SME IPOs: How Sebi, exchanges may further strengthen SME space after 90% price control cap

Amid rising concerns about speculative bubbles forming in SME stocks, the National Stock Exchange (NSE), on Thursday, announced the implementation of a 90% price control cap on the issue price of SME initial public offerings (IPOs) during the pre-opening session.

So, what does it mean for SME IPO investors? And what are the other steps market regulators may change to strengthen the SME IPO space?

In an interaction with Business Today, Kulbhushan Parashar, Founder and Managing Director, Corporate Capital Venture (CCv) shared his insights: Edited excerpts:

How do you see the announcement by NSE to put a cap on SME IPOs?
The development is positive for curbing market volatility and negative for those investors who could have sold their investments at a higher price. With these restrictions, people will have to shave their earnings and SME IPOs, which are seeing robust demand, may see low subscriptions going ahead.

How may the regulator further strengthen the SME IPO space and protect investors?
To strengthen the SME IPO space and protect investors, regulators such as Sebi can put in place several key measures:

• Raising the minimum IPO size to Rs 30 crore is an essential and important decision. This step ensures that only large companies with adequate resources and manpower enter the capital market, increasing the stability and reliability of the companies listed. Early-stage companies, which may lack the necessary stability, are filtered out, shielding investors from high-risk investments.
• Second, Sebi should consider revising its lot size policy. Individual investors may find it difficult to participate when the current lot size is too large. A policy of early and frequent lot size revisions could increase the accessibility of SME IPOs to a wider range of investors. Reducing lot size or requiring more frequent adjustments would lower the entry barrier, resulting in increased retail participation and market liquidity.
• Third, the timeline for companies transitioning from the SME board to the main board should be flexible. Rather than being solely time-based, migration criteria should consider the company’s net worth, market capitalisation, and financial performance. If a company has a net worth of Rs 100 crore or a market cap of Rs 1,000 crore, it should be able to migrate to the main board earlier than the current timeline. This flexibility would allow successful SMEs to expand and attract significant investment without undue delay.

As you analyse hundreds of SMEs, how has the working environment for SMEs changed in the country over the past 10 years?
Over the past decade, the working environment for SMEs has undergone significant changes due to various policy implementations and regulatory reforms. The introduction of the Goods and Services Tax (GST) has notably transformed accounting practices, requiring businesses to adopt proper disclosure and accurate reporting standards. This shift has increased transparency and ensured compliance with regulatory standards, fundamentally altering the internal operations of SMEs.
Moreover, stringent regulatory actions against defaulters, including large corporations, have instilled a greater sense of responsibility among businesses. Measures such as raids and arrests have promoted a culture of compliance, significantly impacting SME operations to align with legal and financial regulations and avoid penalties.
Additionally, the government’s policy mandating payments to MSMEs within 45 days has been transformative. Previously, late payments severely affected SMEs’ working capital and operations. This policy has streamlined payment processes, enhancing cash flow and operational efficiency for SMEs.
The advent of bill discounting platforms like TradeX Markets has further alleviated financial pressures on SMEs. These platforms allow SMEs to receive early payments, providing much-needed liquidity and improving their financial stability.

With the rising economy, how do you see the growth of SMEs in the country going ahead?
With an improving economy, the growth of SMEs in India is expected to accelerate significantly. Recent statistics indicate that the rate of SME listings is projected to increase dramatically. In the past decade, approximately 1,000 companies were listed; projections suggest this number could be matched within the next two years, with a potential listing boom occurring in as little as 1.5 years.

This rapid increase in SME platform listings is anticipated to lead many newly listed companies to eventually transition to the main board, a trend expected to persist as these companies grow and stabilise.

The SME sector is poised for transformative growth, akin to being “hit by a storm,” as more companies seek the benefits of listing. This surge will enhance SMEs’ visibility and credibility, providing greater access to capital markets, and facilitating their expansion.

Finally, the country's SMEs have promising growth prospects. The anticipated increase in the number of listings as well as the subsequent transition of companies to the main board, highlight the SME sector’s constantly changing environment.

How do you see the profit growth of the SME space going ahead?
The profit growth of India’s SME sector appears highly promising in the coming years. SMEs are increasingly recognising the necessity of demonstrating profitability to achieve higher valuations and ratings, enhancing their net worth and fundraising capabilities. This awareness is driving a trend towards active profit reporting within the sector.

Banks play a crucial role in this context, as they have indicated that lower profitability results in reduced exposure from their end. Consequently, SMEs are incentivized to improve profitability to secure favourable equity market valuations and debt support. This dual pressure from equity and debt markets is expected to lead to overall profitability increases for SMEs.

Promoters are also placing greater emphasis on profitability due to its tangible benefits. Successful case studies of profitable companies are being used as models, encouraging other promoters to closely monitor financial performance with the aim of launching successful IPOs. This focus on achieving high valuations reinforces the importance of maintaining robust profit margins.

Various government initiatives further contribute to SME profitability. Policies such as the Approved List of Models and Manufacturers (ALMM), customs duties, export support, and subsidies are designed to bolster the financial health of manufacturing companies and other SMEs. These measures include tax breaks, support for new manufacturing units and startups, and export subsidies, all of which enhance the bottom line for SMEs.

Which IPOs from the SME space may deliver robust returns to investors going ahead?
In the past few years, a couple of SME IPOs have provided investors with strong returns. Looking ahead, while specific companies cannot be pinpointed with certainty, certain industries are expected to continue performing well, providing investors with promising returns.

While one cannot comment on which IPOs will deliver results in the future, there are certain industries to look out for. Especially, industries that benefit from ongoing government assistance and favourable policies are especially notable. For example, the energy sector has grown significantly and continues to benefit from government policies promoting energy efficiency, renewable energy, and sustainability. These factors contribute to their strong performance and high profit potential.

The manufacturing sector, particularly companies that produce innovative and in-demand products, is expected to expand further. The government's support for new manufacturing units and start-ups, combined with export subsidies and other financial incentives, positions these businesses for significant growth.
Due to the growing market presence and profitability, rapidly scaling companies frequently provide attractive returns.

Furthermore, industries such as technology, pharmaceuticals, and renewable energy are expected to thrive. Global demand for technological and healthcare innovations, combined with local support for green initiatives, make these industries appealing for investment.

Investors can earn high returns by focusing on sectors that align with government priorities and have strong growth potential, such as energy, manufacturing, technology, and pharmaceuticals. These industries are well-positioned to benefit from both domestic and global market trends, making them promising investment opportunities in the SME space.

How do most of your SME IPOs turn into multibaggers? What are the things you keep in mind while valuing an IPO?
The selection process plays a role in the success of most SMEs’ IPOs in becoming multi-baggers. The key is to choose companies that have something unique about their business, business model, promoter pedigree, financials, and operating environment.

When valuing an IPO, it’s important to concentrate on companies with unique characteristics. These companies’ expansion should not be linear or limited. This involves looking for companies operating in high-growth industries with significant market potential. The promoters’ track record and industry experience are also important, as they ensure their ability to drive their businesses to success. Another important consideration is financial well-being.

How can a small company launch its SME IPO? Is it a complicated process?
The process for a small company to launch an SME IPO is not overly complicated, but it can be challenging. The entire procedure takes approximately four to five months. During this time, the company goes through several stages to become listed.

Regulators have designed the process to be relatively simple, but it has become complex with time. This complexity is the result of the exchange’s stringent testing and multiple rounds of queries. Despite these challenges, the process is manageable and usually completed within four to five months.

Small companies benefit from less stringent disclosure requirements than larger IPOs. This makes it easier for small businesses to meet the required standards. Although the process has several steps and can appear intimidating at times, it is feasible and designed to be accessible to small businesses seeking to enter the capital market.

What are the things required to have for the launch of an IPO?
o launch an IPO, a company must have several important components in place. First, it must have established business operations based on a clear and viable business model. The promoters must demonstrate a genuine interest and commitment in taking the company public.

There should be a well-defined plan for using the funds raised from the IPO, which are typically intended for growth capital to expand operations, enter new markets, or improve capabilities. The company’s financial health must be strong, with accurate and transparent financial statements indicating profitability or a clear path to profitability. Standard operating procedures (SOPs) should be developed to ensure smooth and efficient operations.

Finally, the company must have sufficient resources, including human, financial, and technical, to support the IPO and subsequent business growth. If these elements are in place, the company is well-positioned to launch an IPO and raise the capital required to drive further development and expansion.

How are SME IPOs helping small companies to unlock value?
Parashar: SME IPOs have helped small businesses discover an immense amount of value. These IPOs provide a platform for companies that, despite their huge potential, frequently go unnoticed.

Going public increases these companies’ visibility and credibility, attracting recognition as potentially great enterprises. As is commonly noted, all great companies began as small and medium-sized enterprises. Unless they come from an established parent company, their journey begins as a small enterprise.

The key is to recognise and understand these “little champions.” When a promising company is identified and brought to market via an IPO, the opportunity for value unlocking is huge. This process reveals the company's true worth, which often exceeds its promoter’s expectations.

Thus, SME IPOs provide an important opportunity for small businesses to gain recognition, attract investment, and realise their full potential, resulting in significant value creation that may have previously been unattainable.