Small and medium enterprises (SMEs) wanting to list their securities on NSE Emerge will be required to fulfill additional criteria from September 1.

The companies that will file draft offer documents will need to have positive free cash flow to equity (FCFE) for at least two out of three financial years preceding the application.

FCFE is calculated as cash flow from operations minus purchase of fixed assets plus net borrowings minus interest expense on total borrowings.

Mitigating the risk

The requirement for positive free cash flow to equity is a measure to gauge a company’s financial health and its ability to generate cash from operations. It indicates that the company is generating sufficient cash to fund its growth and operations without relying heavily on external financing, said experts.

“The aim is to mitigate the risk of investing in companies that may have unsustainable business models or may be struggling financially. While the new norm may increase the hurdles for some SMEs seeking IPOs, it is likely to have a positive long-term impact on the overall quality of listed companies. It could also encourage SMEs to focus on improving their financial performance and sustainability,” said Amit Goel, Co-Founder and Chief Global Strategist at Pace 360.

He added that the move can help protect investors from potential losses and enhance the credibility of the SME market by ensuring that only financially sound companies are allowed to list.

“We can expect exchanges to tighten norms further given that some promoters and operators have often misused current norms. Very small companies are coming out with an IPO and getting very high market cap. Ideally there should be a cut off on market cap based on offer price along with a minimum revenue and profit threshold for SME IPOs,” said Deepak Jasani, Head - Retail Research, HDFC Securities.

Last month, NSE said it would apply a cap of 90 per cent to all SME stocks that list on its platform in a bid to restrict runaway gains and bring more stability to the opening price discovery process for such stocks.

This means that gains for an SME stock with an issue price of ₹100 will be limited to ₹90 on debut.

Complaints of misuse

SEBI is looking to tighten the norms for the SME IPOs following certain complaints of misuse. For instance, the minimum issue size could be increased to ensure that only serious companies have access to the capital markets.

The companies are currently required to have a post issue capital base of ₹25 crore.

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