What are Key Performance Indicators (KPI) in IPO (Initial Public Offer)

What is the importance of the KPI in IPO?

• KPI are very important in an IPO, whether an SME IPO or a Mainboard IPO, because they show a clear picture of the company's performance. KPI give vital information about profitability, growth, financial strength, and efficiency of the company.
• When a company discloses about KPI in the DRHP, it helps investors to compare the company with others in the same industry and make an informed investment decision.
• For the company, KPI build trust and transparency with potential investors by proving its ability to grow and manage business operations. KPI are a key part of evaluating the true value of the company during the process of IPO.

SME IPO Eligibility

It is mandatory to disclose KPI in Draft Red Herring Prospectus (DRHP) while filing for IPO. Following forms part of KPI disclosure in DRHP:

Sample illustration of Key Performance Indicators (KPI) along with their explanations, as generally required to be disclosed in a Draft Red Herring Prospectus (DRHP).

• Revenue from Operations: 

It is the income company earns from its main business activities, such as selling products or providing services. This is the figure that shows how well the company is performing in terms of income or sales. A company is considered to be doing good if its revenue is growing. So, tracking the growth percentage in revenue is important to understand its progress over the past years.

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• Profit after Tax (PAT)

PAT is the net profit remaining after paying all taxes and expenses by the company. It is one of the most important indicators of the company’s financial health and is also known as the bottom line in the Profit and Loss statement.

A higher PAT represents that the company is managing its expenses well and has strong profitability. PAT is calculated by subtracting all the expenses and tax liabilities from the total income of the company.

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• Profit After Tax Margin (PAT Margin)

PAT is the Net profit remaining after paying all the taxes and expense by the company. It is expressed as a percentage and reflects the company’s overall profitability. 

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• Return on Capital Employed (RoCE)

Return on Capital Employed (RoCE) shows how effectively a company is using its total capital, including debt and equity, to generate profits. It is calculated by dividing operating profit (EBIT) by the capital employed. 

In simple words, RoCE shows how much return the company is earning from the money invested in its business. A higher RoCE ensures better efficiency and stronger financial performance of the company. It is also required to disclose in the DRHP because it helps investors to compare the company’s profitability with industry peers and understand whether the business is using its resources wisely before investing in the company.

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• Return on Equity (RoE)

Return on Equity (RoE) is a profitability ratio that shows how well a company is using the money raised from shareholders. It shows how well a company can make money using the money its owners have put in. The main difference between RoE and RoCE is that RoE looks only at equity, while RoCE considers both equity and debt (total capital).

RoE is calculated by dividing the company’s net profit by shareholders’ equity. It is an important factor for investment decisions, as it shows how efficiently the company is rewarding its investors. A RoE that ranges between 15% to 20% is usually considered good, but it can vary for each company based on its industry and financials. Looking at how this compares to other companies in the same field helps give a better understanding of how well a company is performing.

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• Return on Net Worth (RONW%)

Return on Net Worth (RONW) is a ratio that shows a company’s profitability in percentage terms. It is calculated by dividing the company’s net income (profit) by the shareholders’ equity.

In simple words, it explains how much profit the company is giving back to its owners based on the money they have put in. RONW is used by investors because it shows them how effectively their money is being used to make profits.

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• Debt-Equity Ratio

The debt-equity ratio represents the balance between the borrowings of the company (Debt) and funds invested by the investors (Equity).

In simple words, it shows how much of a company’s business is financed through loans compared to shareholders’ funds. A high ratio indicates that the company relies more on borrowed money, which can increase the financial risk of the company. A low ratio indicates that the company is using more of its funds raised from investors, which is generally considered safer.

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• Earnings per Share (EPS)

Earnings Per Share (EPS) is very widely used tool for measuring a company’s profitability. It presents the profit that is earned for each share which are owned by the investors. In general, a higher EPS means the company is more profitable and financially stronger.

There are two types of EPS – Basic EPS and Diluted EPS that are disclosed in the DRHP. Basic EPS is calculated using only the existing outstanding shares of the company. While Diluted EPS also includes future outstanding shares that could be created in the future from options, warrants, and convertible securities. Diluted EPS is usually lower and gives a more conservative view of the company’s profitability.

• Price-to-Earnings (PE) Ratio

The Price-to-Earnings (P/E) ratio is one of the most widely used tools for assessing stock valuation among investors. P/E ratio is also a crucial metric when a company goes public for IPO valuation. It is the ratio of the current price of a company’s share in relation to its earnings per share (EPS). 

It gives an indication about the valuation of whether a company's stock is undervalued or overvalued. It also serves as a comparative metric with industry benchmarks and peers. Also known as the price multiple of earnings.

P/E ratio assists investors in understanding the stock market and valuations of BSE and NSE-listed companies, enabling them to make strategic decisions.

• EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)

EBITDA is a commonly used financial metric that helps in measuring a company’s operating performance. It presents the profit a company makes from its primary business activities before accounting for expenses like interest, taxes, and depreciation.

For companies, EBITDA is useful to evaluate financial performance and compare results with other businesses in the same industry. For investors and lenders, it gives a clearer picture of the company’s profitability from operations, without the effect of financing and accounting decisions.

What is the Process of Identification of KPI?

These are the key steps involved in the process of identification of KPI for an IPO:

Step:1 Responsibility for Identification of KPI

The management of the company is responsible for deciding which KPI should be included in the offer document. They must make sure that the KPI follow the rules given under the KPI Standards.

Step:2 Criteria for Inclusion

Only measurable and numerical data can be included as KPI. Any subjective or qualitative information cannot be considered as a KPI.

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Step:3 Data Collection and Compilation of KPI for IPO

Key Performance Indicators (KPI) are measures of a company’s past financial and operational performance. For an IPO, the management of the company must gather and collate specific historical information to ensure transparency and compliance. This includes:

• GAAP/Non-GAAP Financial Measures must be disclosed in the offer document as per SEBI ICDR Regulations and considered as KPI.
• Key financial or operational information refers to data that the Issuer Company has shared with any Investor in different scenarios. This includes:

1. Information provided to investors who were allotted Relevant Securities (excluding ESOPs) during any primary issuance in the three years before the filing of the offer document.
2. Information shared during a secondary sale of the Issuer Company’s Relevant Securities, in cases where the company itself was involved in facilitating such a transaction and had shared specific data with the transferees at the time of sale. This also covers instances that took place within the three years preceding the offer document filing.
3. Information provided to investors based on contractual rights, such as information rights, or through any other similar arrangement, again within the three years prior to the filing of the offer document.

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• Information that included in any private placement offer, right offer, for issuance of securities, during the 3 years prior to the date of filing of offer document.
• KPI that are regularly presented or discussed at Board meeting of Issuer company to monitor and track the performance of company during the 3 years prior to the date of filing of offer document.
• KPI that are considered by the Management of the Issuer company to arrive at the basis for the Issue price.
• In case, Issuer company has not made any disclosure to investor regarding KPI the 3 years prior to the date of filing of offer document, then the Issuer company is required to identify the KPI based on the key measure used by the management of the Issuer company.

Step:4 Identification of KPI of Industry peers

The management of the Issuer Company, along with the lead merchant banker(s), is responsible for identifying suitable industry peers for KPI comparison. The following points guide this process:

1. The company should try to identify peers of similar size, operating in the same industry and business model. If an exact comparison is not possible, appropriate notes must be added to explain the differences.
2. The company should aim to compare its KPI with at least three peers, wherever possible, following this order:

• First preference: Indian listed peers.
• If not available, then listed global peers may be used, with financial data converted into Indian Rupees (INR) and the basis of conversion disclosed.
• If relevant, both Indian and global peers may be disclosed together.

1. If fewer than three peers are available, the company must state that only one or two peers are available for KPI comparison.
2. If no suitable peers exist, the company should explain the uniqueness of its business model or industry and clearly mention that no industry peers are available for comparison.

Step:5 Shortlisting KPI from selected data and Peer KPI disclosure

• From the selected data, the management of the Issuer Company must carefully shortlist the KPI to disclose by following factors:
• Projections or future estimates should not be included.
• Any data that cannot be verified, certified, or audited must be excluded. A proper explanation should be given in the audit committee note.
• Only the data that the company’s management actually uses to monitor performance should be included. If some data is outdated or irrelevant due to changes like acquisitions, divestitures, or shifts in the business model, it should be excluded with proper reasoning in the audit committee note.
• If certain data is already covered within another KPI or is just a detailed breakdown of it, it may be excluded. However, if industry peers regularly disclose this data, the company must also disclose it.
• Data that is confidential or sensitive to the company’s competitiveness may be excluded, but again, if peers disclose similar data, the company should not exclude it.

• 1. After shortlisting its KPI, the company’s management must also identify similar KPI disclosures from peers (based on regulatory filings or their websites) for comparison, wherever possible.
  2. Finally, based on these steps, the management will finalize the KPI that should be disclosed in the offer document.

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Step:6 Certification of Selected KPI

The KPI that are selected to disclose in the “Basis for Issue Price” chapter of the offer document shall be certified by the Managing Director (MD) or Executive Director, or Chief Executive Officer (CEO) or Chief Financial Officer (CFO) or Manager on the behalf of the management of the Issuer company.

Management Note: The management of the Issuer company is required to prepare a note which state the following:

• Specifies the GAAP Financial Measures identified as KPI.
• Specifies the Non-GAAP Financial Measures identified as KPI.
• Specifies the Operational Financial Measures identified as KPI.
• Details the process and factors that are considered while preparing and shortlisting of the KPI
• Give explanation about excluded KPI.
• Specifies selected data

FAQS

• Who helps in identifying KPI, and what is the role of the Merchant banker in KPI Disclosure in DRHP?

The KPI of the company are first identified and prepared by the management of the company. These KPI reflect the company’s operational and financial performance over a certain period. After identifying, these KPI are reviewed and approved by the Audit committee. 

The Merchant banker ensures that the KPI disclosed in the DRHP are presented as per SEBI guidelines. This process helps companies to build trust among the investors and other stakeholders. It also gives confidence to investors so they can make better investment decisions.

• Why are these KPI important for Investors?

KPI are important for investors because they show how well a company is performing and growing. In an IPO, whether an SME IPO or Mainboard IPO, KPI helps investors understand the company’s strength, financials, and future potential. 

It is a very easy way to compare the company with its industry peers. By comparing that investors can make informed investment decisions.

• What is EBITDA, and why is it important in an IPO?

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It shows how much profit a company makes from its main operations before paying interest, taxes, or accounting for depreciation and amortization costs.

In an IPO, whether it is an SME IPO or Mainboard IPO, EBITDA is important because it helps investors compare the financial performance of different companies without being influenced by tax rules, financing structures, or accounting choices.

• What are the different categories of KPI?

KPI are broadly classified into three categories. These categories are:

• GAAP Financial Measures
• Non-GAAP Financial Measures, including financial ratios
• Operational Measures, which are not included in above mentioned categories.