Addressing Concerns in the SME IPO Landscape: A Call for Regulatory Reform
The landscape of Small and Medium Enterprises (SMEs) in India has witnessed a significant transformation over the past decade, particularly with the introduction of a light regulatory framework by the Securities and Exchange Board of India (Sebi) in 2012. This initiative aimed to boost SME listings and contribute to economic growth, resulting in a remarkable increase in market capitalization and investor participation. However, recent analyses have revealed troubling concerns that threaten investor protection and market integrity, necessitating a reevaluation of the existing regulatory framework.
The Rise of SMEs and Emerging Concerns
As of October 2024, there are 745 companies listed on SME exchanges, boasting a market capitalization of ₹2 trillion. The fiscal year 2023-24 alone saw 196 IPOs raising over ₹6,000 crore, with investor participation soaring to 46 times in FY2022. While these figures are promising, they also expose vulnerabilities within the SME sector. Sebi’s analysis highlights issues such as misuse of IPO proceeds, fund diversion, promoter exits, and market misconduct. Alarmingly, many SMEs engage in substantial related party transactions (RPTs), with nearly half of these transactions exceeding ₹10 crore and one in five surpassing ₹50 crore.
The predominance of promoter-driven or family-run businesses further complicates the scenario. With minimal involvement from private equity or sophisticated investors, there is a lack of checks on promoter influence, leading to potential risks for retail investors. Recent cases of misuse of IPO proceeds underscore the urgency for regulatory intervention to safeguard investor interests.
The Need for Stricter Regulations
In response to these challenges, Sebi has proposed tightening the regulatory framework governing SME listings. The proposed changes aim to enhance the credibility of SME offerings and protect investors from undue risks. Key proposals include stricter eligibility criteria, increased application values, enhanced lock-in requirements for promoters, tighter migration norms to the main board, and improved corporate governance measures.
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Stricter Eligibility Criteria: The introduction of stringent eligibility criteria, such as requiring an issue size of ₹10 crore and an operating profit of ₹3 crore in two of the last three years, is crucial. This measure will ensure that only financially viable companies can issue public offerings, preventing the listing of companies without a solid track record. The absence of minimum requirements has previously led to oversubscription of SMEs with questionable fundamentals, reminiscent of the dotcom bubble.
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Increased Application Value: Raising the application value for SME listings to ₹2 lakh aims to limit participation from vulnerable retail investors. This approach mirrors entry barriers in futures and options markets, helping to reduce speculative behavior and ensuring that only well-informed investors with a higher risk appetite engage in SME investments.
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Promoter Accountability: Measures to prevent promoters from reducing their holdings post-listing are essential for maintaining investor confidence. Additionally, disallowing corporates from using IPO funds for loan repayments ensures that investor capital is directed towards growth rather than debt servicing.
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Market Making and Liquidity: While Sebi’s efforts to streamline SME listings are commendable, addressing liquidity remains a key focus area. The introduction of a robust market-making mechanism is vital to foster genuine market participation, enhance valuations, and ensure better liquidity. Past instances of circular dealings to inflate revenue highlight the need for a more transparent approach to market-making.
- Increased Disclosures: The misconduct of certain entities has prompted proposals for enhanced disclosures and compliance requirements. While this may increase operational costs for SMEs, it is a necessary step to ensure transparency and accountability in fund utilization.
Bridging the Gap: Educating SMEs
Despite the challenges, the potential of SME exchanges remains largely untapped. Out of approximately 7.96 lakh SMEs in India, only 750 have been listed, indicating a significant gap in capital-raising opportunities. To bridge this divide, it is essential to educate SMEs about the benefits of raising capital through stock exchanges rather than relying solely on traditional bank financing. Furthermore, SMEs should actively seek support from stock exchanges to navigate the fundraising process effectively.
Conclusion
The proposed regulatory reforms by Sebi represent a crucial step towards enhancing the integrity of the SME IPO landscape in India. By implementing stricter eligibility criteria, increasing application values, and promoting transparency, Sebi aims to protect investors and foster a more robust market environment. As the SME sector continues to evolve, it is imperative for stakeholders to collaborate in creating a sustainable ecosystem that encourages growth while safeguarding the interests of all participants. The journey ahead may be challenging, but with the right measures in place, the potential for SMEs to thrive in the capital markets is immense.