SEBI Chairman M. Damodaran explains the rational behind rating though many content that equity is by definition risk capital.

An entrepreneur comes to the market with the idea of realising his dream and he wants support (funds) from investors at a low cost. Will grading affect a genuine entrepreneur and prevent him from entering the market to raise funds?

Mr. Damodaran said, “I don’t see any reason why it should. Let me explain. First, take the nature of the product itself. And second, the process through which grading is done.

What is the nature of the product? We know that equity is risk capital. We also know that a share that is attractive at Rs. 10 may not be so at Rs. 1,000. And most importantly, we know that ultimately an investor will make his decision based on a number of parameters. One of them is the IPO grading. Grading is not intended to be a substitute for the judgment of an investor. “The rating agency does not say you buy or don’t buy a scrip. It cannot because it is not a price recommendation. A sell side recommendation from a broking house is a recommendation with a price. Grading does not have a price. What does a grading have? It looks at the fundamentals of an issue. It looks at five different parameters. It is the minimum. It may look at some other parameters too. It will look at what is the business like, what are its prospects. It will notice any negative in its track record. If does not have a track record, it doesn’t have a negative track record either.

“The second is very important. Why do we think of IPO grading? Because when the market started going up suddenly a lot of people started coming to the market. It is not that only the best and the brightest continue to come to the market, there are a lot of other people who started entering the market.

“One of our concerns is whether we are going to have another round of `vanishing companies’ which will raise money and never spend it for the intended purpose. I firmly believe that grading, if made mandatory, will prevent vanishing companies in future.”