SEBI’s Proposed Changes to SME IPO Norms: An In-Depth Analysis

The Securities and Exchange Board of India (SEBI) released a Consultation Paper on 19th November, proposing significant changes to the norms governing Small and Medium Enterprise (SME) Initial Public Offerings (IPOs). These proposals aim to enhance transparency, protect investor interests, and ensure that the SME platform fulfills its original purpose—providing growth capital to deserving small and medium enterprises.

Note: These are proposed changes, and SEBI is currently seeking comments and feedback from industry experts and stakeholders before finalizing any amendments

1. Key Proposed Changes and Rationales

1. Offer for Sale (OFS)

• Current Norm: No cap on the OFS portion of the issue size.
• Proposed Norm: Cap OFS at 20-25% of the total issue size.
• Rationale:
  • SEBI noted that in FY 2023-24 and FY 2024-25 (up to October 2024), two SME IPOs consisted of 100% OFS, where no fresh capital was raised for the issuer company.
  • Additionally, in 52 SME IPOs conducted over these two fiscal years, 30 IPOs (57.7%) had an OFS portion exceeding 20% of the total issue size.
  • This trend suggests that promoters are primarily using IPOs to dilute stakes rather than raising funds for the company’s growth.
  • By capping OFS at 20-25%, SEBI aims to align IPO proceeds with the original goal of fostering SME expansion and discouraging misuse of the SME platform.

2. Minimum Subscription Amount

• Current Norm: Minimum application size of ₹1 lakh.
• Proposed Norm: Increase to ₹2 lakh or ₹4 lakh.
• Rationale:
  • The retail investor category (defined as investors applying for up to ₹2 lakh) has grown significantly in recent years. This increase in retail participation reflects heightened interest but also raises concerns due to the higher risks associated with SME IPOs.
  • SEBI proposes increasing the minimum subscription size to filter out smaller, less-informed retail investors.
  • Statistical Insight: Over the past 14 years, market indices like Nifty and Sensex have grown 4.5 times. Adjusting the application size in proportion ensures relevance to current market conditions.
  • If the minimum subscription amount is raised to ₹4 lakh, the retail individual investor category may be merged into the non-institutional category for better market segmentation.

3. Minimum Allottees

• Current Norm: At least 50 investors required for an SME IPO.
• Proposed Norm: Increase to 200 investors.
• Rationale:
  • SEBI emphasizes that the investor base in India has grown significantly since 2010, necessitating broader participation in SME IPOs.
  • With more allottees, post-listing liquidity improves, benefiting both issuers and investors.

4. EBITDA Requirement

• Current Norm: Positive EBITDA in two of the last three financial years.
• Proposed Norm: Minimum EBITDA of ₹3 crore in at least two of the last three financial years.
• Rationale:
  • In the absence of financial thresholds, smaller or less viable companies may enter the public market, increasing risks for investors.
  • A defined EBITDA benchmark ensures that companies entering the market demonstrate profitability and financial stability, reducing investment risks.

5. Promoters’ Lock-In Period

• Current Norm: Promoters can release their entire locked-in shares after three years.
• Proposed Norm: Implement a phased release of promoters’ locked-in shares.
• Rationale:
  • SEBI observed that after the initial lock-in period, promoter holdings often dropped significantly, leading to concerns about long-term commitment.
  • By phasing the release, SEBI ensures that promoters retain “skin in the game” and align their interests with the company’s stability and performance.
  • Important Stat: SEBI highlighted that in SME IPOs, promoter holding drops significantly within one year of the lock-in release, excluding the mandatory 20% locked-in for a longer period.

6. General Corporate Purposes (GCP)

• Current Norm: Up to 25% of IPO proceeds can be allocated for GCP.
• Proposed Norm: Limit GCP allocation to 10% of the issue size or ₹10 crore, whichever is lower.
• Rationale:
  • GCP lacks specific monitoring mechanisms, increasing the risk of misuse.
  • For instance, in a ₹100 crore issue, a 25% GCP allocation allows the company to utilize ₹25 crore without clearly defined objectives, which is disproportionately high.
  • Limiting GCP ensures greater accountability and better utilization of IPO proceeds for growth-related activities.

7. Monitoring Agency Requirement

• Current Norm: Required for IPOs exceeding ₹100 crore.
• Proposed Norm: Extend requirement to issues between ₹20 crore and ₹50 crore.
• Rationale:
  • A monitoring agency (usually a SEBI-registered Credit Rating Agency) certifies the utilization of IPO proceeds, reducing the risk of diversion or misuse.
  • Impact: This change ensures better oversight for smaller IPOs, where risks of mismanagement are typically higher due to weaker governance structures.

8. Conversion from Partnership/LLP

• Current Norm: No cooling-off period required post-conversion.
• Proposed Norm: Introduce a 2-year cooling-off period for companies converting from a partnership or LLP structure to a public/private limited company.
• Rationale:
  • Financial reporting standards differ for partnerships/LLPs and companies. A cooling-off period ensures that the company’s financials stabilize and reflect its operations accurately before listing.

9. Minimum Issue Size

• Current Norm: No minimum issue size specified.
• Proposed Norm: Set a minimum issue size of ₹10 crore.
• Rationale:
  • Companies with smaller funding needs can typically access loans or alternative funding sources.
  • A higher threshold ensures that only businesses with substantial growth potential and funding requirements enter the public market.

10. Related Party Transactions (RPTs)

• Current Norm: No stringent RPT norms for SMEs.
• Proposed Norm: Align with mainboard regulations.
• Rationale:
  • SEBI’s analysis revealed that:
    • 1 in 2 SME-listed entities undertook RPTs exceeding ₹10 crore.
    • 1 in 7 SME-listed entities engaged in RPTs amounting to more than 50% of their consolidated turnover.
  • These statistics highlight the systemic risks posed by RPTs, including fund diversion and misuse. Stricter norms will improve transparency and protect investor interests.

3. Implications for SMEs and Investors

For SMEs:

• Higher compliance costs and eligibility thresholds may increase preparation time and financial burden.,
• Companies meeting the new requirements will gain greater credibility in the market.

For Investors:

• Stricter norms mean higher-quality investment opportunities with reduced risks.
• Enhanced transparency and accountability improve investor confidence in SME IPOs.

4. Conclusion

The 19th November Consultation Paper reflects SEBI’s commitment to creating a transparent, reliable, and growth-oriented SME IPO ecosystem. The proposed changes aim to address existing loopholes and strengthen the framework for both issuers and investors.

Remember: These are only suggestions open for stakeholder feedback. SEBI encourages experts to provide comments and insights, ensuring the final regulations strike the right balance between investor protection and SME growth.