TLDR: The Securities and Exchange Board of India (SEBI) has recently introduced a series of stringent regulations aimed at strengthening the framework for Small and Medium Enterprises (SMEs) seeking to enter the public market. These measures are designed to ensure that only financially robust and transparent SMEs can access public funds, thereby enhancing investor protection and market integrity.
 

1. Mandatory Operational Profit Requirement

To qualify for an Initial Public Offering (IPO), SMEs are now required to demonstrate a minimum operational profit of ₹1 crore from operations in any two of the preceding three financial years at the time of filing the Draft Red Herring Prospectus (DRHP). This criterion ensures that only SMEs with a consistent track record of profitability are permitted to raise funds from the public.
 

2. Cap on Offer for Sale (OFS)

The Offer for Sale component in SME IPOs has been capped at 20% of the total issue size. Additionally, existing shareholders are restricted from selling more than 50% of their pre-issue holdings during the IPO. This measure is intended to prevent significant promoter exits and ensure that promoters maintain a substantial stake in the company post-IPO, aligning their interests with those of new investors.
 

3. Lock-in Period for Promoter Holdings

SEBI has introduced a phased lock-in period for promoter holdings exceeding the Minimum Promoter Contribution (MPC). Specifically, 50% of such excess holdings will be locked in for one year, and the remaining 50% for two years post-IPO. This staggered approach ensures promoter commitment to the company's long-term growth and stability.
 

4. Allocation Methodology for Non-Institutional Investors (NIIs)

The allocation process for NIIs in SME IPOs has been aligned with the methodology used in main board IPOs. This standardization aims to create a more equitable distribution of shares among investors and enhance the overall transparency of the allocation process.
 

5. Limitation on General Corporate Purpose (GCP) Funds

The amount allocated for General Corporate Purposes in SME IPOs is now capped at 15% of the total issue size or ₹10 crore, whichever is lower. This restriction ensures that a significant portion of the funds raised is directed towards specific, disclosed objectives, thereby enhancing accountability in fund utilization.
 

6. Prohibition on Using IPO Proceeds for Promoter Loan Repayment

SEBI has prohibited the use of IPO proceeds for repaying loans taken by promoters, promoter groups, or related parties. This measure ensures that the funds raised are utilized for business expansion and operational needs rather than settling promoter liabilities, thereby safeguarding investor interests.
 

7. Public Availability of Draft Red Herring Prospectus (DRHP)

The DRHP for SME IPOs must now be made available for public comments for a period of 21 days. Stock exchanges are required to facilitate this by making public announcements and providing access through QR codes in newspapers. This initiative promotes greater transparency and allows potential investors to make informed decisions.
 

8. Post-IPO Compliance and Fundraising

SMEs can continue to raise funds on the SME platform without migrating to the main board, provided they comply with the Listing Obligations and Disclosure Requirements (LODR) applicable to main board companies. This provision offers flexibility to SMEs while ensuring adherence to stringent compliance standards.
 

9. Applicability of Related Party Transaction (RPT) Norms

The norms governing Related Party Transactions, as applicable to main board-listed entities, will now extend to SME-listed entities. The threshold for considering an RPT as material is set at 10% of the annual consolidated turnover or ₹50 crore, whichever is lower. This extension aims to enhance corporate governance standards among SMEs.
 

Implications of the New Regulations

These regulatory enhancements by SEBI are poised to bring about significant changes in the SME IPO landscape:

  • Enhanced Investor Confidence: By ensuring that only financially sound and transparent SMEs can access the public markets, these measures are likely to boost investor confidence and participation.

  • Improved Corporate Governance: The extension of RPT norms and the requirement for public comments on the DRHP are steps towards fostering better corporate governance practices among SMEs.

  • Balanced Fund Utilization: Capping the GCP allocation and prohibiting the use of IPO proceeds for promoter loan repayments ensure that funds are utilized for genuine business needs, promoting sustainable growth.

  • Promoter Commitment: The lock-in requirements for promoter holdings ensure that promoters remain committed to the company's long-term success, aligning their interests with those of public shareholders.

 

Conclusion

SEBI's proactive approach in tightening the SME IPO regulations reflects its commitment to maintaining the integrity of the Indian capital markets. These measures are expected to create a more robust and transparent environment for SMEs seeking to raise capital, ultimately contributing to the overall health and stability of the financial ecosystem.