A comprehensive guide to SME IPOs in India – the benefits, the eligibility criteria and the process
Did you know that there are over sixty-three million MSMEs in India, contributing approximately 30 percent of the country’s total GDP, 40 percent of its manufacturing output, and nearly 50 percent of its total exports (figures)? Employing roughly 110 million workers, MSMEs hold significant importance for India’s economy. (Source: Atlantic Council)
These MSMEs’ most significant challenge is the lack of capital to finance Working Capital requirements and future growth. Considering the critical role that MSMEs play in India’s economy, it is crucial to address this scarcity of capital that is restricting their growth. The most obvious way to address this is to arrange more credit facilities through banks and financial institutions. However, all MSMEs may be unable to avail of credit facilities due to a lack of collateral.
Many small companies try to overcome these hurdles by seeking out investors who may be interested in making equity investments in their companies. The first challenge they face is of finding investors who may be interested in their businesses. Even if they find such an investor, the investment rarely works out as most investors are concerned about the lack of exit from their investment due to the lack of liquidity in unlisted shares.
If the investor agrees to invest despite these issues, he will want at least a 26% stake and a seat on the board of directors. This condition may not be very palatable to the business owner. In this scenario, we must look for a solution that provides funds to businesses without high-interest costs, collateral requirements, and challenges related to private investors.
What is an SME IPO?
One option seldom considered is stock market listing for SMEs (SME IPO). The Initial Public Offering (IPO) for Small and Medium Enterprises (SME) is the listing of MSME companies on national stock exchanges like the BSE and NSE. In the SME IPO, any SME that meets the criteria for listing can offer shares to the public for subscription. In the IPO, the promoter offloads at least 26% stake to the public, and the shares get listed on the SME board of the stock exchange.
Benefits of going for an SME IPO
The benefit of an SME IPO for the promoter is that they get access to funds without interest costs and losing control of the company. The investing public gets to invest in a small cap that may give high returns in the future. We must remember that all of today’s large companies, like Britannia, Infosys, Reliance, Sun Pharma, Titan, etc., were small caps once upon a time.
Further, the SME also benefits from the high visibility that a stock market listing gives any company. This visibility provides the SME an upper hand in dealing with Banks and Financial Institutions for borrowing, etc. Another advantage of SME IPO is that it converts the promoter’s shares into an asset that can pledge to borrow more funds if required. The stock is moved to the Exchange’s main board three years after the SME IPO, resulting in more analyst coverage and visibility.
The IPO is also an excellent exit option for venture capitalists and other shareholders wishing to liquidate their shareholding in the company. Another benefit of SME IPOs is that it is easier for a company to issue further shares to raise additional capital for further expansion. Thus, we see that SME IPOs are a creative solution to today’s lack of funds facing businesses in India.
Eligibility Criteria for an SME IPO:
Any SME considering the IPO option should ensure that it meets specific minimum criteria. It should have a positive net worth and have tangible assets of at least Rs. 1.5 cr. The business should have been in operation for at least three years and have a minimum turnover of Rs. 25 cr in the latest financial year and a net profit of at least Rs. 2.5 cr. For further details about SME IPO criteria, please refer BSE SME IPO website here.
How to go about an SME IPO?
Once the business meets the criteria mentioned above, it must begin consulting and appointing merchant bankers in an advisory capacity to take them through the listing process. The appointed merchant bankers then file the draft prospectus with the Exchange and SEBI. The Exchange reviews the documents and then arranges for a site visit and an interview for the promoters with the Listing Advisory Committee of the Exchange. Once the Exchange is satisfied that all are in order, the merchant banker files these documents with the Registrar of Companies (RoC), indicating the opening and closing dates of the issue.
Once the IPO has closed, the issuing company submits the documents as per the checklist to the Exchange for the finalization of the basis of allotment. Then the Exchange finalizes the basis of allotment and issues the Notice regarding Listing and Trading. The allotment process favours retail investors who generally apply for a smaller number of shares, resulting in a widely dispersed shareholding so that no entity corners a significant portion of the stock.
Thus, we have seen that the SME IPO route is an excellent option for businesses to raise additional capital for growth and working capital requirements. This option is appealing because it allows for capital without periodic interest payments.
The shareholders will be happy to hold on to the stock even in the absence of dividends as long as the company shows rapid growth, as is usually the case with SMEs. The company gets to retain its cash to finance its expansion. Due to the relative liquidity in the stock, shareholders can effortlessly enter and exit the stock as required.
Our firm, TJ Consulting, helps businesses with identifying merchant bankers who will be able to guide them through the process of getting their companies listed through SME IPOs. Please reach out to us at joe@tjconsulting.in or at +91-900 855 7845 to know how you can solve your shortage of capital by utilizing this very innovative solution.
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