There has been a surge in initial public offerings (IPOs) from small and medium-sized enterprises (SMEs) in recent years. More than 90 SME firms have already gone public in the first five months of 2024. In fact, FY24 saw a record 204 SME public issues, according to data from Prime Database.
While this surge indicates a vibrant and growing ecosystem, it has also sparked a debate regarding some firms misusing the segment for personal gain. There have been instances of issues being oversubscribed hundreds of times and stock prices surging despite the absence of any supporting growth in the companies’ fundamental metrics.
To ensure better oversight, the Securities and Exchange Board of India (Sebi)—the capital markets regulator—may tighten listing norms. A couple of months ago, speaking about the SME IPO space, Sebi Chairperson Madhabi Puri Buch said the regulator had reasons to believe that some entities were misusing the segment for price manipulation.
“The reality is that these are relatively small entities, the market capitalisation is small, and the free float is small. It is relatively easy to manipulate both at the IPO level and the trading level,” she had stated.
Some experts argue that the existing regulations, which offer lenient listing and disclosure requirements for SMEs compared to mainboard companies, may inadvertently fuel speculation and expose investors to heightened risk. “There are concerns with SME IPOs, as the issue size is small and the segment has much more lenient listing and disclosure norms compared to the main exchange or the mainboard. This has led to high speculative activity, and many companies’ valuations are unheard of,” says market veteran A.K. Prabhakar.
The rapid pace at which SME IPOs are being offered raises several concerns, says Aurelia Menezes, Partner at law firm King Stubb & Kasiva. “This may lead to a compromise in the due diligence process, potentially bringing lower-quality companies to the market. An influx of SME IPOs might overwhelm investors, leading to insufficient demand and underperformance of these IPOs post-listing,” Menezes explains.
Another problem she highlights is valuation. “With many companies rushing to go public, there might be pressure to accept lower valuations, which can be detrimental to both the companies and their investors. Ensuring thorough regulatory oversight becomes challenging when the number of offerings increases significantly, potentially leading to lapses in compliance,” Menezes adds.
Even though there have been reports of price manipulation by some firms, G. Chokkalingam, Founder and MD of market research firm Equinomics Research, believes that an uptick in SME IPOs is healthy for the economy. “SMEs can drive the economy and also participate in employment generation. Hence, aggressive resource mobilisation by SMEs through IPOs is good for the economy,” Chokkalingam says.
When asked what the changes to the existing rules could be, Prabhakar suggests, “Maybe the lock-in period for IPO applicants can be three to six months, and subsequent buyers in the segment should hold the shares for a minimum of three months before selling. It would keep fly-by-night corporations in check.”
Menezes says it is vital to ensure that only fundamentally strong companies are listed, and this will maintain investor confidence and market integrity. “Many retail investors may not be familiar with the risks associated with investing in SMEs. Education programmes can help mitigate potential losses,” she says. But, at the same time, she says the regulator must consider smaller firms’ potentially limited ability to meet extensive reporting requirements, so a balanced approach can ensure compliance without excessive burden. “Post-IPO monitoring can help maintain market discipline and protect investors from potential fraud or mismanagement.”
Chokkalingam proposes that the regulator encourage the splitting of shares before IPOs. This can help to keep a check on rallies in SME stocks with very low retail floats driven purely on perception. Splitting of shares and increasing the supply of shares in the markets could curb over-valuation in some SME counters. “They can also broaden public holdings and expand retail holdings by encouraging a larger share of public ownership, up to 49%.” These experts also feel that there is a need for a minimum threshold for SME IPOs. “By setting a threshold, the market can avoid an influx of very small, potentially volatile companies that might underperform and harm the overall perception of SME IPOs. Institutional investors might be more willing to invest in SME IPOs if there is a minimum standard, which can provide more stability and liquidity to the market,” Menezes says.
Chokkalingam feels that reducing the minimum trading lot and the number of allottees could encourage greater participation by investors, avoiding the concentration of holdings by a limited number of investors. An official statement from Sebi is yet to come. That being said, there are indications aplenty that the capital markets watchdog is tightening the noose around those who aim to misuse the SME IPO space.
@prashuntalukdar