Strategic Moves for IPO-Bound SMEs

Strategic Moves for IPO-Bound SMEs
How Can SMEs Craft Pre-IPO Strategies To Navigate SEBI's Amendments?
- Last Updated
With the increasing favourability of market conditions, the growth of Small and Medium Enterprises (SMEs) has been at its peak post-COVID-19 restrictions. Ever since the issue of an Initial Public Offer (IPO) has been the strongest catalyst for SME growth. An SME IPO helps the company to raise capital and attract investments easily. An IPO also increases the SME’s visibility in the public eye and adds to its credibility by attracting new customers, suppliers and helping to hire the best talent.
SME IPOs have seen the highest boom in the last two years. Approximately 150 SMEs got listed in the first half of 2024-25 with capital rising close to ~INR 5,000 Crores. With a growing number of SMEs going into IPOs, regulatory compliance has been catching up at a pace.
Amount Raised in Crores
The Securities and Exchange Board of India (SEBI) is reinventing the scenario for SME IPOs by introducing a standardised regulatory framework. New IPO measures are being introduced by SEBI for a smoother listing of credible and profitable SMEs, making access to the capital market easier. SEBI focuses on bringing equilibrium between the augmented growth of SMEs and the safeguarding of investor interests by promoting transparency, raising efficiency, and standardizing inter-company transactions. Therefore, both – SMEs’ contribution towards the Indian economy and investor protection are ensured.
SEBI has brought about amendments in a board meeting dated December 18th, 2024, vide PR no. 36/2024. The SEBI (ICDR) Regulations, 2018 and SEBI (LODR) Regulations, 2015 are amended in order to ensure the growth of SMEs and the protection of investors.
Applicability:
The SEBI regulations so amended, are applicable to the SMEs whose DRHP (Draft Red Herring Prospectus) for the IPO has been filed on or after December 19th, 2024.
Key Changes & Practical Insights
1. Setting Standards for Capital and Profitability
In addition to the existing restrictions on SME IPOs, the following are the additional restrictions levied by SEBI –
a. Cap on Offer for Sale (OFS)
Selling shareholders can offer up to 20% of the total issue size and such selling shareholders cannot sell more than 50% of their holding.
b. Profitability as a Criterion for SME IPOs
SMEs must have an operating profit (EBITDA) of INR 1 crore in at least two of the last three financial years before filing.
c. Phased Lock-In for Promoter Holdings
Promoters’ holdings exceeding the Minimum Promoter Contribution (MPC) are subject to a lock-in period of 1 year from the date of allotment in the SME IPO. Such locked-in holding will unlock in phases:
– 50% after 1 year.
– Rest 50% after 2 years.
d. Additional exchange criterion
In addition to the SEBI guidelines, stock exchanges can have their independent listing criteria for SME IPO. Recently, in August 2024, the National Stock Exchange (NSE) introduced an additional condition of positive Free Cash Flow (FCF) for at least two out of three financial years preceding the application for SME IPO.
2. How SME IPO Proceeds Can Be Used?
Proceeds of SME IPO are subject to the following restrictions:
a. Cap on General Corporate Purposes (GCP)
GCP allocation was earlier restricted to a maximum of 25% of the amount being raised by the issuer. In order to prevent misuse of SME IPO proceeds, SEBI has now restricted GCP allocation to
– maximum 15% of issue size or
– INR 10 crores, whichever is lower.
b. Restrictions on the use of SME IPO Proceeds
Loans from promoters, promoter groups, or related parties cannot be repaid using proceeds from the issue of an SME IPO.
3. Rationalising the Related Party Transactions
a. Strengthened RPT Norms for SME IPO
SMEs did not abide by any RPT norms earlier. After the amendment in the SEBI regulations, SMEs will abide by the main board RPT norms with a materiality threshold of
– 10% of turnover or
– INR 50 crores, whichever is lower.
According to SEBI (LODR) Regulations 2015, the following transactions are exempted from the scope of Related Party Transactions:
– Issue of securities on a preferential basis, subject to compliance with the requirements under SEBI (ICDR) Regulation,2018
– Issue of Right Shares
– Issue of bonus Shares
b. Restrictions on the Use of SME IPO Proceeds
• According to the amended SEBI regulations, the proceeds from an SME IPO cannot be used to repay loans taken from related parties. However, there is ambiguity about the specific types of instruments classified as loans in this context.
• Business transactions with related parties can be carried out subject to ceiling requirements as per the Companies Act, 2013 and conducted at arm’s length.
4. SEBI Regulations Specific to SME IPO
a. DRHP Public Comment Period
An SME going public through IPO must open its Draft Red Herring Prospectus (DRHP) of the IPO for public comments for 21 days, with QR codes in newspapers for better accessibility.
b. SME Fundraising Without Main Board Migration
Before these amendments, SMEs were often required to migrate to the main board for further fundraising. Now under the SEBI amendments, SMEs can raise further capital without migrating to the main board, subject to compliance with applicable SEBI (LODR) norms.
c. Alignment of Allocation Methodology for NIIs (Non-Institutional Investors)
Earlier, NII allocation norms under SEBI were distinct and complex for SME IPOs. There was no distinct segregation between Big and Small NIIs in SME IPO.
- Now, SME IPOs will follow the same NII allocation methodology as Main Board IPOs, making the investor participation framework uniform.
- Each NII investor will receive a minimum bid lot based on share availability, and any remaining shares will be allotted on a pro-rata basis.
- The allotment method is the same for both Small and Big NII categories.
- Even for Big NIIs, which have a minimum subscription of INR 10 lakhs, shares worth INR 2 lakhs (the minimum NII bid amount) will be allotted in case of oversubscription, aligning with the allocation method for Small NIIs.
Objectives of SEBI amendments:
Related Read: SME IPO Listing Process: A Step-by-Step Guide
• To safeguard investor’s interests:
The introduction of profitability restrictions and phased promoter exits ensures investor confidence.
• To enhance transparency:
Enhanced DRHP disclosures and uniform RPT norms build trust for SMEs.
• To promote the growth of SMEs:
Access to capital for SMEs is made easier by eradicating unnecessary funding barriers.
Conclusion:
These new SME IPO regulations introduced by SEBI boost the credibility, profitability, and transparency of the IPO listing process for SMEs. Major amendments made by SEBI include restriction on Offer for Sale, stringent profitability criteria, phased lock-ins for promoters, strengthened and uniform related party norms, and restriction on the use of SME IPO proceeds. Migration to the mainboard is not required for fundraising, NII allocation methods are more uniform and DRHPs are open for public comments.
The amendments brought by SEBI make the SME IPO process more streamlined. Now, more than before, SMEs will have to structure and plan the pre-IPO preparation rigorously. Post introduction of these amendments, SMEs must navigate the SEBI regulations carefully and seek professional help from advisors and consultants for a successful pre-IPO and IPO listing journey.
Why Choose InCorp Global?
Are you an SME? Are you planning an IPO? Are you looking to navigate these SEBI changes?
We, at InCorp are a team of seasoned advisors with years of experience in guiding SMEs through the entire process of IPO. InCorp assists SMEs in IPO right from ideation and strategizing to building a blueprint, supporting the pre-IPO journey, collaborating with external agencies, and ensuring post-issue compliance.
Let us discuss how these updates affect your business and how InCorp can help in navigating them.
For more information about our services, feel free to contact us at (+91) 77380 66622 or email us at info@incorpadvisory.in.
FAQs
An SME planning to go public through an IPO should focus on various critical activities before filing of DRHP:
- Critical review of financials for at least 2 years,
- Â Devise growth strategy,
- Assess fund requirement,
- Optimize capital structure,
- Improve corporate governance standards
These activities help streamline the SME IPO process and set the foundation for a successful public offering through IPO.
Yes, SME IPO proceeds can be used for related-party business transactions other than loans, when carried out at arm’s length price subject to relevant provisions of the Companies Act, 2013 and the Income Tax Act, 1961. However, any investment in related parties needs to be compliant with the Companies Act, 2013 and SEBI (LODR) Regulations.
No, before filing a prospectus, an SME must have an operating profit of at least INR 1 crore in at least two of the last three financial years. Operating profit must pertain to core business activities, as defined under the chartered documents of the SME.
As per SEBI regulations, General Corporate Purpose (GCP) in a broader sense, means the funds from IPO proceeds that are allocated for general unspecified needs of the business. E.g. operating expenses, working capital, and other miscellaneous business activities done to promote the company’s functioning.
The requirement of public comments on the DRHP is both a boon and a bane to SMEs. Public comments boost investor confidence and foster transparency in an SME IPO. Simultaneously, this may pose a risk to SMEs as their financials and company status would now openly be available for public scrutiny subjecting them to reputational risk. Therefore, aspiring SMEs need to take all the necessary precautions to ensure that all the prerequisites required for listing an IPO are satisfactorily complied with.
Yes, various committees need to be formed for an SME IPO.
- Risk Management Committee
- Stakeholder Relationship Committee
- CSR Committee
- Board Composition (including appointment and remuneration of Independent non-executive Directors)
- Audit Committee
- Nomination & Remuneration Committee
Yes, for an SME IPO, the lock-in period for pre-IPO shareholders other than promoters should be 12 months from the date of allotment in the IPO, except in case of shares allotted by way of ESOPs to the employees under Employee Reservation during the IPO.
Share
Share