Should you invest in SME IPOs? – myMoneySage Blog

Before getting into SME IPO, Let’s first try to understand what SMEs are, their role in the Indian economy, and the challenges they face. Small and medium scale enterprises (SMEs) are businesses that maintain revenues, assets, or a number of employees below a certain threshold, these thresholds are different for each country. As per the ministry of MSME of India, the classification is based on the investment in plant and machinery and the annual turnover, which should not exceed ₹10 Crores for plant and machinery and ₹50 Crores annual turnover for Small scale and ₹50 Crores of plant and machinery and ₹ 250 Crores annual income for Medium scale Businesses respectively.

Should you invest in SME IPOs?

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SMEs play a very important role in the Indian economy by contributing significantly to employment generation, innovation, exports, and inclusive growth of the economy as a whole. They are the backbone of the socio-economic development of our country and India has approximately 6.3 Crore MSMEs, they account for 45 % of total industrial production and 40% of total exports. The number of registered MSMEs grew 18.5% Y-o-Y to reach 2.5 million units in 2020 from 2.1 million units in 2019. The Indian MSMEs sector contributes about 29% towards the GDP through its national and international trade.

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IPOs:

Access to capital is one of the major challenges for an SME and one of the ways to overcome this problem is by going public and getting themselves listed the stock exchanges which would allow public investors to invest in their company but there is a problem, they generally fall short of meeting the eligibility criteria for NSE and BSE.

Realizing this, most of the major capital markets have proposed a separate exchange for the SME segment. Now more than 20 countries operate separate SME exchanges. These markets have tried to create an SME-friendly market environment supported by effective institutions and forging links to policies that foster a new class of investible equities.

In India, BSE SME and NSE Emerge platforms were introduced to solve this problem. BSE SME and NSE Emerge platforms are a trading platform dedicated specifically  for the trading of shares of small and medium enterprises where these companies can come out with their IPO. Businesses who want to get listed here have to fulfil few requirements, the criteria vary between the 2 platforms.

Also read: How to identify a good IPO?

Generally, the criteria include:

  1. It must be a public limited company. Proprietorships, Partnership Firms, Private Limited Companies need to change to convert to a public limited company’
  2. The companies post paid-up capital should not be more than Rs. 25 Crores.
  3. Distributable profits for at least two years out of the immediately preceding three years.
  4. It must have certified copies of the annual report for 3 years.
  5. It must agree with both depositories and mandatorily facilitate DEMAT trading of securities.
  6. An auditors certificate stating there is no default in payment of interest by the promoter or by the promoter’s holding companies.
  7.  If there is any litigation case filed against the applicant, promoter or promoter held companies then it must be disclosed along with the nature and status of the litigation.
  8. If there are any criminal cases filed against the director or directors then the nature and status of such investigations which can have a direct impact on the business must be disclosed.
  9. A minimum of 50 allottees are needed by the company at the time of listing through IPO.

Even though listings of SME IPOs are much easier compared to main IPOs, the process is still lengthy and complicated, This includes:

  1. Appointment of Merchant Banker

2. Capital Structuring, Due Diligence, and Pre-IPO preparation

3. Appointment of Bankers, Registrar, Market Makers, RTA etc.

4. Preparation of Draft Red herring prospectus (DRHP)

5. Filing of DRHP with Stock Exchange

6. Approval from Exchange and RoC

7. Issue Pricing

8. The Opening of Public Issue

9. Closure of the Issue & Allocation of Shares

10. Listing & Trading at the Exchange

Also read: Everthing you should know about Initial Public Offering- IPO

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Should you invest in SME IPOs?

After getting brief info about SMEs, now we reach the main question, should you invest in them? The short answer is it depends on the type of investor you are. SME IPOs have drawn a lot of attention in recent years. It is not only the retail investors who are now investing in these but also numerous financial institutions. SMEs are usually in their initial business stages when they may go for an IPO. These companies may show a huge potential for development in the future and this lures the investors to finance these ventures. However, they pose a great amount of risk since there is no guarantee whether the business will actually grow. Many investors are drawn to SME IPOs by the desire to for listing gains and post-listing gains and they are not wrong with assumptions since they can earn a very high return on their investment if the company succeeds but at the same time there is also a possibility of your investment being completely wiped out if the business fails. The SME exchange platforms also face a high liquidity problem, in both NSE and BSE platforms outside of the top 50 the others rarely see trades meaning you can’t exit an investment easily.

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Conclusion:

Inherently these types of businesses are highly risky and generally, people who can invest in such businesses would be HNIs (High Net worth Individuals) with a high-risk appetite because usually, the lot sizes are in few thousands making the amount for the lot between ₹ 1–1.5L. For most retail investors it would be a better option to stay away from this since it would require a lot of capital and low liquidity of the market which would make it too risky of an investment. But with that being said if you identify an opportunity by taking time to research about the company then you can go for it keeping in mind the risks involved.

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