Mint Primer: Will new norms calm the rush for SME IPOs?

What are these new regulations?

Sebi last week notified amendments to tighten rules for initial share sales by SMEs. This follows the Sebi board approving these changes at its meeting in December. As per the notified norms, only those SMEs can raise funds through IPOs that have a minimum Ebitda (earnings before interest, taxes, depreciation and amortization) of ₹1 crore for at least two of the previous three financial years.

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Additionally, the amount earmarked for general corporate purposes in the SME listing has been capped at 15% of the issue size or ₹10 crore, whichever is lower, among other provisions.

Are there any restrictions?

Promoters’ shareholding above the minimum promoter contribution (MPC) will be subject to a phased lock-in period. Half of the excess holding will be released after one year, while the remaining 50% will be unlocked after two years. Also, selling shareholders cannot offload more than 50% of their existing holding. The offer for sale (OFS) component of the IPO, too, has been capped at 20% of the issue size. SMEs have also been disallowed from using the IPO proceeds to repay loans taken from promoters, promoter groups or related parties, whether directly or indirectly.

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What necessitated these measures?

SME IPOs have been under the regulatory scanner for a while. A slew of IPOs by firms with questionable financials, coupled with a FOMO-driven buying mania during the recent bull run, made the SME space among the most heated. 2024 was a record year for SME IPOs, with around 240 companies raising over ₹8,700 crore, nearly double the amount raised in 2023.

How have SME IPOs performed recently?

While the domestic markets overall have been weighed by lacklustre corporate earnings, high valuations, global strife and record selling by foreign institutional investors, SMEs were hit really hard. Of the 53 stocks in the BSE SME IPO index, only two have delivered positive returns on a three-month basis, as many counters plunged up to 50%. The SME IPO index has crashed nearly 30% this year till date, compared with a 7% drop in the Sensex. However, on a one-year timeframe, the SME IPO index has delivered gains of 58%.

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How should investors approach SME IPOs?

With abundant caution, going by the new norms. Sebi has not only increased the minimum application size in SME IPOs to two lots, which is likely to curb the feverish speculation for listing day gains, but has also directed that the firms’ draft red herring prospectus (DRHP) be made available for public comments for 21 days. The regulator is clearly nudging investors to curb their casino instincts in the SME space and subject the firms to the same level of scrutiny that mainboard companies receive.