The Securities and Exchange Board of India (SEBI) recently came out with a consultation paper to make the SME IPO market foolproof.

According to SEBI, the applicant-to-allotted investor ratio jumped dramatically from 4 times in FY22 to 245 times in FY24.

Recently, there have been instances where issue proceeds were diverted to related or connected parties and shell companies, along with revenue inflation through circular transactions involving these entities.

SEBI observed that in some SME companies, the entity diverted money raised through the IPO and the subsequent Rights Issue to shell companies controlled by the promoters.

One out of two SME listed entities have undertaken related party transactions (RPTs) of more than ₹10 crore and 20 per cent of companies have undertaken RPTs of more than ₹50 crore, SEBI said.

In terms of the amount, it was observed that 50 per cent of SME listed entities have undertaken RPTs of more than 10 per cent of their consolidated turnover, and 1 out of 7 more than 50 per cent.

Dozen proposals

To address these issues, SEBI has come out with over dozen proposals in its consultation paper, including to double the application size to ₹2 lakh to ensure that only informed investors with sufficient risk appetite and investment capacity can apply.

It seems SEBI has done its homework well before coming out with these proposals that concern both procedural and corporate governance-related issues.

“The retail individual participation has increased in SME IPOs over the last few years. Therefore, considering that SME IPOs tend to have higher element of risks and investors getting stuck if sentiments change post listing, in order to protect the interest of smaller retail investors, it is proposed to increase the minimum application size from ₹1 lakh per application to ₹2 lakh per application in SME IPO,” SEBI noted in its consultation paper.

Another important suggestion is to discontinue proportionate allotment in the case of NII category and “draw of lots” allotment to be introduced, as in the case of mainboard IPOs.

Increasing the investor base is another key proposal. The current regulation requires that for an SME public issue to be considered successful, there should be a minimum of 50 allottees in the public issue. The consultation paper mooted the number to be hiked to 200.

Another proposal is that the offer for sale in SME IPOs should be restricted to 20 per cent of the issue size. The consultation paper also backed the appointment of a monitoring agency if the fresh issue size is higher than ₹20 crore to check the misuse of the fund raise.

Repayment of loans of the promoter, the promoter group or any related party from the issue proceeds will not be permitted.

Besides, the paper proposed that “general corporate purpose” of the SME IPO amount will be restricted to 10 per cent of the issue size or ₹10 crore, whichever is lower. The face value should also be ₹10 for SME IPOs.

Governance issues

RPT norms under LODR Regulations should be extended to SME listed entities other than those which have paid up capital not exceeding ₹10 crore and net worth not exceeding ₹25 crore. Besides, these firms have to disclose the composition and details of meetings (date, number of directors present, etc) of board of directors and its committees, as in the case of main board companies.

SME-listed entities may be required to submit shareholding pattern, statement of deviation(s) or variation(s) and financial results on a quarterly basis, instead of the existing requirement of half-yearly basis, at par with the mainboard listed entities.

As this paper has been advocating tighter norms to tame the frenzy in the SME IPO market, the above proposals hit the bull’s eye. However, SEBI may consider giving relaxation on minimum allottees of 200 — it may either be restricted to 100 or exchanges may be allowed to decide on a case-to-case basis. Stringent norms should not dissuade genuine companies from raising funds for ambitious growth plans.

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