SME IPOs: The new gold rush or a fool’s gold?

India's small and medium enterprises (SMEs) are flooding the stock market, raising billions through initial public offerings (IPOs). The surge in activity signals robust investor confidence, but beneath the surface, questions about market manipulation and the sustainability of this growth are emerging. Could this wave of SME IPOs be a sign of strength, or are investors being drawn into a potential bubble?

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In recent years, SMEs have increasingly tapped into the stock market to fuel their growth, with public offerings typically ranging between ₹5 crore to ₹50 crore. What started as a trickle has now become a wave. The average issue size of SME IPOs has more than tripled, soaring from ₹10 crore in 2020-21 to ₹36 crore in 2024-25. The momentum is staggering: between April and August 2024-25, 109 SMEs raised a staggering ₹3,983 crore—surpassing the funds raised in the entire financial years of 2020-21, 2021-22, and 2022-23 combined. The IPO issuance pace has averaged nearly one per working day.

While 2023-24 also saw record activity, with ₹6,265 crore raised across 203 SME IPOs, the question remains whether the market can sustain this level of growth without tipping into instability.

The dark side of oversubscription

The flood of SME IPOs, while a sign of confidence, has also sparked concerns. Chief among them is the extreme oversubscription of some IPOs—sometimes by thousands of times the initial amount sought—raising questions about the market's long-term sustainability. Although high investor interest doesn’t inherently suggest foul play, the SME segment has witnessed instances of market manipulation.

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Corporate governance issues can impact companies of any size, but smaller businesses, with fewer compliance requirements, are particularly vulnerable. Raising compliance standards to mainboard levels would undermine the SME board’s intent—easing access to fundraising for these firms. To mitigate risk, only investors with a higher risk tolerance are permitted, as reflected in the minimum application size of ₹1 lakh, compared to less than ₹15,000 for mainboard IPOs. While this approach is designed to attract serious investors, some malpractices still plague SME issues. It’s a double-edged sword: simpler compliance boosts fundraising but also leaves the door open for potential abuse.

One prevalent malpractice involves inflating IPO subscription numbers to deceive investors. Scammers submit hundreds of duplicate applications, creating the illusion of high demand. Initially, the exchange reflects these as valid, but the registrar later rejects the duplicates. By then, however, many investors have already been misled into investing, often leading to losses.

The scam works by artificially inflating demand through multiple applications. Typically, it unfolds as follows:

A scammer submits 100 or more duplicate applications, causing a spike in reported subscription numbers.

This artificial demand stirs excitement among retail investors, who rush to invest, believing the IPO is in high demand.

Meanwhile, the scammer has no intention of purchasing shares, knowing the registrar will eventually reject their duplicate applications during the allotment process.

Regulatory crackdown

There have been few regulatory changes brought in place to counter such manipulative practices.

Registrars and transfer agents (RTAs) have always been responsible for identifying duplicate or ineligible bids, ensuring that such applications never result in allotments. However, in the past, these duplicate applications still appeared in the subscription numbers, creating a misleading perception of demand. Exchanges have now tightened controls, filtering out these applications from the start to prevent distortion in IPO subscription data.

For SME IPOs specifically, stock exchanges now validate PAN (permanent account number) details at the time of application, automatically rejecting any duplicate applications under the same PAN. This change effectively prevents scammers from artificially inflating subscription figures. Additionally, special categories like employees or existing shareholders are now screened directly at the exchange level, further tightening controls against fraudulent or ineligible applications.

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In a further step to improve market integrity, the National Stock Exchange has introduced a rule requiring SMEs to be cash flow positive for at least two of the last three financial years. This measure aims to enhance the quality of companies opting for SME listings.

However, the challenge remains in striking a balance between maintaining simplicity and ensuring sufficient scrutiny to keep the platform accessible for smaller firms.

So, avoid or buy?

Investing in SME IPOs carries more risk than mainboard IPOs, given that SMEs are smaller companies with shorter track records and higher market susceptibility. These stocks tend to be more volatile due to lower market capitalization and limited trading volumes.

Additionally, since they trade in multiples of a lot size, liquidity issues can arise, making it harder to buy or sell shares without significantly affecting the price.

Despite the risks, SME IPOs provide an alternative investment avenue with a higher risk-reward profile compared to mainboard IPOs. Recent regulatory changes have improved the transparency and quality of the SME platform, boosting investor confidence.

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However, investing in SMEs is far from a guaranteed path to profit. It requires thorough research and a deep understanding of the inherent risks. Only investors prepared to dedicate time to careful analysis should consider this option.

Mohit Mehra is vice president, primary markets & payments, at Zerodha.