SEBI Tightens Rules for SME IPOs: Profitability Clause Introduced, Loan Repayment to Promoters Prohibited

The Securities and Exchange Board of India (SEBI) has introduced stricter regulations for Small and Medium Enterprise (SME) Initial Public Offerings (IPOs). The aim is to ensure only entities with credible financial track records can raise funds from the public while enhancing investor protection.

The board, in a meeting held in Mumbai, unveiled several amendments to the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, and SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.

Key Highlights of SEBI’s New SME IPO Rules

Profitability Clause for SME IPOs

• Securities and Exchange Board of India (SEBI) has mandated that SMEs must have an operating profit (earnings before interest, depreciation, and tax) of at least Rs 1 crore from operations in two out of the previous three financial years to qualify for an IPO.

• This criterion ensures only financially stable SMEs can access public markets.

SEBI Restrictions on Loan Repayment to Promoters

• “SME issues shall not be permitted, where objects of the issue consist of repayment of loan from promoter, promoter group or any related party, from the issue proceeds, whether directly or indirectly,” stated SEBI in its announcement.

• This move aims to prevent misuse of IPO proceeds and safeguard investor interests.

Cap on Offer for Sale (OFS) Portion

• The OFS portion of an SME IPO cannot exceed 20% of the total issue size.

• Selling shareholders are restricted from divesting more than 50% of their holdings.

General Corporate Purpose Fund Limit

• SEBI has capped the allocation for General Corporate Purpose at 15% of the IPO size or Rs 10 crore, whichever is lower.

Enhanced Disclosure and Comment Period

• IPO draft documents filed with stock exchanges will now be open for public comments for 21 days. This measure aims to improve transparency and accountability in the listing process.

Promoter Lock-In Requirements

• Lock-in on promoters’ holdings exceeding the Minimum Promoter Contribution (MPC) will be released in a phased manner:

  • 50% of the excess holdings will be released after one year.

  • The remaining 50% will be released after two years.

Alignment with Main Board IPO Allocation for Non-Institutional Investors (NIIs)

• SEBI has aligned the allocation methodology for NIIs in SME IPOs with the methodology used for main board IPOs, promoting consistency across markets.

SEBI’s Review of SME IPO Framework

Last month, SEBI released a discussion paper proposing significant changes to the SME IPO framework:

• Increasing the minimum application size to Rs 2 lakh from the current Rs 1 lakh.

• Introducing a “draw of lots” mechanism for NIIs instead of the proportionate allotment, similar to the retail investor category.

• Limiting the OFS portion to 20-25% of the total issue size.

These proposals aim to enhance investor protection and discourage retail investors from taking excessive risks. For instance, SEBI’s proposal for “draw of lots” was designed to curb leverage use and mispricing, which were prevalent under the proportionate allotment method.

Record Fundraising in SME IPOs in 2024

This year has been exceptional for SME IPO fundraising. Over 225 companies have raised more than Rs 8,200 crore, a significant jump from last year’s Rs 4,686 crore. The segment has gained attention due to massive oversubscriptions—some issues being subscribed by multiples of hundreds—and substantial listing gains.

Increased Scrutiny from Exchanges

Stock exchanges have already tightened their scrutiny of draft documents filed by SMEs. Many documents have been returned due to inadequate disclosures, indicating a higher level of vigilance.

Conclusion

SEBI’s new regulations mark a significant shift in the SME IPO landscape, ensuring only financially robust companies can access public markets. These measures aim to protect investors and enhance the credibility of the SME segment, which has seen unprecedented growth in recent years. While the tightened framework may initially challenge some SMEs, it promises a healthier and more transparent market ecosystem in the long run.