The Securities and Exchange Board of India (SEBI) has introduced a new set of rules for Small and Medium Enterprises (SMEs) planning to launch Initial Public Offerings (IPOs). These regulations aim to improve market transparency, promote financial discipline, and protect investor interests. The move comes as SEBI seeks to address concerns over governance and the misuse of funds in the SME segment.
What’s Changing? Key Highlights of SEBI’s New Rules
Profitability Requirement
SMEs now need to show an operating profit of at least ₹1 crore in any two of the last three financial years to qualify for an IPO. This ensures only financially sound businesses enter the public market, reducing the risks for investors.
Limit on Offer for Sale (OFS)
To protect retail investors, SEBI has capped the OFS component at 20% of the issue size. Furthermore, selling shareholders cannot offload more than 50% of their holdings during the IPO. These limits discourage excessive promoter exits and maintain the credibility of the business.
Phased Lock-in Period for Promoters
Promoters must now follow a phased lock-in period for shares exceeding the required contribution. Half of these shares can only be sold after one year, while the rest are locked in for two years. This step encourages promoters to stay committed to their businesses, aligning their interests with investors.
Restrictions on Fund Usage
IPO proceeds can no longer be used to repay loans to promoters, their groups, or related parties. This rule ensures funds are utilized for business growth rather than for financial restructuring or settling personal liabilities.
General Corporate Purpose (GCP) Allocation
The allocation for GCP is capped at 15% of the issue size or ₹10 crore, whichever is lower. This restriction brings more focus and accountability to how IPO funds are spent.
Public Comment Period
Draft Red Herring Prospectuses (DRHPs) must now be open for public comments for 21 days, allowing investors and stakeholders to provide feedback. To make information accessible, the DRHP must include a QR code linking to the full document, and public announcements must appear in leading newspapers.
Why the New Rules? Addressing Investor Concerns
While SME stocks offer potential returns, they come with inherent risks. Impressive gains can mask weak fundamentals. For example, a stock in its IPO listed at ₹40 soared to ₹373, only to plummet to ₹15. Similarly, another stock jumped from ₹184 to ₹1250 before dropping to ₹84. Such volatility makes SME stocks risky, especially for those investing at peak prices in hopes of sustained growth.
SEBI’s stricter regulations aim to filter out weaker players and create a more reliable investment environment. By focusing on transparency and accountability, these changes seek to restore investor confidence in the SME platform. In recent years, several SME IPOs raised concerns due to inadequate disclosures and poor governance.
Who Benefits and Who Faces Challenges?
For SMEs:
While the stricter criteria may make it tougher for some companies to go public, it raises the overall quality of businesses on the SME platform. This helps build trust in the sector, benefitting SMEs that are genuinely growth-oriented.
For Investors:
Retail and institutional investors stand to gain from greater transparency and better safeguards. Restrictions on OFS and phased lock-in periods ensure promoters remain committed, reducing risks for investors.
For Merchant Bankers:
Merchant bankers managing SME IPOs will face increased compliance responsibilities. While this adds to their workload, it enhances due diligence and strengthens the integrity of the SME market.
What’s Next?
SEBI’s updated framework is a step towards building a well-regulated and investor-friendly ecosystem for SMEs. By focusing on financial stability and accountability, these rules not only safeguard investors but also strengthen the SME sector’s potential to contribute to economic growth.
For market participants, these changes may require adaptation, but they also signal an opportunity to establish India’s SME platform as a credible and resilient avenue for raising capital. The new rules are not just about regulation they are about creating a fair and robust system for businesses and investors alike
