“Small businesses are the backbone of our economy and the cornerstone of our communities”
Barack Obama
Evolution of SME IPOs
In recent years, India has witnessed a significant surge in initial public offers (“IPO”) with prominent companies like Zomato and Swiggy tapping into this opportunity to raise capital. According to a global data report, India’s IPO ecosystem achieved a historic milestone in 2024, with proceeds doubling from USD 5,500,000,000 (United States Dollars Five Billion and Five Hundred Million) in 2023 to USD 11,200,000,000 (United States Dollars Eleven Billion Two Hundred Million).[i]
Beyond these large corporations, India’s small and medium enterprises (“SMEs”) have also begun capitalizing on IPOs to meet their funding requirements. SME IPOs were introduced by the Securities and Exchange Board of India (“SEBI”) pursuant to the recommendations of the Report of Prime Minister’s Task Force on Micro, Small, and Medium Enterprises issued in January, 2010 which advocated for the establishment of SME exchanges[ii]. Subsequently, dedicated SME exchange platforms were launched under the Bombay Stock Exchange and the National Stock Exchange.
Among other elibility conditions issued by SEBI and the SME exchanges, an issuer is eligible to make an IPO on the SME exchange only if its post issue paid up capital is less than or equal to INR 10,00,00,000 (Indian Rupees Ten Crores Only) or if the post issue face value capital is more than INR 10,00,00,000 (Indian Rupees Ten Crores Only) and less than INR 25,00,00,000 (Indian Rupees Twenty Five Crores).
In 2024, SME IPOs have raised a record INR 8288,00,00,000 (Indian Rupees Eight Thousand And Two Hundred Eighty – Eight Crores), a significant increase compared to INR 4967,00,00,000 (Indian Rupees Four Thousand Nine Hundred Sixty – Seven Crores) in 2023 and INR 1995,00,00,000 (Indian Rupees One Thousand Nine Hundred Ninety – Five Crores) in 2022.[iii]
However, not all that glitters is gold. While the glossy statistics around SME IPOs paint an impressive picture, they mask significant gaps and issues that have allowed misuse to creep in, eroding trust among investors and the general public. These issues and lacunae were identified and addressed by SEBI its its consultation paper on the review of SME segment framework under SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR Regulations”) and applicability of corporate governance provisions under SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”) on SME companies to strengthen pre-listing and post-listing SME provisions released on November 19, 2024 (“Consultation Paper”)[iv]
SEBI’s Proposals to Address Key Challenges in SME IPOs
SEBI, under the Consultation Paper has addressed certain concerns about SME IPOs and had provided proposals to address them.
Offer For Sale
Under the IPO mechanism, existing shareholders, including promoters and other significant stakeholders, are permitted to sell their shares in the company. This process is categorized as an offer for sale (“OFS”), where the proceeds from the sale of shares are directed to the selling shareholders rather than the company itself.
As per SEBI’s records, there were 2 (two) pure OFS SME IPOs conducted in the financial year 2023-24, and 1 (one) pure OFS SME IPO in the financial year 2024-25 (up to October 2024). Additionally, during this period, 52 (fifty-two) SME IPOs included an OFS component, and in 30 (thirty) of these 52 (fifty two) cases, the OFS portion constituted more than 20% (twenty percent) of the total issue size. [v]
Currently, ICDR Regulations regulating issuers listing on SME exchanges do not contain any restrictions on OFS.
SEBI observed that SME IPOs were originally intended to serve as a source of financing for SMEs to support their growth. However, promoters of companies listing on SME exchanges were increasingly using OFS as an exit strategy by selling off their shareholding, rather than leveraging the IPO to raise funds for business expansion. To address this concern, in the Consultation Paper, SEBI had proposed a cap on the OFS component for such IPOs, limiting it to 20% (twenty percent) of the total issue size. Additionally, for selling shareholders in such IPOs, SEBI had suggested capping the offered sale shares at 20% (twenty percent) of their pre-issue shareholding on a fully diluted basis.
Allocation of the Issue for General Corporate Purposes
The ICDR Regulations impose a cap on the allocation of the issue size for general corporate purposes (“GCP”), limiting it to 25% (twenty – five percent) of the total amount being raised by the company listing on the SME exchange. The ICDR Regulations further establish a combined limit of 35% (thirty -five percent) of the total amount raised under the IPO, for GCP and such objects where the company has not identified acquisition or investment target as mentioned in the object of draft offer document (“Combined Limit”).
GCP is defined as identified purposes for which no specific allocation is made, or any amount designated as GCP or under any similar nomenclature in the offer document for the IPO.
In the Consultation Paper, SEBI had proposed limiting the amount allocated for GCP in such IPOs to 10% (ten percent) of the issue size or INR 10,00,00,000 (Indian Rupees Ten Crores) , whichever is lower. The proposal also included the deletion of the Combined Limit. SEBI justified this proposal by highlighting the lack of specific monitoring mechanisms for expenses incurred under GCP, which allows companies listing on the SME exchange to classify a broad range of expenditures under GCP. This flexibility has raised concerns over the potential misuse of IPO proceeds by such companies, as large amounts can be used and justified as GCP expenses without any specific information to investors on usage of such amount.
Related Party Transactions
In the Consultation Paper, SEBI had highlighted various malpractices by companies listing on the SME exchange concerning related party transactions. It observed instances of siphoning of funds to the issuer’s related parties, connected entities, or shell companies, as well as revenue inflation through circular transactions involving these entities. SEBI further noted that some SME-listed entities had diverted their IPO proceeds to shell companies controlled by their promoters.
SEBI attributed these issues to the absence of comprehensive approval and disclosure requirements for related party transactions under the LODR Regulations, as they currently do not apply to SME-listed entities.
To address this gap, under the Consultation Paper, SEBI had proposed extending the provisions related to related party transactions under the LODR Regulations to SME-listed entities, excluding those with a paid-up capital of up to INR 10,00,00,000 (Indian Rupees Ten Crores) and a net worth of up to INR 25,00,00,000 (Indian Rupees Twenty Five Crores).
Lock-In of Securities Held by Promoters Listing on the SME Exchange
Under the ICDR Regulations, promoters of companies listed on the SME exchanges are required to hold at least 20% (twenty percent) of the post-issue capital of the entity (“Minimum Contribution”). The Minimum Contribution is subject to a lock-in period of 3 (three) years. Additionally, the promoter’s shareholding exceeding the Minimum Contribution (“Excess Shareholding”) is locked in for 1 (one) year following the IPO.
The Consultation Paper highlighted concerns that the promoters, upon the expiration of the lock-in period of their Excess Shareholding, often seek to reduce their stake by selling such Excess Shareholding. This practice undermines the sustainability and stability of the issuer’s operations.
To address this issue, SEBI, in the Consultation Paper had proposed extending the lock-in period for the issuer’s promoter’s Minimum Contribution to 5 (five) years. Additionally, a phased release mechanism was recommended for the Excess Shareholding: 50% (fifty percent) of the Excess Shareholding would be unlocked after 1 (one) year of the IPO, and the remaining 50% (fifty percent) would be unlocked after 2 (two) years of the IPO.
Other Key Proposals
The Consultation Paper also outlined several key proposals aimed at introducing reforms to the SME IPO framework. These proposals include:
- Monitoring of IPO Proceeds: To enhance transparency for investors and to ensure greater accountability, SEBI had proposed extending the requirement for the appointment of a monitoring agency for the issuer listing on SME exchange with an issue size exceeding INR 20,00,00,000 (Indian Rupees Twenty Crores), as opposed to the current threshold of INR 100,00,00,000 (Indian Rupees One Hundred Crores) under ICDR Regulations. A monitoring agency helps in certifying that the proceeds of the IPO are being utilised for the puposes stated under the offer documents.
- Eligibility Restrictions on the Promoter Group: The ICDR Regulations inter alia, prevent issuers from undertaking IPOs if their promoters or directors are promoters or directors of any other company which has been debarred from accessing the capital markets. SEBI noted that the majority of companies listing on SME exchanges are managed by the promoters and the promoter group, and therefore, any action against any member of the promoter group may have a significant bearing on the issuer. As a result, SEBI had proposed that if any member of the promoter group is a promoter director of another company that has been debarred from accessing the capital market shall also be prohibited from launching IPOs. Further, SEBI had suggested that if any member of the entity’s promoter group has been identified as a wilful defaulter or a fraudulent borrower or a fugitive economic offender, such entity will also not be eligible to make an IPO.
- Quaterly Filings for SME-listed Entities: SEBI had proposed that companies listed on SME exchanges should be required to submit their shareholding pattern, statement of deviations or variations, and financial results on a quarterly basis, replacing the existing mandate under the LODR Regulations, which currently requires these filings to be made on a half-yearly basis.
- Disclosures of Compositions and Board of Directors: SEBI had proposed that companies listed on SME exchanges, with a paid-up capital exceeding INR 10,00,00,000 (Indian Rupees Ten Crores) and a net worth exceeding INR 25,00,00,000 (Indian Rupees Twenty-Five Crores), should be mandated to submit the composition and details of meetings of their board of directors and its committees, aligning with the requirements applicable to main board-listed entities under the LODR Regulations.
- Conversion of Outstanding Convertible Securities: SEBI had proposed that issuers with any outstanding convertible securities should be ineligible to undertake an IPO on the SME exchange, aligning with eligbility requirements for main board IPOs under ICDR Regulations.
- Public Announcement of Draft Red Herring Prospectus: SEBI suggested that the draft red herring prospectus (“DRHP”) of an issuer undertaking IPO on the SME Exchange should be made available for public comments for atleast 21 (twenty one) days from the date of its public announcement by hosting it on the websites of SME exchanges and lead managers. Further, a public announcement of the filing of the DRHP and invitation for public comments should be made in one English, Hindi and regional language newspaper based on the location of the registered office of the issuer, aligning with the requirement for main board IPOs under the ICDR Regulations.
- Increase of Issue Size & Operating Profit for Eligibility: It was also suggested by SEBI that an issuer will only be eligible to make an IPO under the SME exchange if the issue size is more than INR 10,00,00,000 (Indian Rupees Ten Crores) and if the issuer’s operating profit is of INR 3,00,00,000 (Indian Rupees Three Crores) from operations for at least 2 (two) out of 3 (three) financial years preceeding the filing of IPO.
- Prohibition on Repayment of Loan of Promoter/Promoter group: SEBI also proposed prohibition on IPOs on SME exchanges where the issuer through the IPO, aims to fulfill repayment of loan from its promoter, promoter group or any related party with the proceeds of the IPO.
SEBI’s Board Meeting and Proposed Amendments
In its Consultation Paper, SEBI presented several proposals for reforming the SME IPO framework and sought feedback from stakeholders and the public. After reviewing the comments received and conducting further internal discussions, out of all the suggestions provided by SEBI in its Consultation Paper, only a few suggestions were accepted by SEBI during its 208th board meeting held on December 18, 2024 (“Board Meeting”)[vi]. The notable proposals that were not accepted in the Board Meeting include the appointment of a monitoring agency, eligibility restrictions for debarred promoter groups, quarterly filings for SME-listed entities, disclosures of composition and board of directors, conversion of outstanding convertible securities and increase of issue size for eligibility.
The key approved amendments to the SME IPO Framework include:
- Limit on OFS: Under ICDR Regulations, OFS by selling shareholders in an SME IPO will be limited to a maximum of 20% (twenty percent) of the total issue size. Additionally, selling shareholders will be allowed to sell no more than 50% (fifty percent) of their shareholding.
- Cap on GCP Amount: A cap of 15% (fifteen percent) of amount raised under SME IPO or INR 10,00,00,000 (Indian Rupees Ten Crores) whichever is lower, will be imposed on the allocation for GCP.
- Related Party Transactions: The provisions governing related party transactions under the LODR Regulations will also apply to SME-listed entities. The threshold for considering related party transactions as material will be the lower of 10% (ten percent) of the annual consolidated turnover of the SME-listed entity or INR 50,00,00,000 (Indian Rupees Fifty Crores).
- Extension of Lock-in for Excess Shareholding: A phased release mechanism shall be applicable for the lock-in for the SME listed entity’s promoter’s Excess Shareholding: 50% (fifty percent) of the Excess Shareholding shall be unlocked after 1 (one) year of the IPO, and the remaining 50% (fifty percent) shall be unlocked after 2 (two) years of IPO.
- Publishing DRHP: Companies pursuing an IPO on SME exchanges are required to make a public announcement regarding the filing of the DRHP with the SME exchange. This announcement must remain accessible for 21 (twenty-one) days for public comments. Additionally, the public announcement must include a QR code for easy access to the DRHP.
- Increase of Operating Profit: To be eligible for an IPO on SME exchanges, the issuer must have achieved an operating profit of at least INR 1,00,00,000 (Indian Rupees One Crore Only) from operations in any 2 (two) of the 3 (three) preceding financial years as of the date of filing the DRHP.
- Restriction on Repayment of Promoter/Promoter Group’s Loan: Now, IPOs on SME exchanges are prohibited where issuer aims to, either directly or indirectly repay loan from its promoter, promoter group or any related party from the procceds of the IPO.
Conclusion
While SEBI has approved the amendments to the SME IPO framework in its Board Meeting, the official notification for the amendments to the ICDR Regulations and LODR Regulations is still awaited.
It will be intriguing to observe how these reforms impact the SME IPO landscape in the long term. It remains to be seen whether the current high momentum of SME IPOs will persist following these amendments, or if it will gradually subside. SEBI’s proactive approach is a positive step towards ensuring that SME IPOs are conducted with a focus on business expansion and investor protection. By instilling stricter guidelines and oversight, SEBI aims to restore investor confidence and strengthen the credibility of the Indian capital markets, ultimately fostering sustainable growth for SMEs and reinforcing public trust in the IPO process.
Author: Aishwarya H, Harshit Meena
Publication Date: January 13, 2025
[i] India’s IPO market set for record growth in 2025 too: Report , The Economic Times available at https://economictimes.indiatimes.com/markets/ipos/fpos/indias-ipo-market-set-for record-growth-in-2025-too report/articleshow/116731453.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst
[ii] Report of Prime Minister’s Task Force on Micro, Small and Medium Enterprises, Government of India available at https://dcmsme.gov.in/final_report.pdf
[iii] Pranati Deva, SME IPO Frenzy: Opportunity or bubble ? 2024 sees record ₹ 8,200 crore raised by SME firms, mint available at https://www.livemint.com/market/ipo/sme-ipos-raise-record-8-200-crore-in-2024-is-it-an-opportunity-or-a-brewing-bubble-11731484777805.html
[iv] Consultation paper on Review of SME segment framework under SEBI (ICDR) Regulations, 2018, and applicability of corporate governance provisions under SEBI (LODR) Regulations, 2015 on SME companies to strengthen pre-listing and post-listing SME provisions released on November 19, 2024, Securities and Exchange Board of India available at https://www.sebi.gov.in/reports-and-statistics/reports/nov-2024/consultation-paper-on-review-of-sme-segment-framework-under-sebi-icdr-regulations-2018-and-applicability-of-corporate-governance-provisions-under-sebi-lodr-regulations-2015-on-sme-companies-to-_88627.html
[v] Ibid
[vi] SEBI Board Meeting available at https://www.sebi.gov.in/media-and-notifications/press-releases/dec-2024/sebi-board-meeting_90042.html
