SME IPO Meaning & Process: Ultimate Guide for New Investors

The Securities and Exchange Board of India (SEBI) introduced dedicated Initial Public Offering (IPO) guidelines for Small and Medium Enterprises (SMEs) in 2012. These guidelines created a separate platform for smaller businesses to raise funds from public investors, outside of traditional private equity or venture capital. This has also opened up new opportunities for equity investors outside large-cap stocks.

This article explains what SME IPO is, outlines the application process, and highlights key information new investors should know before participating.

What is SME IPO?

An SME IPO is the process through which small- and medium-sized companies raise capital from the public to meet their capital requirements. It provides promoters of cash-starved small companies with a cost-effective way to secure funds without diluting stake to private investors such as venture capitalists.

Traditionally, raising capital through public offerings was considered the domain of large companies. Strong IPO regulations often discouraged smaller businesses from taking this route due to high compliance costs, minimum capital requirements and stock-market related restrictions.

To address these challenges and support India’s growing SME sector, SEBI introduced SME IPO guidelines in 2012. Following this, both the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) launched dedicated platforms for trading shares listed through SME public offerings.

Who are SMEs?

The MSME (Micro, Small and Medium Enterprises) Development Act of 2006 classifies SMEs as:

• Small enterprises: Companies with investments in tangible assets (plant, machinery, equipment, etc.) not exceeding ₹10 crore and annual turnover not exceeding ₹50 crore.

• Medium enterprises: Companies with total investment in tangible assets not exceeding ₹50 crore and turnover not exceeding ₹250 crore.

Who is eligible for an SME IPO?

SEBI has relaxed several criteria necessary for large company IPOs to accommodate SMEs’ limitations and capital requirements. The latest eligibility norms for SME IPOs include:

• Incorporation: SMEs must be registered as public limited companies per the Companies Act 1956 (now replaced by the Companies Act 2013).

• Maximum capital limit: The company’s paid-up capital post-issue should not exceed ₹25 crore.

• Asset size: The minimum tangible assets should be worth ₹1.5 crore.

• Track record: Companies must have at least three years of financial track record in ‘public limited’ form if they were converted from proprietorship, partnership, or LLP.

• Financials: The issuing company should have earned an operating profit (EBITDA) of at least ₹1 crore in two of the last three years. The net worth and free cash flow to equity (FCFE) should be positive in at least two of the previous three years.

• Promoter holding: The Offer for Sale (OFS) by promoters should not exceed 20%. Post-issue, promoters must hold at least 80% of the company’s shareholding.

• Lock-in period: Promoters must retain their post-issue shareholding for at least one year.

• Demat format: The issuing company must issue shares in demat format, requiring a contractual agreement with a depository.

SME IPO issuance and listing process

For investors interested in SME IPOs, understanding the listing process is essential. Here are the key steps:

• Appointment of an underwriter: The company must appoint SEBI-registered underwriters (merchant or investment bankers) who manage all IPO-related activities on the company’s behalf.

• Preparation of offer document: Known as the Draft Red Herring Prospectus (DRHP), this document contains detailed information about the company and the IPO. It is prepared by the underwriters in collaboration with the issuing company.

• Submission to the SEBI: The DRHP is submitted for review and approval. The IPO process cannot proceed without SEBI’s clearance.

• Promotion of the offer: To attract potential investors, the IPO must be promoted through marketing activities organised by underwriters.

• Book building process: Investors place bids stating the number of shares and the price they are willing to pay. Based on these bids, the underwriter and the company finalise the share price.

• Allotment and listing: Shares are allotted to successful bidders, and the company lists the shares on SEBI-approved SME exchanges. Post-listing, investors can trade these shares.

What new investors must look for in SME IPOs?

SMEs are growing companies with high-risk, high-return investment potential. Investors willing to apply for SME IPOs should follow a few basic guidelines. These will help them learn about SME IPO and make informed decisions.

• Purpose of the IPO: Understand how the IPO issuing company intends to utilise the funds raised through the offer. Will it be used in profitable capital investments? What is the expected rate of return for that investment? IPOs offered to finance revenue expenditures may not be a wise investment.

• Business model and industry: This involves understanding competitiveness in the industry; the company’s pricing power, market share, etc.

• Financial performance: Review the company’s balance sheet and profit and loss statements.

• Application process: SME IPOs usually require investing in larger lot sizes. This means the minimum investment sizes are higher than those of regular IPOs. So, it is important to learn about the minimum lot size, price ranges and payment options before applying for a public offer.

• Promoters’ background: Evaluate the promoters’ track record, industry experience and reputation.

Conclusion

SMEs are the backbone of any growing economy. Understanding what an SME IPO is crucial for both businesses and investors. Through SME IPOs, small businesses in India can access much-needed growth capital without depending solely on private investors. At the same time, investors get to invest early in promising companies with high growth potential. However, as with any equity investment, thorough due diligence is essential before investing in an SME IPO to ensure sound financial decisions.

Sources:

Mint
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HDFC Bank