Transforming SME IPOs: Sebi Set to Revamp Rules and Custodian Practices

The Securities and Exchange Board of India (SEBI) is set to implement significant transformative reforms for SME IPOs, bolstering governance, improving transparency, and protecting investor interests. The suggested modifications demonstrate SEBI's proactive stance to tackle increasing issues such as fund misappropriation, promoter misconduct, and heightened concerns regarding retail investor safety in SME listings and concerns related to unusually increasing participation of investors and growing issues proceeds to related party and shell companies.

The board meeting set for December 18 examines various proposals, including tightening eligibility standards for SME IPOs, redefining custodian structures, raising participation thresholds, and reassessing the definition of Unpublished Price Sensitive Information (UPSI).

These modifications seek to improve transparency, safeguard investors, and guarantee that only strong and trustworthy credible small and medium enterprises (SMEs) enter the capital markets. Let’s examine these important changes more closely.

Key Proposed Changes for SME IPOs

1.  Raising the Minimum Application Size

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One of the key suggestions SEBI will evaluate is raising the minimum application size for SME IPOs from the existing ₹1 lakh to ₹2 lakh or even possibly ₹4 lakh. This action targets the reduction of undue retail involvement in SME matters, which has increased significantly in recent times. For example, the ratio of applicants to allottees rose from 46 times in FY23 to 245 times in FY24, prompting worries about speculative behavior.

By increasing the minimum application size, SEBI intends to draw in genuine investors who can evaluate the risks tied to SME investments. This action may aid in stabilizing SME IPO markets and lessen volatility generated by smaller, speculative investors.

2.   Minimum IPO Size and Operating Profit Requirements

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To more effectively eliminate unqualified companies, SEBI has suggested that SMEs should fulfill stricter eligibility requirements:

• Minimum IPO Size: The size of the issue must be no less than ₹10 crore.

  
  

• Operating Profit: Firms need to show an operating profit of ₹3 crore in a minimum of two out of the last three financial years.

  
  

These steps guarantee that only financially stable and adequately prepared SMEs enter public markets. SEBI's action will probably eliminate smaller firms that might not have a reliable business model or financial integrity, therefore safeguarding investors from possible potential risks.

Basis	Old	New
Minimum IPO Size	₹5 crore	₹10 crore
Minimum Application Size	₹1 lakh	₹2 lakh
Minimum Number of Allottees	50	200

3.   Extended Promoter Lock-In Period

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At present, promoters must hold onto their shares for at least three years following the IPO. SEBI plans to extend this lock-in duration to five years. The reasoning for this is to guarantee that promoters stay dedicated to the company's growth and synchronize their interests with the long-term benefits of investors.

An extended lock-in period acts as a safeguard protection mechanism, ensuring promoters have “skin in the game” and are not looking for a short-term and quick exit. 

4. Offer-for-Sale (OFS) Restrictions

SEBI intends to set some limit the Offer-for-Sale (OFS) portion in SME IPOs to 20% of the entire issue size. Furthermore, selling shareholders will be restricted from offering more than 20% of their holdings prior to the issue. For example, in a ₹100 crore IPO, the OFS must not surpass ₹20 crore.

These actions aim to avoid significant dilution of promoter stakes and guarantee that the capital acquired is mainly focused on fostering business expansion and progress instead of immediate shareholder exits.

• Focus on Fund Utilization and Transparency

5.  Prohibition on Loan Repayment

SEBI proposes to prohibit the use of IPO funds to pay off loans taken by promoters, promoter groups, or associated related parties. This action tackles worries about the misuse of funds and recurring transactions frequently observed in SME sectors. Attention will turn to directing funds into expanding businesses and authentic growth prospects and opportunities.

6.   Cap on General Corporate Purpose (GCP) Funds

To maintain accountability, SEBI recommends limiting the funds designated for General Corporate Purposes (GCP) to 10% of the issue size or ₹10 crore, depending on which amount is smaller. This cap restricts optional fund usage and enhances clarity in the distribution of funds.

7.   Mandatory Monitoring of Fund Utilization

SEBI has suggested establishing a mechanism in which monitoring agencies regularly check and certify the use of IPO proceeds every quarter. Issuers must provide certificates from statutory auditors, confirming that the funds are being utilized as outlined in the IPO prospectus.

For issue sizes surpassing ₹20 crore, it might be required to appoint a monitoring agency to supervise the use of funds. This stipulation seeks to avoid the misuse of IPO funds.

• Enhancing Investor Participation and Fairness

8.   Minimum Number of Allottees

At present, a successful SME IPO necessitates at least 50 allottees. SEBI is expected to raise this requirement to 200 allottees. This action seeks to boost liquidity, strengthen market depth, and guarantee wider investor participation.

9.   Draw of Lots for Non-Institutional Investors

SEBI suggests splitting the Non-Institutional Investor (NII) group into two subcategories to ensure fair and equitable distribution:

• Sub-Category 1:   Applications not exceeding ₹10 lakh (1/3rd distribution).

• Sub-Category 2:  Applications exceeding ₹10 lakh (2/3rd allocation).

  
  

This system ensures that smaller investors are more likely to obtain allocations in oversubscribed SME IPOs, fostering equity in opportunities and a level playing field.

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• Strengthening Custodian Framework and UPSI Guidelines

  
  

10.   Net Worth Requirements for Custodians

SEBI is expected to bring reform that seeks to double minimum subscription by increasing the minimum net worth requirement for custodians from ₹50 crore to ₹100 crore. Custodians are essential in protecting investor assets, and this modification guarantees that only financially strong entities participate in the market.

11.  Broadening the Definition of UPSI

SEBI wants to provide greater understanding on Unpublished Price Sensitive Information (UPSI), which pertains to significant material information regarding a company that remains undisclosed but may influence stock prices. This information is not publicly available but known to some management level. SEBI may incorporate the following into UPSI:

• Loan restructuring or one-time settlements.

  
  

• Forensic audits or regulatory actions against top executives and senior management.

  
  

• Fundraising activities and significant agreements impacting control of the company.

These updates will bring uniformity, consistency and regulatory certainty for listed small and medium enterprises.

12.   Angel Funds: Boosting Start-Up Investments

The board of SEBI will additionally evaluate regulations regarding angel funds within Alternative Investment Funds (AIFs). The main proposals consist of:

Exclusively Accredited Investors:  Limiting investments to accredited investors who have confirmed net worth.

Decreased or reduced Minimum Investment:  Lower the minimum investment threshold limit from ₹25 lakh to ₹10 lakh.

Increased Maximum Investment:  Increasing the highest investment cap from ₹10 crore to ₹25 crore.

These adjustments seek to enhance the appeal of angel funds for affluent investors while ensuring that only suitable qualified investors with the right risk tolerance are involved.

13.   Mandatory Disclosure of Merchant Bankers' Fees 

SEBI plans to require the disclosure of fees imposed by merchant bankers in the IPO prospectus. This clarity and transparency will enable investors to evaluate the expense frameworks linked to the public offering.

Why These Reforms Matter

The SME IPO sector has experienced significant expansion in recent times. As of October 15, over 159 SMEs secured more than ₹5,700 crore in FY24. This increase underscores the growing significance of public listings for SMEs in promoting economic growth. Nonetheless, it has also revealed weaknesses like fund misallocation, promoter misconduct or wrongdoing, and speculative involvement.

By introducing these reforms, SEBI seeks to:

• Enhance and boost investor confidence and trust by improving transparency and accountability.

  
  

• Ensure efficient fund utilization for genuine business development and authentic reliable purposes.

  
  

• Safeguard retail investors against speculative and high-risk initial public offerings (IPOs).

Conclusion

SEBI's suggested modifications to the SME IPO structure represent a major advancement in reshaping India's capital markets. Through stricter eligibility criteria, improved fund oversight, and encouraging equitable investor involvement, SEBI seeks to establish a stronger and more reliable environment for SMEs to secure funding. With the implementation of these reforms, it is anticipated that they will harmonize growth prospects for SMEs with the safeguarding of investors, thus fostering a sustainable and resilient marketplace for every stakeholder involved.

SEBI's active strategy in revamping the SME IPO framework highlights its dedication to promoting a safe and effective capital market landscape. These changes are expected to enhance investor trust and aid in the sustainable development of SMEs in India.

 

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