SEBI Tightens IPO Regulations for Small Businesses: A New Era of Scrutiny
In a significant move aimed at enhancing the integrity of the capital markets, the Securities and Exchange Board of India (SEBI) has announced stricter regulations for initial public offerings (IPOs) by small businesses. This decision, made public on December 18, 2024, comes in response to a surge in IPO activity among small and medium-sized enterprises (SMEs) in India, which has raised concerns about the financial health and sustainability of these companies.
The New Profitability Requirement
One of the most notable changes introduced by SEBI is the requirement that small businesses must demonstrate profitability before they can launch an IPO. Specifically, a company must have made a profit of at least ₹10 million (approximately $120,000) from operations in two out of the last three financial years. This new criterion aims to ensure that only financially viable companies can access public capital markets, thereby protecting investors from potential losses associated with unproven or struggling businesses.
Context of the Regulation
The backdrop to this regulatory shift is a remarkable boom in IPOs by SMEs, which are defined in India as companies with an annual turnover ranging from ₹50 million ($589,157) to ₹2.5 billion ($29.46 million). According to SEBI data, over 159 SMEs raised a staggering ₹57 billion ($675.46 million) through IPOs in the financial year up to October 15, 2024. This figure is impressive, especially when compared to the previous year’s record of ₹60 billion, highlighting the growing interest in public offerings among smaller firms.
Limitations on Offer for Sale
In addition to the profitability requirement, SEBI has imposed restrictions on the offer for sale component of IPOs. The regulator has stipulated that the portion of shares sold by existing shareholders cannot exceed 20% of the total issue size. This measure is designed to prevent excessive dilution of ownership and ensure that a significant portion of the IPO proceeds is directed towards the company’s growth and operational needs rather than merely benefiting existing shareholders.
Restrictions on Fund Utilization
Another critical aspect of the new regulations is the prohibition on using funds raised from these IPOs to repay loans from large shareholders or related parties. This rule aims to ensure that the capital raised is utilized for genuine business expansion and operational improvements rather than merely servicing existing debts. By enforcing this restriction, SEBI seeks to promote transparency and accountability in the use of IPO proceeds.
Consultation on Minimum Application Size
While SEBI has refrained from mandating a minimum size for IPOs or the least required subscription for small business offerings, it has previously floated proposals to increase the minimum application size for SME IPOs from ₹100,000 to ₹200,000. Additionally, there was a suggestion that an SME should only be eligible for an IPO if the issue size exceeds ₹100 million. These proposals reflect SEBI’s ongoing efforts to refine the regulatory framework governing small business IPOs, ensuring that only serious and well-prepared companies can access public markets.
Conclusion
The tightening of IPO regulations for small businesses by SEBI marks a pivotal moment in India’s capital markets. By enforcing profitability requirements and placing restrictions on the use of funds and share sales, SEBI aims to foster a more robust and transparent environment for investors. As the landscape of SME IPOs continues to evolve, these regulations will likely play a crucial role in shaping the future of small business financing in India, ensuring that only the most viable companies can take advantage of the opportunities presented by public offerings. This new era of scrutiny not only protects investors but also promotes the long-term sustainability of small businesses in the competitive market landscape.