First introduced in India in 2008, small and medium enterprise IPOs (SME IPOs) opened the floodgates for numerous relatively smaller companies to raise capital from the general public through the IPO route. Since then, more than 565 companies have listed on NSE Emerge while more than 524 companies have listed on BSE SME, the dedicated SME listing platforms of the exchanges. Impressively, around 322 of these companies have successfully migrated from the SME board to the main board of these stock exchanges. As per SEBI data, INR 1.99 lakh crore of market capitalization is commanded by these companies as of October 15, 2024.
SME IPOs are once again back as a topic of discussion, this time on account of SEBI's long-overdue proposal to revamp the governing regulations, stemming from concerns around family-owned operations of most SMEs and the attendant lack of checks and balances on the activities of the promoters, often leading to instances misuse/diversion of IPO funds, IPOs by financially weak issuers, artificially inflated revenue through circular transactions between the issuer and related entities, incorrect disclosures and omissions in the draft red herring prospectus (DRHP) etc. As a first step, the exchanges have now begun asking 7-8 rounds of queries from issuers/merchant bankers after filing of their DRHP, compared to the earlier 2-4 rounds.
Key proposals in the Consultation Paper
To alleviate some of the above concerns, SEBI released a consultation paper titled ‘Review of SME Segment Framework under SEBI (ICDR) Regulations, 2018' on November 19, 2024. In this consultation paper, SEBI has proposed approximately 11 significant changes to the existing rules in the SEBI (ICDR) Regulations, 2018. Some of the key proposals pertain to the following aspects:
- Minimum application size: SEBI has proposed increasing the minimum application size for SME IPOs from the present value of INR 1 lakh to INR 2 or 4 lakh, with the rationale that an increase in minimum application size will ensure that such IPOs only attract investors with a higher net worth, and therefore, a higher risk-taking capacity.
- The offer for sale size: SEBI proposes to restrict the offer for sale (secondary sale) of shares as part of the IPO to not more than 20% of the total issue size. This will help to position the IPO as a means for the company to raise capital to expand its operations/repay debt rather than providing a way for the promoter(s) to exit from the company.
- Promoter contribution lock-in: Another key proposal is to increase the lock-in period for Minimum Promoter Contribution (MPC) to at least 5 years.
- Limiting the objective of IPO: SEBI has proposed that the object of the IPO cannot, even in part, be to repay a loan which has been taken by the promoter, the promoter group, or a related party, in order to ensure that the IPO funds are being used to grow the company and benefit the investor.
- Monitoring of IPO proceeds: The deployment of IPO proceeds, where the fresh issue size is more than INR 20 crore, will now have to be monitored by a monitoring agency. The lowering of this threshold from INR 100 crore earlier will help ensure that funds are not diverted to objects apart from those disclosed in the DRHP, even for smaller IPOs.
Rationale and Implications of the Consultation Paper
The proposed amendments to the ICDR Regulations are well-intentioned and geared towards protecting retail investors in the capital markets and while causing some consternation, they have been favourably received by the SME community. Manav Goenka, President (Investment Banking) of Horizon Management Private Limited, a prominent merchant banker in the SME IPO ecosystem, believes that ‘the SEBI consultation paper aims to strengthen SME IPO market integrity by addressing key issues like misuse of IPO proceeds, diversion of funds, promoter exits and corporate governance. The proposal to increase the minimum application size to INR 2 lakh shall ensure that only well-informed investors and those with high-risk appetite participate in the SME market. The proposals relating to monitoring agency and related party transactions address issues relating to diversions of funds and shall ensure that the funds are utilised for the growth of the company'.
On the flip side, there is some concern amongst the smaller-end of SMEs which were preparing to undertake an IPO. While some SME IPO-bound companies yet to file their offer documents with the exchange(s) may have to race against time to file before enactment of the proposals (we expect these to come in force from January), companies which have already formally kicked-off their IPO process may find themselves in a tricky situation where they may not be fulfilling the conditions prescribed in the consultation paper once they are codified in law.
Given the increased regulatory scrutiny over the last quarter, we would not be surprised if an overwhelming majority of SEBI's proposals are enacted as-is. On their part, the exchanges seem to be already treating the proposals as enacted law, and discouraging IPO-bound companies from filing their DRHPs or returning their DRHPs if they fall afoul of the consultation paper. However, certain proposals (if enacted into law), including those on minimum allottees being 200, or on partnership firms having to wait 2 full years after conversion into limited companies, could be diluted/examined on a case-to-case basis to continue to enable genuine companies to list. In this context, Vinay Jajodia, Director of Giriraj Stock Broking, which acts as market maker on a number of SME IPOs notes that ‘the proposed changes in SEBI's SME IPO regulations are welcome and we believe that this will filter out issuers which are weak in terms of corporate governance. However, we also think that SEBI should reconsider the proposals relating to: (i) the increase in the lot size for retailer investors because this proposal will lead to increased risk for them by concentrating their money in one stock, and; (ii) the imposition of a 2-year cooling-off period for LLPs and partnership firms post conversion before the IPO because the conversion from an LLP or partnership structure to a limited company is often a natural progression for companies that have reached a certain level of growth'.
In conclusion, we believe that not all measures ought to make doing business easier and doing business the right way is just as vital. SEBI has struck the right balance between investor protection and enabling companies to raise capital on the SME board, while seeking to uphold the integrity of the country's capital markets. The proposed amendments in the consultation paper are a clear manifestation of the regulator's intent to ensure that funds raised from the public are being used appropriately with greater transparency, similar to the standards expected from companies listing on the mainboard.
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