A case for bolstering SME IPOs for the wealthy investor

There is a life lesson to be had in the growth of Chinese bamboo. The tree takes about five years to sprout. But once it does, it has a growth spurt, rising to even 80 feet in just a few weeks. That is what has been happening with SME IPOs in the recent past.

Last year was remarkable for small and medium enterprises, with 182 companies getting listed on SME exchanges via initial public offerings of their shares. This year, we have already seen 87 SME IPOs. The subscription figures, too, have been astonishing, with many SME IPOs being oversubscribed by 500-1,000 times the issue size. 

That said, due to the unique risks involved, SME IPOs are more suitable for retail and wealthy, or so-called high net worth (HNI), investors.

A simple listing process, but also less scrutiny

One of the primary draws in the SME IPO process is the relative ease with which companies can raise capital from listing on the SME exchanges. While mainline IPOs on NSE and BSE require stricter regulatory scrutiny and approval from the Securities and Exchange Board of India, SME IPOs need only an exchange approval. Filing of the listing prospectus with Sebi is a post-IPO formality for record-keeping purposes. But this relative ease places the onus on investors to look deeper into a company before investing in it.

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Additional surveillance and trade-to-trade settlements

The market regulator has placed the SME IPO segment under additional surveillance measure (ASM) and trade-to-trade (T2T) settlement practices. This restricts the number of participants and trading volumes, making SME stocks a better choice for HNIs than retail investors.

To protect retail investors from the higher risks associated with smaller companies, Sebi sets a higher minimum ticket size for SME IPOs, attracting more experienced and financially capable investors. This helps maintain market stability, ensuring thorough due diligence and promoting overall market integrity.

Higher minimum application size

An intriguing aspect of SME IPOs is the significantly higher minimum application requirement than mainline IPOs. While mainline IPOs require an investment of Rs15,000-20,000, SME IPOs have a concept of minimum lot size for the number of shares, with the application amount exceeding ₹1 lakh for retail investors. This steep capital requirement deters retail investors, making it more challenging for them to participate. 

Consequently, the smaller capital base and concentrated shareholding result in a lower free float, which can lead to substantial price fluctuations. Such situations are more apt for HNIs who have an appetite for higher volatility and concentrated holdings.

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Strengthening SME IPOs: From an HNI’s perspective

To bolster investor participation in SME IPOs, the market expects a few enhancements:

1. Pre-IPO scrutiny: The regulatory process for SME IPOs could include more comprehensive pre-IPO scrutiny, similar to that for mainline IPOs. This will help identify governance-related loopholes early in the process.

2. Increased transparency: Transparency and disclosure standards for SME IPOs need to be strengthened. Adequate information about their business, financials, and risks is essential for investor protection. Adherence to more transparency and disclosure standards by SMEs could also lead to their listing on the mainboards.

3. Stronger surveillance: The surveillance mechanism for SME IPOs may be bolstered, enabling market participants to identify and avoid irregularities promptly.

4. Investor education: Enhancing financial literacy and educating retail investors about the risks associated with SME IPOs is crucial. Investors should be encouraged to make informed decisions and understand the potential risks.

5. Widening the base: Currently, SME IPOs need a minimum 50 subscribers for an issue, which is fairly low when compared with mainboard IPOs. This number should be increased. With 82% of the companies on the SME exchange giving positive returns on listing day, HNI interest is building up, which can be leveraged to promote broader participation.

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The SME IPO platform has undoubtedly benefited small businesses, providing them with a pathway to growth. Several SMEs have even migrated to the mainboards after fulfilling the eligibility criteria.

Regulators have constantly refined their rules and guidelines to safeguard investor interests while simultaneously ensuring that SMEs can obtain the necessary equity capital for growth. 

Investor interest in SME IPOs is constantly increasing. Already this year, 10 SME IPOs were oversubscribed more than 500 times, led by wealthy investors.

Strengthening governance, transparency, and investor protection by reducing information asymmetry is imperative for regulators to augment the growth of small and medium enterprises and create a vibrant and transparent capital market for all.

Rahul Bhutoria is the director and founder of multi family office Valtrust Capital.