[Analysis] SEBI Proposes Enhancements to the SME IPO Framework | A Detailed Overview of the New Regulations and Their Impact

SME IPO Regulations refer to the regulatory framework established by SEBI under the SEBI (ICDR) Regulations, 2018, and SEBI (LODR) Regulations, 2015, to govern the listing and post-listing compliance of Small and Medium Enterprises (SMEs) on SME Exchanges. These regulations aim to facilitate access to capital for SMEs while ensuring transparency, investor protection, and robust corporate governance. Key provisions cover areas such as minimum application size, allotment methodology, lock-in periods for promoters, restrictions on the use of issue proceeds, enhanced disclosure requirements, and the introduction of profitability and governance thresholds. SEBI periodically reviews and updates these norms to align SME practices with Main Board standards, fostering a transparent and investor-friendly ecosystem.

Table of Contents

1. Introduction
2. Increase in Minimum Application Size for SME IPOs to Align with Market Growth
3. Alignment of Allotment Methodology for Non-institutional Investors in SME IPOs with Main Board IPOs
4. Increase in Minimum No. of Allottees for SME Public Issues to Enhance Market Liquidity
5. Restriction on Offer for Sale in SME IPOs Capped at 20% of the Issue Size
6. Mandatory Appointment of Monitoring Agency for Issue Size Exceeding Rs 20 Crore
7. Proposal to Increase Lock-in Period on Minimum Promoter Contribution in SME IPOs to 5 Years
8. Reduction in General Corporate Purpose Limit for SME IPOs to Enhance Transparency and Accountability
9. Companies Converted from LLPs or Partnerships Must Exist for 2 Full Financial Years Before Filing DRHP
10. Introduction of Profitability Threshold for SME IPO Eligibility
11. Revised Fundraising Framework for SMEs Exceeding Rs 25 Crore Capital Threshold
12. Restrictions on Using SME Issue Proceeds for Promoter Loan Repayment
13. Enhanced Disclosures for SME Companies
14. Mandatory Disclosure of Merchant Banker Fees
15. Public Access to Draft Red Herring Prospectus for SME IPOs
16. Mandatory Due-Diligence Certificate for SME IPOs
17. Post-Listing Exit Opportunity for Dissenting Shareholders in SME IPOs
18. Extending RPT Provisions to SME-Listed Entities
19. Quarterly Disclosure of Board Composition and Meetings for SME Listed Entities
20. Proposal for Quarterly Reporting of Financial Disclosures by SME-Listed Entities
21. Conclusion

1. Introduction

On November 19, 2024, SEBI released a consultation paper on a review of the SME framework under SEBI (ICDR) Regulations, 2018, and the applicability of corporate governance provisions under SEBI (LODR) Regulations, 2015 on SME companies to enhance pre-listing and post-listing SME provisions.

The proposals are divided into two parts. The first part deals with provisions related to IPO at SME Exchange and conditions of migration from SME platform to Main Board post-listing. The second part deals with corporate governance norms, including post-listing disclosures by issuers listed on SME Exchange. Comments on the same may be submitted by December 4, 2024. The key proposals in detail are as follows:

2. Increase in Minimum Application Size for SME IPOs to Align with Market Growth

As per Regulation 267(2) of the ICDR Regulations, 2018, the minimum application size for Small and Medium Enterprises (SME) IPOs[1] is Rs 1 lakh. Stock Exchanges and Merchant Banks have suggested increasing the minimum application size to Rs 2 lakh per application.

Regulation 2(vv) of SEBI (ICDR) Regulations, 2018, defines a “retail individual investor” as an individual investor who applies or bids for specified securities for a value of not more than Rs 2 lakh.

SEBI observed a rise in retail participation in SME IPOs and, to safeguard the interests of smaller retail investors has proposed increasing the application size to Rs 2 lakh per application in SME IPOs.

Given the 4.5 times growth of Nifty and Sensex over the past 14 years, SEBI is also considering raising the threshold to Rs 4 lakh, in line with the market growth.

3. Alignment of Allotment Methodology for Non-institutional Investors in SME IPOs with Main Board IPOs

Presently, under ICDR norms, the allotment procedure for the non-institutional investors[2] (NIIs) category in a book-built issue for SME IPO is based on a proportional allotment that is different from the allotment procedure for NIIs in Main Board IPOs.

It was suggested that the draw of lot allotment methodology and reservation in the portion available for NIIs, as currently in place for main board IPOs, must also be extended for allocation to NIIs in SME IPOs. The proposed change will align the allocation methodology for the NII category in SME IPOs with the existing allocation methodology for the NII category in main board IPOs.

SEBI has proposed to divide the NII category into two sub-categories –

• Sub-category 1 – 1/3^rd of the allocation earmarked for NIIs must be for application sizes up to Rs 10,00,000
• Sub-category 2 – 2/3^rd of the allocation earmarked for NIIs must be for application sizes above Rs 10,00,000

4. Increase in Minimum No. of Allottees for SME Public Issues to Enhance Market Liquidity

As per Regulation 268(1) of ICDR Regulations, there is a requirement that for SME public issues to be considered successful, there must be a minimum of 50 allottees in public issues.

The investor base in India has grown significantly since 2010. The above requirement will ensure that only companies in which investors have an interest will get listed. This increased requirement will also ensure that a sizeable number of investors will also be present after listing, which will help provide liquidity in the market.

In view of the above, SEBI has proposed increasing the minimum number of allottees in SME public issues to 200.

5. Restriction on Offer for Sale in SME IPOs Capped at 20% of the Issue Size

Currently, the ICDR Regulations impose no restrictions on Offer for Sale (OFS) in SME IPOs. Stock Exchanges and Merchant Banks have suggested either completely restricting OFS or limiting it to 20%-25% of the issue size.

The SME Exchange[3] was established to support small and medium enterprises (SMEs) in accessing finance for growth. Data shows that in FY 23-24, two IPOs were entirely OFS, and in FY 24-25 (until October), one was. Additionally, of the 52 issues with both OFS and fresh issues, 30 had an OFS portion exceeding 20% of the total size.

In response, SEBI has proposed restricting OFS in SME IPOs to 20% of the issue size. It also suggests that the OFS from selling shareholders should not exceed 20% of their pre-issue shareholding on a fully diluted basis.

6. Mandatory Appointment of Monitoring Agency for Issue Size Exceeding Rs 20 Crore

As per Regulation 262 of the ICDR Regulations, 2018, a Monitoring agency must be appointed if the fresh issue size is more than Rs 100 crores for an SME issue. The monitoring agency acts as an independent agency that certifies the utilisation of proceeds and ensures that funds are used for the purposes disclosed in the offer document, thus reducing the risk of misuse or diversion. This will also bring more transparency for investors and accountability for the issuer.

SEBI has now proposed that the appointment of a monitoring agency must be made applicable to the Issuer Company if the fresh issue size is higher than Rs 20 crore.

In cases where there is no requirement for the appointment of a Monitoring Agency, there must be a mandatory requirement of a Statutory auditor’s certificate for utilisation of money raised through the public issue to be submitted to Exchange while filing the half-yearly financial statement till the issue proceeds are fully utilised. These certificates must also be submitted to the Audit Committee and the Board of the Issuer Company.

7. Proposal to Increase Lock-in Period on Minimum Promoter Contribution in SME IPOs to 5 Years

SEBI has proposed increasing the lock-in period for minimum promoter contribution (MPC) in SME IPOs to 5 years, up from 3 years. Additionally, the release of lock-in on promoters’ holdings exceeding MPC will now occur in phases: 50% can be released after 1 year, and the remaining 50% after 2 years. This phased release approach, suggested by Stock Exchanges, aims to ensure long-term commitment from promoters while gradually allowing liquidity for their excess holdings.

8. Reduction in General Corporate Purpose Limit for SME IPOs to Enhance Transparency and Accountability

SEBI has proposed reducing the General Corporate Purposes (GCP) amount in SME IPOs from the current 25% of the issue size to a maximum of 10%, with an absolute cap of Rs 10 crore. The rationale behind this change is to address concerns over the potential misuse of funds, as the GCP category allows issuers to allocate funds without specifying the exact purpose, leading to unclear usage of proceeds.

For example, in a Rs 100 crore IPO, the GCP allocation could be as high as Rs 25 crore, a significant amount that could be spent without sufficient transparency for investors. SEBI also proposed deleting Regulation 230(3), which currently permits raising funds for unspecified targets or acquisitions, to further enhance accountability and protect investors’ interests.

9. Companies Converted from LLPs or Partnerships Must Exist for 2 Full Financial Years Before Filing DRHP

As per Regulation 229 of ICDR Regulations, 2018, an issuer is eligible to make an initial public offer:

• If its post-issue paid-up capital is less than or equal to Rs 10 crore
• If its post-issue face value capital is more than Rs 10 crore and up to Rs 25 crore

Further, ICDR provides a proviso for cases where the issuer was a partnership firm or a limited liability partnership or in case an issuer is formed out of a merger or a division of an existing company, for considering their track record provided they conform to certain requirements regarding financial statements.

SEBI has proposed that in case of a company’s conversion from a Limited Liability Partnership or Partnership firm, the Company must have existed for at least two full financial years before filing DRHP. Further, the restated financial statements of the issuer company prepared post-conversion should be in accordance with Schedule III of the Companies Act 2013.

Also, SEBI proposed to have a 2-year cooling off period before SME IPO for a Company, if there is a change of promoters or new promoters have come after the acquisition of 50% or more shareholding before the filing of the draft offer document.

10. Introduction of Profitability Threshold for SME IPO Eligibility

SEBI has proposed that an issuer must be eligible to make an initial public offer (IPO) only if the issuer has operating profit (earnings before interest, depreciation and tax) of Rs 3 crore from operations for at least any 2 out of 3 financial years preceding the application.

A minimum operating profit threshold indicates that the company has achieved a certain level of profitability and is financially viable.

11. Revised Fundraising Framework for SMEs Exceeding Rs 25 Crore Capital Threshold

Under Regulation 280(2) of the ICDR Regulations, SMEs with post-issue face value capital exceeding Rs 25 crore must migrate to the Main Board. However, SMEs that do not meet the Stock Exchange migration criteria (such as 3 years of listing on the SME platform) face restrictions in raising funds that would push their capital beyond Rs 25 crore.

In response to concerns about the challenges this poses for SMEs, SEBI has proposed allowing companies that are not yet eligible for migration to raise funds without migrating to the Main Board. Once their post-issue paid-up capital exceeds Rs 25 crore, these companies must comply with the Main Board’s corporate governance and disclosure norms under LODR, including quarterly financial reporting. Migration to the Main Board will only be allowed once they meet the necessary eligibility criteria.

12. Restrictions on Using SME Issue Proceeds for Promoter Loan Repayment

The objective of SME issues is to provide necessary financing for the growth of small and medium enterprises. Allowing the repayment of loans taken by promoters, promoter groups, or related parties from the issue proceeds, whether directly or indirectly, defeats this purpose. It is suggested that such repayments should not be permitted as an object of SME issues.

13. Enhanced Disclosures for SME Companies

To enhance transparency and provide investors with detailed insights, SEBI has proposed to mandate SME companies to disclose senior-level employees across departments (e.g., Heads of Sales, Purchase, Plant, Finance, IT, etc.), including their experience. Additional disclosures should cover ESIC/EPF details, such as the number of employees registered, amounts paid, and any delays in payments over the past three years.

Further, a site visit report prepared by the Merchant Banker should form part of the due diligence report and be included in material documents for inspection in the offer document. These measures will improve the overall quality of disclosures and provide investors with comprehensive information about the company’s operations and employee strength.

14. Mandatory Disclosure of Merchant Banker Fees

To ensure transparency and align with the purpose of providing SMEs with an alternative fundraising mechanism, SEBI has proposed that Merchant Banker fees, regardless of form, name, or purpose, must be disclosed in the Red Herring Prospectus (RHP). Currently, there is no requirement to disclose issue-related expenses, and it has been observed that Merchant Banker fees sometimes exceed 30-40% of the issue size, undermining cost-effectiveness for SMEs.

15. Public Access to Draft Red Herring Prospectus for SME IPOs

For Main Board IPOs, Regulation 26 of ICDR Regulations mandates making draft offer documents public for 21 days, with announcements in English, Hindi, and regional newspapers inviting comments. This requirement is currently absent for SME IPOs when filing the DRHP.

To enhance transparency and enable public participation, SEBI has now proposed that the DRHP of SME IPOs filed with stock exchanges be made available to the public for comments for at least 21 days. The DRHP must be hosted on the websites of stock exchanges and lead managers, with a public announcement made in one English, Hindi, and regional language newspaper, inviting comments.

16. Mandatory Due-Diligence Certificate for SME IPOs

In Main Board IPOs, merchant bankers must submit a due diligence certificate at the time of the draft offer document, i.e., at the time of DRHP. SEBI has proposed that merchant bankers submit a due diligence certificate to the stock exchanges when filing the DRHP for SME IPOs.

17. Post-Listing Exit Opportunity for Dissenting Shareholders in SME IPOs

Regulation 59 of the ICDR Regulations provides a post-listing exit for dissenting shareholders in main board IPOs due to changes in objects or contract terms. Still, such provisions are not currently available for SME IPOs.

SEBI has now proposed to introduce provisions in the SME chapter, similar to Regulation 59 of the ICDR, to allow post-listing exit for dissenting shareholders in cases of changes to objects or contract terms stated in the offer document.

18. Extending RPT Provisions to SME-Listed Entities

SEBI has proposed that the provisions related to related party transactions (RPTs) under Regulation 23 of the LODR Regulations should also apply to SME-listed entities, with exceptions for those with a paid-up capital of up to Rs 10 crores and net worth up to Rs 25 crores.

This would align SME RPT norms with those of Main Board listed entities, providing stricter approval and disclosure requirements to prevent risks like fund siphoning through related parties. However, for SME entities, the materiality threshold for shareholder approval of RPTs should be based on transactions exceeding 10% of annual consolidated turnover, rather than the higher Rs 1000 crore threshold.

19. Quarterly Disclosure of Board Composition and Meetings for SME Listed Entities

Regulation 27 of the LODR Regulations mandates that Main Board-listed entities submit a quarterly compliance report, including details on board composition, attendance, and meeting specifics. However, this requirement does not currently apply to SME-listed entities. It is proposed that SME-listed entities should also disclose the composition and meeting details of their Boards of Directors and committees.

This would enhance governance, increase transparency, and enable better monitoring by stock exchanges, analysts, and investors. The requirement would apply to SME entities with paid-up capital exceeding ₹10 crore and net worth exceeding ₹25 crore, with disclosures to be made quarterly in XBRL format, harmonising the disclosure practices with Main Board listed entities.

20. Proposal for Quarterly Reporting of Financial Disclosures by SME-Listed Entities

Currently, SME-listed entities must submit their shareholding pattern, statement of deviation(s) or variation(s), and financial results on a half-yearly basis, whereas Main Board entities submit them quarterly. SEBI has proposed that SME-listed entities should align with Main Board entities by submitting these reports quarterly. This would ensure more timely updates on financial health and fund utilisation, enhancing transparency and consistency in disclosures.

21. Conclusion

In conclusion, these proposed changes to the SME framework under SEBI (ICDR) and (LODR) Regulations aim to enhance transparency, strengthen governance and build investor confidence in SME IPOs and listed entities. By aligning SME norms with those of Main Board companies, introducing stricter disclosure and compliance requirements, and addressing concerns related to fund use, governance and investor protection, SEBI seeks to create a stronger and more transparent system for SMEs, supporting their steady growth while ensuring fair opportunities for investors.

[1] As per Regulation 2(zi) of SEBI (LODR) Regulations, 2015, SME means an entity that has issued specified securities in accordance with provisions of Chapter IX of SEBI (ICDR) Regulations, 2018

[2] Regulation 2(jj) of SEBI (ICDR) Regulations, 2018

[3] Regulation 2(ddd) of SEBI (ICDR) Regulations, 2018