The SME sector has witnessed a significant surge in IPO activity, with approximately 230 SMEs raising ₹8,414 crore this year. Notably, 126 IPOs received subscriptions exceeding 100 times, with an average oversubscription rate of 178 times. While this reflects robust investor interest, it has also raised concerns regarding market inflation, corporate governance, and share price manipulation.
To address this, on December 18, 2024, the Securities and Exchange Board of India (SEBI) introduced a series of stringent regulations aimed at enhancing the framework for Small and Medium Enterprises (SMEs) seeking to enter the capital markets through Initial Public Offerings (IPOs). These measures are designed to bolster transparency, ensure prudent fund utilization, and safeguard investor interests in the burgeoning SME segment.
Why These Changes Were Necessary
The surge in SME IPO activity in recent years brought to light several challenges, including instances of inflated valuations, poor corporate governance, and potential misuse of funds. Many SMEs entering the market lacked the financial stability or operational track record to justify public investment. Moreover, concerns arose over price manipulation and a lack of transparency in fund utilization. These issues not only undermined investor confidence but also threatened the integrity of the SME IPO ecosystem. SEBI’s regulatory enhancements aim to address these gaps, ensuring a more equitable and sustainable market for all stakeholders.
Simultaneously, marketing costs have experienced an upward trajectory. According to the insights gathered from our December survey of Chief Marketing Officers (CMOs), the average cost per click witnessed a substantial increase of 20 percentage points in 2022 compared to the previous year.
Enhanced Eligibility Criteria
Under the new guidelines, SMEs aspiring to launch an IPO must demonstrate a minimum operating profit (EBITDA) of ₹1 crore in at least two of the preceding three financial years at the time of filing the Draft Red Herring Prospectus (DRHP). This criterion ensures that only financially robust and reliable companies access the market, thereby enhancing investor confidence.
“SEBI’s enhanced regulations aim to address gaps in transparency, governance, and fund utilization in SME IPOs, ensuring a more equitable and sustainable market for all stakeholders. “
Restrictions on Offer for Sale (OFS)
SEBI has imposed a cap on the Offer for Sale component, stipulating that it cannot exceed 20% of the total issue size. Additionally, selling shareholders are restricted from divesting more than 50% of their pre-issue shareholding during the IPO. These limitations are intended to prevent significant promoter exits during the IPO process, thereby maintaining stability and ensuring continued commitment from existing shareholders.
Utilization of IPO Proceeds
To promote responsible fund utilization, the regulator has prohibited the use of IPO proceeds for repaying loans extended by promoters, directors, or related parties. Furthermore, the allocation for General Corporate Purposes (GCP) is capped at 15% of the issue size or ₹10 crore, whichever is lower. These measures aim to ensure that the funds raised are directed towards productive business activities that contribute to the company’s growth and value creation.
Alignment of Allocation Methodology
The allocation methodology for Non-Institutional Investors (NIIs) in SME IPOs will now mirror that of main-board IPOs. This alignment seeks to standardize the allocation process across different market segments, promoting fairness and consistency in the treatment of investors.
Public Disclosure and Comment Period
In a move to enhance transparency, SEBI mandates that the DRHP be open for public comments for a period of 21 days. Companies are required to publish newspaper advertisements that include a QR code, facilitating easy access to the DRHP. This initiative encourages public participation and scrutiny, fostering a more transparent IPO process.
Fundraising Flexibility and Governance Norms
SMEs are now permitted to raise additional funds without migrating to the main board, provided they comply with the SEBI (Listing Obligations and Disclosure Requirements) Regulations applicable to main-board listed entities. Additionally, related party transaction norms have been extended to SME-listed entities, with a materiality threshold set at 10% of turnover or ₹50 crore, whichever is lower. These provisions aim to enhance corporate governance standards within the SME segment.
Implications for the SME Ecosystem
SEBI’s enhanced regulations are a proactive response to these challenges, aiming to strengthen the SME IPO market’s integrity and protect investors from potential malpractices. By enforcing stricter eligibility criteria, limiting promoter exits, ensuring responsible fund utilization, and enhancing transparency, SEBI seeks to create a more robust and trustworthy environment for SMEs and investors alike.
These reforms are expected to elevate the quality of listings in the SME segment, ensuring that only companies with sound financial health and governance standards can access public funds. This, in turn, will contribute to the sustainable growth of the SME sector, which plays a pivotal role in India’s economic development.
In conclusion, SEBI’s decisive measures reflect a commitment to fostering a transparent, fair, and efficient capital market ecosystem. As these regulations come into effect, stakeholders within the SME landscape must adapt to the evolving regulatory environment, aligning their practices with the enhanced standards to capitalize on the opportunities presented by the public markets.
