Key performance indicators – communicating the measures that matter

Key performance indicators – communicating the measures that matter

In the offer documents, along with audited financial numbers, issuer companies disclose various key performance metrics/ indicators which are not covered in the financial statements e.g., sales per square foot/meter by entities in the retail sector, refinery utilization. These Key Performance Indicators (KPIs) are disclosed in numerical measures indicating different aspects of issuer company’s operational performance. Presently, SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘ICDR Regulations’) provides a detailed framework for disclosure of information in the offer document, including financial information and information relating to 2basis for issue price. SEBI noted that issue price/ price band is decided primarily basis certain factors, including trends in KPIs over the past years. However, no framework has been provided in the ICDR Regulations for disclosure of KPIs. Accordingly, ICDR Regulations were amended on 21 November 2022 to provide certain disclosures relating to KPIs in the offer document under the basis for issue price section of an offer document.

This article summarizes the key amendments to ICDR Regulations and the glide path that may be followed by companies for moving toward good practices of improving their communication with stakeholders.

Need for disclosure of KPIs

Traditional financial parameters/ ratios currently required to be disclosed in basis for the issue price section of an offer document represents typical evaluation criteria for companies that take profits into consideration. Even for such companies, KPIs would additionally aid the investors in taking better and more informed decision for investment in the said company. Further, the traditional parameters do not exactly correlate with the companies who are yet to turn profitable or who are seeking to scale up their business in the coming years. New age technology/ startup companies opt for scale over profits in their growth phase and thus, generally break even over a long business cycle. Contrary to established businesses, scale is often considered being the means for profit rather than profit being the primary objective of such companies in the initial years of their operations.

Thus, appropriate disclosures on all parameters that are relevant for assessing the issuer’s performance (for both profitable and loss-making companies) are required for helping investors to take informed decision. SEBI felt a need to disclose KPIs, be it profit or loss making, in their offer documents.

Accordingly, ICDR Regulations were amended to provide a framework for disclosure of KPIs under the basis for issue price section of an offer document. The ICDR Regulations do not prescribe a list of KPIs that should be included.  The identification and computation of KPIs have been left to the judgement of the issuer company. The ICDR Regulations also provide that the basis for issue price section of an offer document should contain prescribed matters e.g. cross reference of KPIs disclosed in other sections of the offer document to be provided on the basis for issue price section of the offer document.

ICDR Regulations further provide that the issuer company should continue to disclose KPIs disclosed under the basis for issue price section on a periodic basis at least once in a year (or any lesser period as determined by the issuer company). The duration of such disclosure should at least be later of:

• One year after the listing date or period specified by SEBI; or
• Till the utilization of the issue proceeds as per the disclosure made in the objects of the issue section of the prospectus.

Adequate look-back period

SEBI observed that while there is an in-principle agreement for prescribing a look back period, there were divergent views regarding what would constitute an adequate duration for look back. KPIs disclosed at previous rounds of fund-raising before the IPO may no longer be relevant considering the rapidly changing business environment. Also, KPIs provided to different pre-IPO investors may have been different, based on their specific internal fund requirements and therefore it should be at the discretion of the issuer to decide as to which KPI is material or relevant at the time of IPO.

However, leaving it to the discretion of the issuer company to decide the relevant and material KPIs that may be susceptible to subjective decision. Disclosure of all the KPIs previously disclosed to pre-IPO investors would aid the prospective investors with the same insight that the pre-IPO investors had, before investing in the IPO. It would bring greater alignment and transparency between the information available pre-and- post IPO.

Accordingly, the ICDR Regulations now require that basis for issue price section of offer document should include disclosure of all the KPIs pertaining to that have been disclosed to the investors at any point of time during the three years preceding to the date of filing of the draft red herring prospectus/ red herring prospectus. The issuer company, in consultation with the lead merchant banker, may make disclosure of any other relevant and material KPIs as it deems appropriate, that have a bearing for arriving at the basis for issue price.

Enhanced monitoring and governance

ICDR Regulations were amended to prescribe additional responsibilities on the issuer company and the lead merchant bankers for all KPIs disclosed in the offer document such as ensuring that:

• erms used in KPIs have been defined consistently and precisely in the definitions and abbreviations section of the offer document using simple English terms/phrases to enable an easy understanding of the contents. Technical terms, if any, used in explaining the KPIs shall be further clarified in simple terms.
• KPIs disclosed in the offer document have been approved by the Audit Committee.
• KPIs disclosed in the offer document should be comprehensive and explanation should be provided on how these KPIs have been used by the management historically to analyze, track, or monitor the operational and/or financial performance of the issuer company.
• Comparison of KPIs over time should be explained based on additions or dispositions to the business, if any. e.g., in case the issuer company has undertaken a material acquisition or disposition of assets / business for the periods that are covered by the KPIs, the KPIs should reflect and explain the same.
• or each KPI being disclosed in the offer document, the details thereof should be provided for a period which will be co-terminus, with the period for which the restated financial information is disclosed in the offer document.

Audit Committee of the issuer company is required to provide a confirmation that verified and audited details for all the KPIs that have been disclosed to the earlier investors at any point of time during the three years period prior to the date of filing of the draft red herring prospectus/ red herring prospectus have been disclosed under basis for the issue price section of the offer document. Such confirmation should be disclosed under the basis of issue price section in the offer document.

Further, the issuer company and the lead merchant banker should obtain a recommendation from a committee of independent directors that the price band is justified based on quantitative factors/KPIs disclosed in the basis for issue price section vis-à-vis the weighted average cost of acquisition of primary issuance/ secondary transaction(s) disclosed in such section. Such recommendation is required to be disclosed in the price band advertisement.

Independent assurance of KPIs

While discussing with expert bodies including the Institute of Chartered Accountants of India and Institute of Cost Accountants of India, SEBI noted that members of some of the expert bodies can certify KPIs for financials (disclosed in accordance with applicable accounting framework), financial measures which are not defined under accounting framework, as well as the non-financial measures which are quantitative information that are obtained from the accounting records and are subjected to same controls as those financial measures.

Accordingly, ICDR Regulations were amended to provide that KPIs disclosed in the offer document should be certified by the statutory auditor(s) or chartered accountants or firm of charted accountants or by cost accountants holding a valid certificate issued by the Peer Review Board of the respective expert body. The certificate issued with respect to KPIs should be included in the list of material documents for inspection.

Also, the ongoing KPIs post listing (as discussed in the paragraph - Need for disclosure of KPIs) would continue to be certified by a member of an expert body in the same manner.

Glide path to effective communication of KPIs

An issuer company may consider the following common aspects while disclosing KPIs in an offer document. These considerations provide companies with a sound basis for moving towards good practice, as they seek to improve their communication with stakeholders.

Link to strategy

Linking KPIs with the strategies and objectives, as a measure that depicts business performance, enables readers to assess the company and its potential to succeed. KPIs presented in isolation cannot fulfill the desired objective and will fail to provide the reader with the level of understanding they need.

Source, assumptions and limitations

Identify the sources of the data used in calculating KPIs and any limitations on that data. Consider the robustness of IT/systems, processes, and controls. Any assumptions made in measuring performance should be explained so that readers can reach an informed view of judgements made by management.

Definition/ calculation

Given the rapidly increasing usage of industry-specific terminology, clear definitions of KPIs add greatly to the reader’s understanding of exactly what is being measured and allow comparisons. With companies applying their own indicators, an explanation of the components of a metric and how it is calculated is vital.

Reconciliation to GAAP

Where the amounts measured are financial but are not commonly known measures in the context of financial statements, it is good practice to explain any differences. A reconciliation should therefore be provided between accounting measures and non-GAAP measures.

Purpose

It is important for management to explain - what makes a performance indicator “key”? The starting point for choosing which performance indicators are key to a particular company could be those that the Board of Directors uses to manage the business and use as inputs to make key decisions.

Changes in KPIs

Comparability over time is a key principle of good corporate reporting. When changes are made to the KPIs, either in terms of the KPIs used or how they are calculated - these changes need to be explained.

How we look at it

On the back of heightened IPO activity followed by lackluster performance and subdued IPO activity over the last 18 months, the above amendments seem to be an effort to bolster investor confidence and bring more transparency to IPO pricing process through increased disclosures by reducing the information asymmetry between the issuer and the investor. Indian capital markets are taking a lead in the level of disclosure issuer companies are required to make in relation to KPIs.

Companies should carefully evaluate and determine what would be categorized as KPI for them, the relevant industry benchmarks, the appropriateness of KPIs (especially modifying GAAP recognition and measurement principles to produce non-GAAP measures) that best depicts business performance and impacts the basis of issue price.

The committee of independent directors would need to recommend that the price band is justified based on quantitative factors / KPIs. This puts an onerous responsibility on independent directors since providing such recommendation would generally involve exercise of significant judgement by such directors.

• The committee of independent directors would need to recommend that the price band is justified based on quantitative factors / KPIs. This puts an onerous responsibility on independent directors since providing such recommendation would generally involve exercise of significant judgement by such directors.