SME IPO Introduction

SME stands for small and medium-sized enterprises. These are the businesses governed by the Ministry of Micro, Small and Medium Enterprises and have fewer employees, few assets, smaller revenue and operate on a small scale compared to large corporations. Though the SMEs are small in size, they are the important pillars of India’s economic development. SMEs play a crucial role in employment generation, innovation, entrepreneurship and much more.

SMEs are classified into three categories based on their investment in plant and machinery or equipment and business turnover.

SME IPO meaning

An SME IPO is the first time a small and medium-sized company sells shares to the public. SME IPOs help companies raise capital and get listed. Technically, it is a public capital raising tool where the company reaches a stage where it proves to be capable of growth and wants to raise funds that contribute to a faster growth rate of the SME .

SME IPO is the acronym for Small and Medium Enterprise Initial Public Offering . Raising funds through IPOs helps SMEs to:

• Create wealth for promoters, shareholders, and the public.
• Create demand for the company's stock.
• Increases the credibility of the company.
• Help in business expansion.
• Establish a long-term foundation.

SME IPO History

SME sector being the second largest employer, after agriculture, required funds to grow further and thus a need for a dedicated exchange /platform for SMEs was felt and in 2012, SEBI launched separate platforms, NSE Emerge and BSE SME , for listing of SMEs. The process for SME IPO takes 3 to 4 months in most cases.

• SME IPO List 2012 (IPO at BSE SME & NSE Emerge)
• The first company to list on the BSE SME IPO platform was BCB Finance .
• The first company to list on the NSE SME IPO platform was Thejo Engineering Ltd .

The issuing company must choose one of the two SME platforms as unlike the mainboard IPO shares, the SME shares are listed on only one exchange.

Objects of the issue for SME IPO

An SME company issues an IPO for various reasons. Some of the key objectives for issuing an IPO include the below:

• To meet working capital needs.
• For growth and expansion.
  • To acquire businesses in similar or complementary fields.
  • To invest in strategic acquisitions/joint ventures.
  • To acquire plant and machinery to meet increased production demand or for better productivity and efficiency.
  • To finance expenses for opening new stores.
• For general corporate purposes.
• To enhance market visibility.
• For repayment of loans (other than promoter or related party loans).
• To provide an exit route for existing investors.
• To reduce debt equity ratio.

The object of the issue tells investors how the company intends to use the funds raised from the public. The issuing company can raise funds through either a fresh issue or a combination of fresh issues and an offer for sale .

1. Fresh Issue

   Fresh issue is the issuance of new shares of the company and their sale to investors. The funds raised are intended for use in the company.

2. Offer for Sale (OFS)

   Offer for Sale is the sale of shares by an existing promoter or investor. The company does not receive any proceeds from the OFS. All proceeds go to the selling shareholders in the amount of their pro-rata contribution for the offer for sale.

SME IPO Advantages and Disadvantages

SME IPOs in India provide notable benefits like growth potential, easy capital access, enhanced visibility, and better governance. However, they also involve challenges such as costs, market volatility, risk of underperformance, risk of takeovers, and risk of not generating enough demand for the IPO.

Let us have a look at these SME IPO pros and cons in detail.

1. SME IPO Advantages / Benefits of SME IPO

An SME IPO helps companies raise low-cost capital in the capital market. This helps the companies to expand their business and provide adequate capital infusion. This route also creates wealth for the promoters and shareholders of the company. Below are the key SME IPO benefits that also tell about the reasons as to why an SME company should seek an IPO:

1. Raise interest-free capital

   SME IPOs help companies raise capital by selling shares to the public. The issuer has to pay the expenses incurred in going public. But, there are no recurring costs or interest payments associated with the funds raised through an IPO.

2. Improved value creation

   An IPO increases financial stability and improves the credibility of the company. This leads to:

   • Increased demand for the company's stock.
   • Higher valuation based on industry and company performance.
   • Creation of shareholder value and wealth.
   • Increase in valuation of a company.
   • Improvement in the company's overall equity.
   • Creation of leveraged assets with healthier and stronger balance sheets.
3. Expansion and growth

   An IPO increases the investor base for the shares of the company. It provides growth opportunities such as expansion through secondary offerings, including private placement s.

   SMEs play an important role in social and economic development. SME growth and expansion increase business and employment opportunities in a country.

4. Facilitating liquidity for shareholders

   An IPO provides liquidity to shareholders and promoters. This results in providing companies with several growth opportunities, such as expansion and mergers and acquisitions .

5. Easy exit option

   A capital increase provides existing investors with easy exit options. It also allows new investors to invest in the company. Shareholders and investors in the company can sell their shares and exit through an offer for sale.

6. Lowers the debt burden

   Raising funds through an IPO helps reduce the company's debt by restructuring or paying off the company's debt.

7. Visibility and image building

   Going public gives the company greater visibility in the media and helps promote the brand. This improves the credibility of a company over an unlisted company.

8. Employee motivation

   SME IPOs allow companies to issue stock options to employees, which helps to retain talent and motivate them by aligning their interests with the success of the company.

   Stock options allow employees to own a portion of the company, which promotes a sense of ownership and engagement. As the company's share value increases, employees benefit financially, which can increase job satisfaction and loyalty.

9. Better corporate governance

   Listing usually leads to improved corporate governance and transparency, which can attract more investors and business partners by promoting a more responsible and trustworthy business environment.

   A listed company must adhere to strict regulatory requirements and disclosure standards to ensure that its financial practices, management decisions, and business operations are transparent and verifiable. Improved corporate governance structures, such as independent boards and audit committees, help to ensure that the company is run in the best interests of its shareholders, further enhancing investor confidence.

10. Easy migration to the main board

    SME IPOs help companies grow their business and expand their operations. They also facilitate access or migration to the main board platform for a stable and long-term future and expansion.

SME IPO Disadvantages / Risks

Like all financial instruments, SME IPOs also have some risks. These should also be understood:

1. Costs of the SME IPO

   There are costs associated with raising funds through an IPO. Direct costs include merchant banker fees, underwriting commission, market maker fees, registrar fees, legal fees, audit fees, and filing fees. In addition, the company must also spend money on advertising, road shows, and PR (public relations) activities.

   The costs of an SME IPO vary depending on the size of the IPO, the services used, and the expenses incurred for advertising the IPO. They range from Rs 50 lakhs to a few crores. Read SME IPO costs for more details.

2. Exposure to sensitive data

   When a company goes public, information about financial details, executives, corporate transactions, violations related to management, and any other important information becomes public.

3. Loss of Valuation

   When listed shares do not perform well on the stock market, the company's valuation decreases. This affects the reputation of the company and its brands. It also has an impact on the promoters, management and employees.

4. External factors for poor performance

   Many challenges can affect the company, such as poor industry performance, poor industry outlook, taxation rules, low industry profitability may lead to poor stock performance.

5. IPO withdrawal

   Often SME IPOs are withdrawn at the last minute, due to various reasons. These include:

   • Disputes between the company and its house bank,
   • Lack of agreement with the underwriter or other fund managers,
   • Lack of disclosure of key information in the DRHP , etc.

   In this case, the company has to bear the cost of the IPO.

6. Need to hire fund managers to stabilize the price after listing

   In a SME IPO , 40% to 70% of small investors sell the shares in the first 2 weeks. This is done to make a quick profit or to book losses and invest the funds in another IPO.

   The massive selling of these shares leads to sharp fall in prices. Some companies hire fund managers or wealthy investors to buy such shares to stabilize the price. Once the price has stabilized, the fund manager's responsibility comes to an end.

   The role of such hired fund managers is very limited which comes at an additional cost. This is beyond the role of the market maker in a SME IPO.

7. Risk of Hostile Takeover

   Listed companies are more exposed to the risk of a hostile takeover because their shares are publicly traded and can be bought by anyone. This makes it easier for an outside party to acquire a significant portion of the company's shares and potentially gain control, which can lead to unwanted changes in the company's management or direction. If a large corporate acquires a majority stake, the independence of the SME company is at risk.

SME IPO limits

We all know that an SME IPO has little relaxed norms compared to a mainboard IPO. However with risks associated with SME IPO, SEBI has rolled out certain restrictions and limitations for SME IPO issuing companies as listed below:

• Restriction on Offer for sale (OFS): The OFS component in an SME IPO should not exceed 20% of the total issue size . Also in case of an OFS, the selling shareholders cannot sell more than 50% of their holding.
• Longer promoter lock-in periods: The lock-in on promoter holding in excess of minimum promoter contribution (MPC) to be released in two tranches: (i) 50% to be released after 1 year (ii) remaining 50% to be released after 2 years,
• Capping on funds to be raised for general corporate purpose: The general corporate amount should not exceed 15% of amount being raised by the issuer or Rs. 10 crores, whichever is lower.
• No repayment of loan from SME IPO proceeds: The SME IPO funds cannot be used for repayment of Loan from Promoter, Promoter Group or any related party, from the issue proceeds, whether directly or indirectly.

Post-Issue Paid-up Capital Restructuring

Company's paid-up capital is restructured in the pre-IPO phase. SME companies use Bonus Issue or Buyback to bring the post issue paid-up capital between Rs 1 Crore to Rs 25 Crores.

Example of how an SME company reallocates capital to be eligible for SME IPO:

Let's say an SME Company has:

• Paid-up Capital: Rs 1 Lakh.
• Total Equity Shares: 10,000.
• Face Value (FV): Rs 10.
• Reserve s: Rs 10 Cr.
• Net Worth : Rs 10.01 Cr (Rs 10 Cr + Rs 1 Lakh).

To increase paid-up capital:

• Company issue Bonus to promoters of Rs 10.00 Cr / Rs 10 FV = 1 Cr shares.
• Total Promoters holding: 1 Cr + 10,000 = 1.001 Cr shares (100% holding).

SME IPO Public Issue:

• Fresh Issue - Additional shares issued to the public: 33.5 lakhs (reverse calculated as 25% of 1.001 Cr + 33.5 lakhs shares).
• In case of OFS, the shares are deducted from promoters holding.

Post-IPO shareholding:

• Total Share After public issue: 1.001 + 0.335 = 1.336 Cr shares.
• Total Public holding = 33.5 lakhs shares (25%) (Out of this 1.6 lakh shares (5% of public issue) are given to Market Maker ).
• Total Promoters holding = 1.001 Cr Shares (75%).

Thus:

Post-Issue Paid Up Capital = Rs 1.336 Cr * Rs 10 FV = Rs 13.36 Cr (which is below Rs 25 Cr).

If the company issues shares at Rs 100 price (Rs 10 FV + Rs 90 Premium), the Rs 90 goes to reserve and surplus.

Key Takeaways

• IPO is an important milestone for small and medium-sized companies as it helps them to raise capital, increase brand awareness, and promote growth.
• SME IPOs were introduced in India in 2012 and have since become an important investment tool.
• For investors, they are a good investment opportunity. This is because SMEs are responsible for at least 60% of the jobs and business created in India.
• SME IPOs have similar advantages and disadvantages as regular IPOs.
• Companies must weigh the benefits against challenges such as market volatility and regulatory hurdles to make informed decisions about going public. Ultimately, a successful SME IPO can lead to long-term success and sustainability in a competitive market.