Small and Medium Enterprises (SMEs) form the backbone of India’s economy. They contribute significantly to the country’s Gross Domestic Product (GDP), employment, and industrial output. According to Government estimates, SMEs contribute around 38% of India’s GDP and generate employment for millions.
Despite their pivotal role, SMEs often face challenges in accessing adequate financing to sustain and grow their operations. One innovative solution to this challenge is the SME Initial Public Offering (IPO), which allows these businesses to raise funds from the public. For investors, these SME IPOs provide an opportunity to invest in high-growth potential companies during their early stages.
If you want to know more about SME IPOs, this blog is for you. Here, we will cover everything you need to know about SME IPOs, including their meaning, eligibility criteria, benefits, the application process, and associated costs. Keep reading.
What are SME IPOs?
An SME IPO is a public offering in which small and medium enterprises raise funds by issuing shares to the public for the first time. Unlike mainboard IPOs of large corporations, SME IPOs are specifically tailored for smaller businesses. They are listed on specialised SME platforms of stock exchanges, such as the BSE (Bombay Stock Exchange) SME and NSE (National Stock Exchange) Emerge in India.
SME IPOs allow small businesses to secure much-needed capital to fund daily operations, expand their market presence, or reduce debt. Investors, on the other hand, get the opportunity to invest in companies with significant growth potential.
The key features of SME IPOs include:
Smaller Issue Size: An SME IPO’s size is considerably smaller than mainboard IPOs.
Less Stringent Regulations: The stock exchanges and regulatory bodies have simplified regulatory requirements for SMEs to encourage participation.
Niche Investor Base: SME IPOs primarily attract informed retail and institutional investors familiar with smaller companies’ growth potential.
Higher Minimum Investment: Although the IPO sizes are smaller, retail investors must make a higher minimum investment to apply for an SME IPO. According to Securities and Exchange Board of India (SEBI) guidelines, the minimum application size for SME IPOs must be Rs. 1 lakh for retail investors.
Eligibility Criteria For SME IPOs
Not every SME in India is eligible to launch an IPO. The SEBI and stock exchanges have laid out specific guidelines for SMEs to be eligible for an IPO:
Registration: The company must be registered under the Companies Act of 1956.
Company Age: The company should have existed for at least three years. If it is younger than three years, it must be funded by a central or state government bank.
Net Worth: The net worth of the company should be positive.
Profitability: Although not mandatory for all exchanges, many require the SME to have a record of profitability for at least two of the last three financial years.
Post-Issue Paid-Up Capital: The post-issue paid-up capital of the SME should not exceed Rs. 25 crore.
Net Tangible Assets: The company must have net tangible assets worth Rs. 1.5 crore.
Minimum Application Size: The minimum application size for a trading lot must be Rs. 1 lakh.
Qualified Professionals: The company should have qualified directors and key personnel to run its operations efficiently.
Underwriting: The issue must be fully underwritten, meaning that merchant bankers must guarantee the subscription of shares.
Benefits of SME IPOs
Closed SME IPOs offer numerous benefits for companies and investors. These include:
For Companies:
Access to Capital: Raising funds through an IPO enables SMEs to access long-term capital that can be used for expansion, technological upgrades, and other business needs.
Enhanced Visibility and Credibility: Listing on a recognised stock exchange improves the company’s visibility, credibility, and reputation.
Liquidity for Promoters: An IPO allows business owners and early-stage investors to liquidate their holdings.
Reduced Dependency on Debt: SMEs can reduce their reliance on high-interest loans by raising equity capital.
For Investors:
Investment Opportunity: SME IPOs allow investors to invest in promising businesses at an early stage.
Diversification: SME IPOs allow investors to diversify their portfolios by adding companies from emerging industries and untapped markets.
Higher Growth Potential: SMEs often operate in niche sectors with significant growth potential, offering higher returns than mature companies.
Attractive Valuations: SME IPOs typically have lower valuations than large-cap IPOs, making them accessible to retail investors.
The Process to Launch an SME IPO
Companies need to follow specific steps to launch an SME IPO. The steps are listed below:
Appointment of an Underwriter
SMEs must appoint an underwriter to guide them through the IPO process. The underwriter can be a merchant banker, legal advisor, or auditor.
Preparation of the DRHP
With the help of the underwriter, the company prepares a Draft Red Herring Prospectus (DRHP). The DRHP contains detailed information about the company, including its business model, financials, risks, and future plans.
SEBI Approval
The company sends the DRHP for SEBI’s review and approval. After receiving approvals, the company can proceed with the IPO.
IPO Promotion and Marketing
Companies conduct roadshows and marketing campaigns to pitch their IPO to institutional and retail investors.
IPO Launch, Share Allotment, and Listing
The IPO opens for public subscription for a specific period, usually three to five days. After the subscription period closes, shares are allotted to investors, and the company’s stock is listed on the SME platform of the chosen exchange.
Costs Involved In SME IPOs
Launching an SME IPO involves the following costs:
Merchant Banker Fee: Merchant bankers or underwriters typically charge 2 to 5% of the IPO offer price. In return, they manage the entire IPO process, from preparing the DRHP to getting SEBI’s approval to regulatory compliances and price determination.
Exchange Fee: The exchanges, i.e., the BSE and the NSE, charge a one-time processing fee apart from an exchange refundable deposit and bid verification charge. The exact fee may vary from one exchange to another.
Service Fee: Several intermediaries, including legal advisors, auditors, registrars, brokers, depositories, etc., charge service fees from the issuing company.
Miscellaneous expenses: These include costs for marketing, advertising, printing, and travelling, among others.
How to Apply For an SME IPO?
Applying for an SME IPO entails the following steps:
Open a Demat Account: Open a Demat account with a stockbroker and link it with your savings bank account. A Demat account is mandatory for IPO applications.
Select the SME IPO: From the list of upcoming IPOs, select the SME IPO you want to apply for. Study the company’s prospectus and growth potential.
Apply Through ASBA: Use your UPI app to apply for the SME IPO through the Application Supported by Blocked Amount (ASBA). The application amount will be blocked in your bank account but not debited until shares are allotted.
Wait for Allotment: If allotted, the shares will be credited to your Demat account. If not, the blocked amount will be released.
To Conclude
SME IPOs are potent tools for small businesses to raise funds for growth and expansion. For investors, they present a chance to invest in innovative and promising companies at an early stage. However, you must carefully evaluate the opportunities and risks associated before investing.
With HDFC SKY, you can open Demat account for free and start investing in a gamut of avenues, including stocks, IPO, ETFs, and mutual funds. The process is straightforward and takes a few minutes to open a demat account.
