With instances of fund diversion and inflated RTPs, SEBI proposes an overhaul of the SME IPO process
“Exuberance”, “frothy” and occasionally “bubble” are words being used by the market to describe India’s small and medium enterprise (SME) initial public offering (IPO) market. The increasing appetite of domestic investors and the rally in India’s equity markets have led to SMEs bypassing the traditional bank financing route and opting for a source that gives them more bang for their buck considering the high valuations that come in a bull market! The last financial year saw 196 SME IPOs mobilizing more than Rs. 6,000 crores. This financial year till October, 159 SME IPOs have hit the markets raising more than Rs. 5,700 crores.
The troubling cases of some SME IPOs
However, underneath the fundraising action and the listing day rally are alleged instances of diversion of issue proceeds to shell companies controlled by promoters and questionable related party transactions. As per SEBI’s analysis, one out of two SME-listed entities have undertaken related party transactions of more than Rs. 10 crore and one out of five SME-listed entities have undertaken RPTs of more than Rs. 50 crore.
But the allegations don’t end there. Some companies have also been indulging in booking fraudulent transactions to justify valuations of their IPOs which, more often than not, tread in the overvalued bracket. The SEBI circular says, “It has also been observed that a company has booked fraudulent sales and purchases through circular transactions amongst related or connected parties. By doing so, such companies try to create a positive sentiment to induce investors into purchasing such securities.” The bullish mode that the market has been in recently does not help as “FOMO” precludes investors from critical thinking and judging a business.
SEBI’s proposed changes
SEBI has been playing a proactive role in identifying and taking corrective measures to stem actors exploiting the market setup for wrongful personal gains. In the works is an overhaul of the SME IPO process that aims to make the segment safer for investors. Some of the proposals are:
- Increasing the minimum SME IPO size to Rs. 10 crores. Currently, there is no minimum size.
- Hiking the application size to Rs. 2 lacs from Rs. 1 lac
- Limiting offers for sale by promoters to 20% of the issue size
- Setting up a compliance monitoring agency for SMEs that went public to keep a tab on the utilisation of the money taken from investors
Many of the proposals are directed towards monitoring how the IPO proceeds are used. The primary market cannot be used as a way for the promoters to offload wholesale, hence the 20% OFS restriction. Further, the paper reads that not more than 10% or Rs. 10 crores of the issue can be allocated towards “general corporate purposes.” To enforce proper corporate governance norms, the paper floats the idea of a monitoring agency for companies that have raised more than Rs. 20 crores via IPO, to ensure that the funds are being utilized as per the issue objective.
But SEBI’s restrictions are not just for companies. The regulator is also trying to tame the retail market frenzy around SME IPOs which is seeing investors with possibly low risk-taking capabilities applying for a lot or two, hoping to see listing day gains. Doubling the application size to Rs. 2 lac is aimed at discouraging some of these investors from subscribing to IPOs.
These are just some of the proposals in the consultation paper. However, it is evident that they’re all directed towards making the SME IPO market safer for investors, either by monitoring SMEs who are going public or by limiting the number of investors who are subscribing to such IPOs. “These steps will help separate the scrupulous from the unscrupulous”, says Sunil Shah, Group CEO and Director, of Khambatta Securities. He adds that, “SEBI has been constantly working towards improving the investment infrastructure and it will be an ongoing process”.
A healthy SME IPO ecosystem should enhance the confidence of not just the investors but even the promoters of the SMEs as well. However, higher regulation comes at the price of increased compliance costs by SMEs that would anyway be adjusting to life post listing. While norms like these are good for investors, they may increase the cost of capital for companies.