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21 May 2025

Navigating SME IPOs - Recent Regulatory Changes

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As capital markets become more and more accessible to both investors and companies, the Securities Exchange Board of India (SEBI) has the primary duty of protecting and safeguarding the interests of its investors.
India Corporate/Commercial Law
Nitin Jain
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Introduction

As capital markets become more and more accessible to both investors and companies, the Securities Exchange Board of India (SEBI) has the primary duty of protecting and safeguarding the interests of its investors.1 Through the implications of rules and regulations, SEBI ensures the smooth functioning across the various segments of the stock exchange. Amongst the varied segments in the stock exchange, the Small and Medium Enterprises (SME) segment is the one which has seen significant growth and development in the past few years. Driven by a recognition of Micro Small and Medium Enterprises (MSMEs) as the foundational pillars of the economic landscape, the government's judicious support and facilitated access to capital markets have cultivated an environment conducive to their robust growth. In an effort to cultivate SME listings, regulatory requirements were judiciously adjusted, providing a more lenient and adaptable framework than that applied to Main Board listings. In response to the burgeoning number of SME listings and the emergence of recent fund misuse cases, SEBI has implemented a series of regulatory modifications to fortify the segment's integrity.

Need for the Regulatory Overhaul

The issuing and listing regulations for the SME segment differ from the entities being listed on the main board based on the issue size, pre and post listing obligations, size of the issuer, etc. The SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR regulations) and the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR regulations) are the primary legislations dealing with these aspects of SME Initial Public Offer (IPO) and listing.

With the rising number of SME issues and increase in allotted investor ratio from 4X in FY22 to 245X in FY24, there was a need for a regulatory overhaul to protect the capital markets and its participants. These listing segments are primarily populated by companies with a promoter-centric or family-owned model, resulting in a high degree of shareholding concentration among a select group of promoters or associated entities. This ownership structure often translates to a dearth of private equity or sophisticated investor participation, thereby diminishing the presence of external oversight. There were also several cases wherein SEBI observed that the issue proceeds were diverted to related parties/ connected parties/ shell companies. Regulatory scrutiny revealed that certain entities manipulated market sentiment by booking fictitious sales and purchases via circular transactions with connected parties, thereby aiming to attract investors to their securities. One of the more recent cases which came into light was of the Gujarat-based Kalahridaan Trendz wherein the SEBI found out 10 months post listing in the SME segment that the company had failed in making material disclosures regarding its default in repayment of dues to HDFC bank and several other non-compliances. The cases of disclosing Related Party Transactions (RPTs) also is one such issue which needed greater scrutiny due to cases of misuse of funds. This was also essentially due to the non-applicability of Corporate Governance provisions provided for under the LODR regulations.

With increasing SME's gaining access to the capital markets and rising instances of financial irregularities, the SEBI over the past months has initiated several steps to secure the SME IPO market.

Regulatory changes for securing SME IPOs

The SEBI on 19 November 2024 published a consultation paper that put forth certain recommendations to ensure the effective regulation of SMEs and strengthen investor confidence in the capital market. It sought recommendations from the stock exchanges and other intermediaries on various aspects such as minimum application size, issue proceeds, lock in period for shares of promoters, disclosure of related party transactions, etc. on the basis of the consultations received, a review paper was filed by SEBI showcasing the recommendations received. The SEBI on its 208th Board Meeting held on 18 December 2024 approved certain regulatory changes based on the consultations it had received. SEBI also published certain amendments in ICDR regulations and LODR regulations on 04 March, 2025 and 28 March, 2025 respectively amending SME IPO regulations.

The changes implemented by SEBI are as follows:

  1. Profitability requirements: An issuer shall make an IPO only if the issuer has an operating profit (earnings before interest, depreciation and tax) of Rs. 1 crore from operations for any 2 out of 3 previous financial years at the time of filing of its draft red herring prospectus (DRHP).2
  2. General Corporate Purposes (GCP): Regulation 230(2) states that the amount for general corporate purposes as mentioned in the objects of the issue in the draft offer document shall not exceed 15% of the amount being raised by the issuer or Rs. 10 crores whichever is less.3 This threshold was implemented as there was no specific monitoring of which expense would be bracketed under GCP so as decrease the risk of misuse of issue proceeds.
  3. DRHP to be made public: The draft offer document which has been filed with the SME exchanges shall be made available to the public for a period of at least 21 days from the date of public announcement by hosting it on the websites of the stock exchanges and lead managers associated with the issue.4 Prior to the enactment of this provision, only entities gearing up to list on the main board were necessitated to make the DRHP public. The rationale based on which SEBI decided to enact this provision was that investor references/ complaints regarding offer documents were mostly received at the time of issue opening and not at the time of dissemination of the draft offer document.
  4. Further issue of shares: Previously, ICDR provisions mandated that SME exchange listed issuers exceeding a ₹25 crore post issue paid up capital threshold due to further issue of capital (rights, preferential, bonus, etc.) would have to migrate to the main board and comply with its listing regulations.5 However, the 2025 ICDR amendment now permits SME entities listed on the SME exchange to undertake further capital issues without mandatory main board migration, provided they adhere to the SEBI (LODR) Regulations, 2015, as applicable to main board listed companies.6 This change ensures the SME segment isn't merely a stepping stone to the main board and allows entities to remain listed on the SME exchange even after their post-issue paid-up capital surpasses the specified limit.
  5. Related Party Transactions: The Related party transactions (RPT) norms, as applicable to listed entities on main board, shall be extended to SME listed entities, provided that the threshold for considering RPTs as material shall be 10% of annual consolidated turnover or Rs. 50 crores, whichever is lower. The SEBI LODR 2025 amendment stated that from 01 April 2025 a transaction with related party shall be considered material if the transactions to be entered into individually or taken together with previous transactions during a financial year shall be subject to the above threshold.7
  6. Cap on Offer for Sale: Offer for sale (OFS) by selling shareholders in SME IPO shall not exceed 20% of the total issue size and selling shareholders cannot sell more than 50% of their holding.8 This would ensure that the issue proceeds contribute towards the business and not provide a cash out option for the promoters of the company.
  7. Objects of the Issue: In 2024, there were several cases wherein the SEBI has objected to the usage of issue proceeds for the purposes of loan repayments especially in the cases of Promoters. This is generally because promoters in the initial days of the company's formation the promoters take hefty loans to set up the entities. In addition to this the core reason for setting up the SME exchange was to make finances available for the growth of SMEs in India and loan repayments do not align with the same. Hence, so as to ensure that the issue proceeds are not utilised for repayment of loans, SEBI responded by amending the ICDR regulations stating that the object of an issue shall not consist of repayment of loan taken from promoter, promoter group or any related party, from the issue proceeds either directly or indirectly.9
  8. Allocation to non-institutional investors (NIIs): Previously the ICDR regulations stated that the allotment procedure for NII category in a book-built issue in cases of SME IPOs was based on proportional allotment which varied from allotment procedure for NIIs in main board IPO. But the 2025 amendment of the ICDR regulations aligns the allocation methodology for NII category in main board IPOs. They are as follows:
    1. 1/3 of the portion available to NIIs shall be reserved for applicants with application size of more than two lots and up to such lots equivalent to not more than Rs. 10 lakhs.
    2. 2/3 of the portion available to NIIs shall be reserved for applicants with application size of more than Rs. 10 lakhs.10
  10. Minimum Application Size: For SME IPOs to be more accessible, the ICDR regulations priorly stated that the minimum application size shall be Rs. 1 lakh per application. But ease in entry led to unnecessary speculation in the market. One of the biggest examples of unnecessary speculation in the SME segment of the Stock exchange can be seen with the listing of shares of Resourceful Automobile. The entity which operated with 8 employees and 2 outlets for selling automobiles received bids over 418.82 times which was worth approximately Rs. 4800 crores for its Rs. 12 crore IPO. This IPO frenzy has now fallen flat as the shares have plummeted to more than 50% from the initial price of Rs. 117 at which it was listed on August 2024. To prohibit such instances wherein investors are investing not because of an IPO fever, the minimum application size was increased to Rs. 2 lakhs per application. SEBI in its consultation paper while proposing the above change stated that SME IPOs tend to have higher elements of risk and investors getting stuck if sentiments change post listing and hence to protect the individual investors from such incidents, the minimum application size was increased.
  11. Promoter lock in period: Prior to the 2025 amendment of the ICDR regulations, minimum promoter contribution (20%)11 by promoters was locked in for a period of 3 years and excess of the same was locked in for a period of 1 year post IPO. It was reviewed and suggested by the stock exchanges that the specified securities held by the Promoters should be released in a phased manner rather than releasing the entire lock in one go. In lieu of this it that the minimum promoter contribution shall be locked in for a period of 3 years. Excess from the minimum promoter contribution shall be released in phases i.e., 50% shall be locked in for a period of 2 years from date of allotment in the IPO and remaining 50% shall be locked in for a period of 1 year from the date of allotment in the IPO.12

With the ongoing IPO frenzy in the Indian capital markets, especially in the SME segment, the enactment of these amendments is a welcome change for the investors, regulators and the intermediaries. By introducing these amendments, regulators aim to safeguard SME IPOs from manipulative practices by entities and individuals seeking undue profits through market inflation and bubble creation. At the same time, they aim to build trust and encourage participation from both SMEs seeking growth capital and individual investors pursuing genuine wealth creation opportunities. Accordingly, these substantive amendments enacted by SEBI and relevant market intermediaries are intended to achieve a balance between the imperative of investor protection and the crucial objective of promoting and facilitating the development of SMEs in India.

In Sum

Therefore, the recent regulatory amendments introduced by SEBI mark a significant step toward fostering transparency, accountability, and investor confidence in the SME IPO segment. By addressing critical issues such as misuse of funds, inadequate disclosures, and speculative market practices, these reforms aim to safeguard the integrity of the SME capital market while ensuring its accessibility to genuine participants. Measures such as stricter profitability requirements, enhanced disclosure norms, caps on offer-for-sale transactions, and phased promoter lock-in periods strike a balance between investor protection and the growth aspirations of SMEs. These changes not only mitigate risks but also encourage the participation of institutional and retail investors in a more secure and structured environment. Ultimately, these reforms underscore SEBI's commitment to promoting sustainable development in India's SME ecosystem, thereby aligning with the broader objective of economic growth and financial inclusion.

Footnotes

1 Section 11 of the Securities Exchange Board of India Act, 1992.

2 Regulation 229(6) of the Securities Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018.

3 Regulation 230(2) of the Securities Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018.

4 Regulation 247(1) of the Securities Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018.

5 Regulation 280(2) of the Securities Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018.

6 Regulation 280 of the Securities Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018.

7 Regulation 3(3)(b) of the Securities Exchange Board of India (Listing Obligations and Disclosure Requirements) (Amendment) Regulations, 2025.

8 Regulation 230(1) (f) and (g) of the Securities Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018.

9 Regulation 230(1) (h) of the Securities Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018.

10 Regulation 253 (2) of the Securities Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018.

11 Regulation 236(1) of the Securities Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018.

12 Regulation 238 (b) of the Securities Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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