SEBI's New Rules for SME IPOs: What's New For Startups & Investors?

The Securities and Exchange Board of India (SEBI) has introduced a comprehensive set of reforms for Small and Medium Enterprise (SME) Initial Public Offerings (IPOs), marking a decisive shift in the regulatory landscape. These changes aim to enhance investor protection, filter out less credible players, and ensure that SMEs accessing public markets are financially sound.

Announced during a board meeting in Mumbai, the updated framework introduces stricter eligibility criteria, curbs on fund utilization, and enhanced transparency. These measures come in response to concerns about mispricing, excessive leveraging, and a lack of adequate disclosures in the booming SME IPO segment.

Here TICE brings you highlights of the New Rules for SME IPOs.

Profitability Now a Key Gateway to IPOs

One of the most impactful changes is the introduction of a profitability requirement for SMEs seeking to launch IPOs. Under the new framework, a company must demonstrate an operating profit of at least ₹1 crore from operations in at least two of the three preceding financial years.

This move addresses a longstanding issue where financially unstable entities were able to raise funds from retail and institutional investors, often resulting in poor post-IPO performance. By mandating profitability, SEBI ensures that only SMEs with proven operational success can access the capital markets, thus reducing the risk for investors.

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For SMEs, this criterion raises the bar, pushing businesses to focus on sustainable growth and profitability before seeking public funding.

Tightening the Use of IPO Proceeds

Another major reform is the prohibition of using IPO proceeds to repay loans taken from promoters or related entities. SEBI has barred such transactions to prevent potential misuse of public funds, ensuring that the raised capital is deployed for the company’s growth.

This restriction is expected to address concerns about financial mismanagement and bring a sharper focus on investments in business expansion, innovation, and operational efficiency. The regulatory move signals a shift towards accountability and strategic fund utilization.

Caps on Offer for Sale and Corporate Funds

SEBI’s reforms also address issues with the Offer for Sale (OFS) mechanism, which allows existing shareholders to sell their stake during an IPO. The new rules limit the OFS portion to 20% of the total issue size and restrict selling shareholders from offloading more than 50% of their holdings.

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Additionally, the amount allocated for General Corporate Purpose (GCP) is now capped at 15% of the IPO size or ₹10 crore, whichever is lower. These caps ensure that IPO proceeds are used with greater precision, balancing shareholder exits with the company’s capital requirements.

Phased Lock-In for Promoters

To instill investor confidence, SEBI has introduced a phased lock-in mechanism for promoter holdings that exceed the minimum promoter contribution (MPC). Under this, 50% of the excess holdings will be unlocked after one year, while the remaining 50% will be released after two years.

This phased release prevents abrupt changes in shareholding patterns, stabilizing the market for a longer period post-listing. For investors, this means increased assurance that promoters remain committed to the company’s growth trajectory.

Improving Transparency and Public Participation

SEBI has taken steps to make the IPO process more transparent and inclusive. Draft documents filed with stock exchanges will now be open for public comments for 21 days. This move allows greater scrutiny by market participants and ensures that potential investors have a say in the process.

Moreover, SEBI has aligned the allocation methodology for Non-Institutional Investors (NIIs) in SME IPOs with that of main board IPOs. This change addresses issues of mispricing and leveraging often observed in the NII category.

The Rationale Behind SEBI’s Reforms

The SME IPO market has been on a record-breaking spree, with over 225 companies raising ₹8,200 crore this year, almost double the ₹4,686 crore raised last year. However, this rapid growth has raised regulatory concerns. Many issues saw subscriptions in the hundreds of multiples, and massive listing gains caught the attention of SEBI and stock exchanges.

The regulator’s new rules aim to curb these excesses. For instance, the prohibition of proportionate allotment for NIIs in favor of a draw-of-lots mechanism prevents undue leveraging and ensures fairer allotments. By addressing these issues, SEBI aims to dissuade retail investors from overextending themselves in high-risk investments.

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Challenges and Opportunities for SMEs

While these reforms tighten entry into the capital markets, they also present a growth opportunity for SMEs with solid track records. Businesses that meet the new criteria stand to benefit from enhanced credibility and investor trust, potentially commanding better valuations during their IPOs.

For SMEs that fall short, these changes serve as a wake-up call to focus on operational efficiency and financial discipline. By aligning themselves with these standards, they can not only access public markets but also sustain long-term growth.

What's Next for Startups & Investors?

SEBI’s updated framework is poised to reshape the SME IPO ecosystem, fostering a more mature and transparent market. By filtering out weaker players and prioritizing investor protection, the reforms aim to create a healthier environment for all stakeholders.

The impact of these changes will be closely watched in the coming months, as SMEs and investors alike adapt to the new norms. While the rules set a higher benchmark, they also promise a more secure and rewarding landscape for India’s burgeoning SME sector.

This revamped SME IPO framework underscores SEBI’s commitment to balancing growth with investor safety, ensuring that India’s capital markets remain a reliable platform for businesses and investors alike.

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