From light regulation to accountability: How Sebi is rethinking SME IPO rules

Markets regulator Securities and Exchange Board of India (Sebi) recently identified several issues plaguing the SME space such as misuse of IPO proceeds, diversion of funds, exit of promoters and market misconduct. These issues pose a threat to investor protection and market integrity. Sebi analysis shows that many SMEs have engaged in material related party transactions (RPTs), with almost half of these enterprises carrying out such transactions worth more than ₹10 crore and every fifth more ₹50 crores. Furthermore, it has been observed that SMEs are promoter-led or family-owned enterprises with minimal private capital or sophisticated investors, which limits the control of the promoter’s influence. Recent cases of misuse of IPO proceeds highlight the urgent need for regulatory intervention.

Sebi’s thoughtfully designed, light regulatory framework was introduced in 2012 to promote SME listings and contribute to economic growth. The results were promising: as of October 2024, 745 companies with a market capitalization of ₹2 trillion. There were over 196 IPOs in 2023-24 ₹6,000 crore and by October 2024. ₹The IPO of 159 SMEs raised an amount of Rs 5,700 crore. Investor participation also increased to 46 times in FY2022. Regulatory models are typically adopted by successful SME exchanges (Korea’s Konex and China’s ChiNext) around the world to provide the necessary impetus. These included less stringent compliance requirements compared to stock exchange listings and the delegation of responsibility to exchanges for maintaining these listings.

However, rapid growth and increased participation have exposed the weaknesses of the light touch approach. To address these challenges, Sebi is now proposing to tighten the framework by introducing stricter eligibility criteria, increased application value, improved promoter dependency requirements, stricter board migration norms and improved corporate governance measures. Let’s examine some of the proposed changes.

More stringent eligibility criteriaincluding: more stringent eligibility criteria (i.e. the requirement for an emission volume of ₹10 crore and an operating profit of ₹3 crore in two of the last three years) would enhance the credibility of SME listings by allowing only financially viable companies to conduct IPOs. The current lack of minimum requirements for SMEs is reminiscent of the dotcom bubble, where companies were listed only because they had the word “dotcom” in their name, which led to the market crash.

Being an SME should not be used as a gateway to listing on stock exchanges, exposing vulnerable investors to undue risk. This rigorous nature is therefore crucial, as SMEs with no experience were oversubscribed (2024: 199% and 2023: 86%). This had to be checked.

Application value: Increasing the value of an application for inclusion on the SME list ₹2 million (instead of ₹4 lakh) should be enough to limit the participation of vulnerable retail investors, thereby protecting them. This approach reflects the barriers to entry into the futures and options markets, where a higher threshold helps reduce risk. It also discourages speculative behavior such as pump-and-dump programs or manipulation similar to penny stock trading. Limiting participation to well-informed investors with a higher risk appetite will strengthen the SME segment. While listing returns will average 75.6% in 2024-25 and 51.21% in 2023-24 may be tempting for retail investors, they must be aware that sentiment may change after listing.

Skin in the game and IPO goal: Measures to prevent promoters from limiting the number of shares they hold once they are listed on the stock exchange are important. Moreover, preventing companies from using IPO funds to repay loans is a much appreciated step, because investors’ funds should be allocated primarily to development, not to repaying loans.

Creating a market: While Sebi’s efforts to improve SME listings are commendable, liquidity should also be a key area of focus. The market making mechanism was established to ensure liquidity. Despite this, it was observed that in order to create ‘positive sentiment’ and induce investors to buy SME shares, companies resorted to circular transactions to artificially inflate revenues and create a positive environment. Therefore, placing greater emphasis on market making under the proposed framework would help support real market participation, improve valuations and provide better liquidity.

Increased number of disclosures: Inappropriate behavior by some entities resulted in stricter regulations. These include proposals for improved disclosure/compliance, as well as the establishment of agencies to monitor transparency of accountability and use of funds. Overall, this could become a more costly affair, which was necessitated by the behavior of listed SMEs. Nevertheless, management cannot encompass.

The potential of SME exchanges remains largely untapped. WITH ₹While India has 7.96 lakh SMEs, only 750 have made the list so far, clearly indicating a long way ahead. To fill this gap, it is important to educate SMEs on the benefits of raising capital through stock exchanges rather than relying on traditional bank financing. Additionally, SMEs should also actively seek support from exchanges to better understand the process of raising funds through the exchange ecosystem.

Kohli is a senior general meeting at the National Institute of Securities Markets (NISM) and Panda is an assistant professor at the Indian Institute of Management (IIM), Raipur. Views are a personal matter.