In India, very small companies should not be publicly available in the capital market, said an industry insider while talking about the Securities and Exchange Board of India's (Sebi's) decision to tighten rules for small and medium enterprises (SME) initial public offerings (IPOs) to counter manipulation.
Earlier, Madhabi Puri Buch, Chairperson, Sebi said, "We do see signs of manipulation in the small and medium enterprises (SME) segment." On 11 March, she suggested that certain players may be engaging in unethical practices to manipulate prices.
After her statement, all hell broke loose on March 11. There was a bloodbath on the bourses as 41 SME stocks were hammered mercilessly causing the Bombay Stock Exchange (BSE) SME IPO index to plummet a massive 20 per cent from its peak. The index lost around eight per cent in the subsequent sessions.
The turmoil in the stock markets led some experts to come down heavily on the regulator where experts noted that any isolated instances of wrongdoings can be catastrophic for the regulator as it would raise serious questions on the overall ecosystem of the securities market.
Sebi's Buch added that the market regulator will likely intensify its scrutiny of the SME segment by deploying enhanced surveillance tools and stepping up enforcement actions against perpetrators of market abuse.
According to a media report, the market regulator is considering raising the minimum size of such public offers to Rs 30 to 50 crore later this year. Recently Sebi also barred three SME companies from capital markets on charges of misusing funds raised via public offers and warned that retail investors need to exercise a certain level of due diligence while investing in SME companies and not be swayed by ‘seemingly attractive returns that may quickly come their way.’
Kulbhushan Parashar, Founder and Managing Director, Corporate Capital Venture said, “Sebi's proposal for tighter rules for listing small businesses will eventually benefit SME ecosystem tripling. The Sebi has proposed that the minimum IPO size should be 30 crore and we feel that it is a very great decision. I think the regulator wants to avoid the IPOs with sizes of Rs 2 crore, 3 crore and Rs 4 crore. When the IPO is small, there could likely be manipulation, but if the size and float are good then the probability of manipulation is less.”
Parashar added that when these norms are applicable, “I don't think that there could be any hindrance in raising money for these small businesses. Rather, the objective of the regulation or the guidance is to have more authenticity over the businesses and now the scalable and growing businesses will be able to raise capital with more easiness because only selective companies will go public.”
BSE SME which was established on 13 March 2012 meant to provide SMEs with easier access to equity funding through relaxed eligibility criteria and streamlined post-listing compliance requirements. With its 500th listing, BSE SME is estimated to raise Rs 6,581 crore through the platform.
NSE Emerge, which was also established in 2012 to promote SME growth in India, crossed Rs 1 trillion market capitalisation in December 2023. Buoyed by India's surging equity markets, public issues by SMEs soared in the financial year (FY) 2024 to 205 companies raising Rs 60 billion compared to the 125 firms that raised Rs 22 billion in the previous year, according to the Prime Database. However, the rules may bring several challenges to stakeholders.
“Qualifying for an IPO might become more challenging for smaller businesses, limiting their funding options. Minimum issuance sizes could make raising capital more difficult for smaller SMEs. More stringent regulations might lengthen the listing process. This could push SMEs towards venture capital or debt financing depending on their specific needs instead of IPOs,” said Amit Goel, Co-founder and Chief Global Strategist, Pace 360, while talking about challenges that can arise from these rules.
The introduction of these new regulations is set to significantly transform the landscape for SMEs seeking to go public as increased tightening is likely to hinder their access to essential capital. SMEs typically depend on future earnings forecasts, often using discounted cash flows, to secure funding. These regulatory constraints could exacerbate their financial vulnerability, forcing them to survive rather than grow. This situation mirrors the fate of the Over-the-Counter Exchange of India (OTCEI), where continuous regulatory changes led to decreased market participation, eventually rendering it impractical.
“These regulatory measures could inadvertently pose significant barriers for smaller enterprises with lower valuations that heavily rely on access to equity capital to mitigate high debt levels and finance their growth. The imposition of minimum issue size thresholds could constrain these firms' market participation, resulting in a more exclusionary market environment,” said Tarun Singh, Managing Director (MD), Highbrow Securities.
Notably, an estimated 50-60 per cent of SMEs currently preparing for market entry may find themselves disqualified from exchange listings under the new framework, Singh told BW Businessworld. He added that consequently, this may lead to reduced employment opportunities, a deceleration in India's gross domestic product (GDP growth) and stifled entrepreneurial dynamism, thereby adversely affecting the broader economic landscape.
More Trouble For SME IPOs?
Sebi is tightening the reins on the SME listing platform in India. A minimum issue size and stricter disclosures could deter smaller companies from pursuing IPOs, leading to a decrease in overall SME listings. Tighter regulations might instil greater trust in SME offerings, potentially attracting more investors with a long-term view. With stricter norms, the focus might shift towards financially strong SMEs with a clearer growth path.
“As the SME IPOs are approved at only the exchange level, Sebi's restrictions should not be considered as interference but as additional surveillance. The stringent oversight of Sebi is essential to ensure the long-term survival of the SME exchange. Without such stringent measures, retail investors are likely to lose money, which could lead to problems down the road. These regulations will help the market survive longer, keep retail investors engaged, and ensure the market grows at a steady, sustainable pace rather than skyrocketing abruptly,” said Kresha Gupta, Founder, Chanakya Opportunities Fund.
Experts told BW Businessworld that tightening of rules is required in the overall capital market from time to time. In India, SME exchange has shown tremendous growth after Covid-19 and is still growing. However, in 2023, one incident that grabbed eyeballs was that the SME initial public offering (IPO) market faced a significant setback, with several offerings failing to meet investor expectations and experiencing lacklustre performance.
According to the data, about 179 SME IPOs were listed in 2023. However, while citing statistics, online wealth management platform Kuvera in a report stated that data from 2023 showed that about a fourth of SME IPOs turned flops eventually. In comparison, investors lost money in just one in 12 IPOs on the main board. Also, the average listing day gain on the SME exchanges was a tad lower than the main board.
The returns generated on the SME exchanges have been much higher. The median return after listing to date on the junior exchanges of the NSE and the BSE has been 47 per cent for investors. This is a full 1500 basis points more than that on the main board (32 per cent), Kuvera’s report revealed.
“Rather than any particular complaint it is the whole SME market. As there is a FOMO among investors on missing out on the SME rally, there is a high demand for investors to invest in these companies which has led to chances of manipulation. There are many reasons for SEBI to keep surveillance over the SME exchange like an immediate surge in the price without the base of top/bottom line disturbing the PE Ratio, sale of stake by Promoters of these listed companies, a limited number of shareholders, not complying with the regulations of listed companies,” Gupta added.
Scope Of Improvement?
While talking about particular areas within the current SME IPO framework that require the most attention, experts stated that there should be more detailed disclosures regarding risk factors and company financials. Sebi or independent auditors should strengthen pre-IPO due diligence and create a more liquid secondary market to facilitate easier exit for investors.
Parashar also pitched for the betterment of the SME IPO framework and transparency for the growth of the segment. He added that Sebi and exchanges should prioritise that these new rules effectively address the misuse in the segment. “The small companies should go for the IPO stage from a group of high-net-worth individuals (HNIs) or investors and they will be able to raise money,” Parashar added.
What Next?
It has observed instances of companies misusing the platform for purposes like diverting raised funds, manipulating financial statements, and misrepresenting facts in offer documents. The market regulator wants to safeguard its interests by ensuring it invests in more established companies and mitigates risks associated with excessive speculation and short-term trading in the SME segment.
“Investors might initially adopt a wait-and-see approach until the effectiveness of the new rules is proven. Initial confusion or wariness due to the new rules could lead to a temporary dip in investor participation. Tighter regulations could lead to a more mature SME IPO market, attracting long-term investors seeking high-growth potential,” Goel added.
Parashar also stated, “There should be a monitoring regulation in which the companies have to report what they have done with the IPO money and all. I think that also requires improvement because smaller companies have diverse dynamic situations.” While talking about investor sentiment, he added that it will emerge more after these kinds of regulations.
Singh stated that imposing limits on the minimum size of IPOs could adversely impact economic growth. Although India's resilience may mitigate the effects over time, the transition could be prolonged. Sebi's efforts to implement stricter regulations should focus on proactive measures rather than reactive responses to failures while preserving an open and inclusive market framework.
