SEBI Tightens Rules for SME IPOs: A Closer Look

Small and Medium Enterprises (SMEs) in India have enjoyed rapid growth in the public market, but this success has brought challenges. The Securities and Exchange Board of India (SEBI) is stepping in with stricter rules for SME Initial Public Offerings (IPOs) to protect investors and maintain market integrity. Let’s dive into what’s changing and why.

The Growth and Challenges of SME IPOs

Since the launch of SME platforms in 2008, these exchanges have become a popular choice for smaller businesses to raise funds. As of October 2024, there are 745 companies listed on SME platforms with a combined market capitalization of ₹2 lakh crore. In the past two financial years alone, SME IPOs have raised over ₹11,700 crore.

However, with this rapid growth, several issues have surfaced:

• Promoters cashing out: The Offer for Sale (OFS) mechanism is often used by promoters to exit rather than raise funds for business growth.
• Misuse of funds: IPO proceeds are sometimes diverted into vague categories or related-party transactions.
• Investor risks: Retail investors, attracted by speculative gains, often find themselves stuck in illiquid stocks.
• Low liquidity: Many SME stocks see minimal trading activity after the initial buzz of the IPO fades.

These problems have raised concerns about governance, fund utilization, and investor protection.

SEBI’s New Proposals to Clean Up SME IPOs

To address these issues, SEBI has proposed several reforms aimed at improving transparency and ensuring funds are used for the right purposes.

1. Stricter Rules for Offer for Sale (OFS)

The OFS mechanism allows existing shareholders to sell their shares during an IPO, but it’s been overused as a promoter exit tool. SEBI proposes:

• Capping OFS at 20% of the total issue size or pre-issue shareholding, whichever is lower.
• Restricting individual shareholders from selling more than 20% of their pre-IPO holdings.

This ensures that the majority of funds raised go towards growing the business, not cashing out promoters.

2. Tighter Monitoring of IPO Proceeds

Misuse of IPO funds has been a major concern. To counter this, SEBI plans to:

• Lower the threshold for mandatory monitoring of funds from ₹100 crore to ₹20 crore.
• Ban fundraising for undefined acquisitions.
• Cap “general corporate purposes” allocations at 10% of the issue size, down from 25%.

These measures aim to ensure funds are used transparently and for legitimate business activities.

3. Higher Minimum Application Size

Retail investors have been pouring money into SME IPOs, often chasing speculative returns. SEBI wants to raise the minimum application size:

• From ₹1 lakh to ₹2 lakh, or potentially ₹4 lakh.

This change will reduce speculative investments and attract investors who understand the risks.

4. Longer Promoter Lock-in Periods

Promoters often sell shares soon after lock-ins expire, destabilizing stock prices. To prevent this:

• SEBI proposes extending the lock-in period for minimum contributions from three to five years.
• Promoters will be required to phase out excess holdings gradually.

This ensures promoters remain invested in the company’s success.

5. Improving Liquidity

Low trading volumes plague many SME stocks. To address this, SEBI plans to:

• Increase the minimum number of IPO allottees from 50 to 200.

A broader investor base should make these stocks easier to trade.

SEBI’s Vision for a Safer SME Market

The proposed changes aim to restore trust in the SME platform by:

• Ensuring IPO funds are used for business growth.
• Curbing misuse of funds and improving governance.
• Protecting investors from high-risk, speculative investments.

These reforms also align SME governance with the higher standards of the Main Board, making the platform more credible and investor-friendly.

The Road Ahead for SME IPOs

The SME platform has immense potential, but misuse and governance lapses have tarnished its image. SEBI’s proposals seek to balance the need for growth with investor protection. While changes like increasing the minimum application size might reduce participation, the focus on transparency and accountability is a step in the right direction.

If these rules are implemented, the SME platform could regain its original purpose—helping small businesses grow while providing investors with safer, more reliable opportunities.

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.