and revaluation of assets or capitalisation of intangible assets is involved in such transaction
• Shares received in the last 3 years through bonus issue from revaluation reserves or unrealized profits or from bonus issue against equity shares which are ineligible for minimum promoters’ contribution
• Shares bought in the past 1 year at a lower price than the IPO price (unless the difference is paid)
• Pledged shares (used as loan security)
• Shares received from partnership/LLP conversions at low prices (unless held for more than 1 year)

There are some exceptions, like shares received through mergers approved by a tribunal or fully paid convertible instruments held for over a year. The list above covers some key points, but there are other ineligible scenarios as well, therefore it is advisable to do a detailed eligibility check before finalising promoter contribution.

Lock-in Period: Why It’s Important

In practice, it has been observed that promoter shareholding in SME companies often declines significantly, soon after the completion of the initial lock-in period. This trend raises concerns about the long-term commitment of promoters. To address this, regulatory provisions aim to discourage promoters from fully exiting their stake immediately after the lock-in release. Ensuring promoters retain a meaningful stake post-IPO supports the long-term stability and operational sustainability of the company. To make sure promoters and key shareholders stay invested even after the IPO, SEBI has introduced the provisions of lock-in periods under Regulations 238 and 239 of ICDR Regulations.

For Promoters:

• The minimum 20% contribution is locked in for 3 years
• If promoters own more than 20%:
• 50% of the extra holding is locked for 2 years
• Remaining 50% is locked for 1 year

For Other Pre-IPO Shareholders:

• Their entire shareholding is locked for 1 year from the IPO allotment date

This prevents early exits and ensures price stability after the listing.