Cracking the whip: Why Sebi is tightening rules for public issues of SMEs

On December 2, the Securities and Exchange Board of India (Sebi) cancelled the initial public offer of Trafiksol ITS Technologies, a company that falls in the category of an SME — a small and medium enterprise. The stock market regulator asked it to refund money to investors.

  This is one of several SME IPOs to run into trouble with the regulator in the recent past. Trafiksol ITS is a Noida-based company which provides intelligent transportation systems and automation solutions for traffic and toll management. It filed its Draft Red Herring Prospectus on May 31, 2024 for an IPO to be listed on the Bombay Stock Exchange’s SME Platform. 

The IPO offered 6.41 million new equity shares at a price of between Rs 66 and Rs 70 a share. The IPO was open between September 10 to 12 and was oversubscribed 345.65 times with listing scheduled for September 17.

  Sebi acted on a complaint alleging that the objects of the issue included the purchase of software of  Rs 17.70 crore from a vendor with questionable financials, concluded after an investigation that the vendor was a ‘shell entity’.

  In another case, C2C Advanced Systems, an IPO on the National Stock Exchange’s Emerge platform, opened November 22-26 at a price band of Rs 214-226, and saw 125-time subscription for the 2.91 million-share issue. The listing on November 29 was deferred due to complaints of discrepancies in financial statements. The NSE consulted with Sebi and told the company to provide subscribers a withdrawal option and appointed an independent auditor for inspection of the accounts.

  About 370,000 applications were withdrawn. But after the audit, Sebi allowed the listing on December 2. Additionally, the regulator asked the NSE to set up monitoring to oversee the utilisation of funds raised through the IPO.

  In yet another case, Rosmerta Digital Services Ltd postponed an IPO scheduled to raise Rs 206 crore between November 18 and 21. Though the company issued a statement about pulling back due to “adverse market conditions”, it is said Sebi asked for a withdrawal after receiving complaints alleging problems with the DRHP and allegations of market manipulation by relatives of the promoters.

  SME IPO is a red-hot market segment. Many of these floats routinely see 100-time subscription and massive gains upon listing. However, Sebi has started tightening regulations after many complaints about sharp practices.

  As of October 15, 12 listings were suspended on NSE Emerge and no trades in another 15 companies in the last 30 days. Similarly, the BSE SME platform had 28 suspensions, and in 35 companies no trade had been executed in the last month. If a stock goes illiquid, actually booking a profit (or loss) becomes difficult.

 

Governance lapses

  SMEs are typically companies with a high concentration of shareholding among a few promoters. There is a limited presence of private equity and other sophisticated investors who can flag lapses in corporate governance.

  The concept of SME IPOs has been around for a decade, but it really took off in the last two years. These issues allow SMEs to raise money and list on the NSE-Emerge and BSE-SME platforms (not on the main board.) The post-issue paid-up capital of the SME must not exceed Rs 25 crore, while eligibility requirements for SME IPO company directors, promoters, etc, are much the same as in a regular IPO.

  Sebi released a consultation paper where it cited problems with Circular Transactions, meaning where companies inflate revenues through transactions with related entities to mislead investors. It cited problems with high-risk related party transactions (RPTs). The regulator says half of listed SME entities have engaged in RPTs of values exceeding 10 per cent of their turnover and a fifth had RPTs exceeding 50 per cent of turnover. The paper cited diversion of IPO proceeds to related parties, connected parties, shell companies, etc.

  Sebi has asked for the minimum SME IPO application value to be doubled to Rs 2 lakh, an increase in the minimum number of allottees to 200 from the current 50, restrictions on Offer For Sale (OFS) to 20 per cent of the issue size. (In an OFS, promoters sell stakes they own, and the proceeds come to them, not to the company.)

  Sebi also wants monitoring agencies to oversee IPO fund utilisation in line with an IPO’s stated objectives, and has suggested the lock-in on minimum promoter contribution (MPC) be extended to five years. (In MPC, the promoters have to continue to own at least 20 per cent stake after an IPO. There will also be a focus on RPTs to prevent fund diversion.

 

Rising popularity

  SME IPO, as a concept, is fantastic for small companies. It raises cash at far lower initial cost than the interest payable on equivalent debt. Moreover, the company is under no obligation to pay a dividend, unlike with its legal obligation to service debt.

Tapping the equity market is therefore a great way to raise capital cheaply. The arithmetic of a low base allows a small business to grow very quickly, so there is a fundamental justification for investors to be interested. But the due diligence for an SME IPO is not as onerous as for a main board IPO. Crucially, the DRHP and other documents for SME IPOs are processed by the stock exchanges and not by Sebi.

  There are around 850 SMEs currently listed on the two platforms, with a combined market capitalisation of over Rs 2 trillion. Since the SME IPO concept was launched, around 1150 companies have listed on the NSE and BSE platforms and some 300 of these SMEs have since graduated to the main board (as on October 15, 2024).

  In Calendar year 2022, 109 SME IPOs raised Rs 1,980 crore. In Calendar year 2023, 182 SME IPOs raised Rs 4,967 crore while in Calendar 2024 (until Dec 11), 228 SME issues raised Rs 8,859 crore. In FY25 (April 1-December 11, 2024), 175 IPOs have raised around Rs 7,109 crore compared to 205 issues raising Rs 6,364 crore in FY24.

  Clearly, the concept has become more popular in the last two years. The investor response has been truly extraordinary. Since September 2024, there have been 61 SME IPOs and 29 of these have received subscription of more than 100 times. Many have received more than 200—times subscription.

  There is no greenshoe option.  But oversubscription of this order guarantees that the issue hits the top end of the price band and it usually means listing at big premiums. Quite a few SME IPOs have gained more than 100 per cent very quickly after listing.

  Rajesh Power, which listed on December 2, has gained 109 per cent since. C2C has gained 99 per cent after being cleared to list on December 3. Neelam Linens has risen by 160 per cent, Danish Power by 168 per cent, and Sahasra Electronics by 136 per cent.

 

Lottery tickets

  Data tells us why SME IPOs are popular. An allotment is almost like a winning lottery ticket, with the possibility of instantaneous, massive capital gains. You don’t even have opportunity costs unless you receive an allotment.

  Earlier, an IPO application meant cash being transferred out of your account, and waiting for a refund if there was no allotment. Now, the money stays in your account earning interest via the ASBA (Application Supported by Blocked Amount) interface until such time as an allotment comes through or  does not.  

  It is no surprise investor participation has jumped.  On average, there are 245 applicants for every single one who receives an allotment – that is up from 4 times in FY22 and 46 times in FY23.

  Investors run some risks, of course, including lack of liquidity, quite apart from outright fraud or malpractice. But so long as the stock market continues to rule high, most retail investors will continue to consider SME IPOs a very attractive proposition.

  If the market does go into correction mode, there will be less interest and the liquidity may dry up further.  But until and unless there’s a broad bear market, the momentum in the SME IPO segment is likely to continue.   

CATCHING ON 

- 850 SMEs are listed on the platforms of BSE and NSE

-  Their combined market capitalisation is more than Rs 2 trillion

- Since the SME IPO concept was launched, around 1,150 companies have listed on the NSE and BSE platforms

- 300 of these have graduated to the main board (as on October 15, 2024)

-  In calendar year 2022, 109 SME IPOs raised Rs 1,980 cr

- In Calendar 2023, 182 SME IPOs raised Rs 4,967 cr

- In Calendar 2024 (until Dec 11), 228 SME issues have raised Rs 8,859 cr

- Since September 2024, there have been 61 SME IPOs and 29 of these have been subscribed more than 100 times, many of them more than 200 times

 

WHAT SEBI WANTS

  -  Minimum SME IPO application value doubled to Rs 2 lakh

-  An increase in the minimum number of allottees to 200 from the current 50

- Restrictions on Offer For Sale to 20% of the issue size

-  Monitoring agencies to oversee IPO fund utilisation in line with an IPO’s stated objectives

- Lock-in on minimum promoter contribution be extended to five years