What is an SME IPO?

If you look closely at the stock market, you will notice that along with large companies, there are several that are smaller in scale. These companies can be classified as small and medium enterprises (SME). SME is a term used to describe small and medium-scale industrial units that have an investment threshold not exceeding ₹50 crore. Similar to larger companies, SMEs may also want to raise funds for various purposes. One of the numerous ways companies can raise funds is through an Initial Public Offering (IPO). In this article, we will explore what an SME IPO is, its benefits, risks, and how they differ from mainboard IPOs.

What is an SME IPO?

To understand what an SME IPO is, it is important that you know what an IPO is and how it can help companies.

When a company needs to raise funds, it can opt for several options, such as raising capital from existing investors or taking on debt.

In an IPO, a company aims to raise funds by offering its shares to the general public. Through an IPO, a company transitions from a private company to a publicly traded company as the shares of the company are traded on the stock exchanges.

For SMEs, an IPO is a suitable option to raise funds. An SME IPO can help a company raise funds to fuel growth, expansion, meet working capital requirements, or repay debt. Further, companies can also benefit from having their shares listed on the stock exchanges.  

How Do SME IPOs Work?

Now that we have understood what the meaning of SME IPO, let’s take a look at how they work -

Selecting an Underwriter

SMEs looking to raise funds through an IPO must first appoint an underwriter. An underwriter is typically a merchant bank that has expertise in the market and the IPO process. The underwriter assists the SME to draft its IPO-related documents and helps in aspects such as determining the selling price of the shares.

Creating the DRHP

The draft red herring prospectus (DRHP) is one of the most crucial documents in the SME IPO process. This document contains details about the issue and helps investors and regulatory authorities understand the objective of the SME IPO, how the funds would be utilised, and the key details about the company. The underwriter creates the DRHP and submits it to the Securities and Exchange Board of India (SEBI) for verification and approval.

Advertising the IPO

Before an SME company goes public with an IPO, it must advertise the issue to attract potential investors. Key details such as the opening and closing dates of the issue, along with the price band, need to be provided to the general public.

Allotting and Listing of Shares

The final step of an SME IPO includes the allotment of shares. Once the subscription period of the issue closes, the company has to allot the shares to the eligible investors. Following the allotment of shares, the shares of the company are listed on the stock exchanges, and the company becomes a publicly traded company.

Eligibility Criteria for SME IPOs

Before raising funds through an SME IPO, a company must know if it meets the eligibility criteria. Here are some key criteria that the company should meet:

• The company must be incorporated under the Companies Act of 1956.
• The face value of the post-issue paid-up capital should not exceed ₹25 crore.
• The minimum value of SME’s net tangible assets should be ₹1.5 crore.
• The company must have a track record of at least 3 years. If the company was previously a proprietorship or partnership, the combined track record must also be of at least 3 years.
• The SME should have an operating profit or positive EBITDA in two of the last three financial years.
• The promoters of the SME should not change for a year after filing the IPO.
• Promoters of the company are required to meet the regulatory and disciplinary compliances. They should not be disqualified or suspended from trading by any stock exchanges.

Advantages of SME IPOs

For investors, an SME IPO investment can offer several benefits.

• An investor can enter a company in its early stages and find long-term bets through an SME IPO.
•  SME IPOs allow investors to diversify their portfolio by adding smaller companies from various industries and sectors.
• SME IPO investments may offer potentially high returns since these companies have more scope for growth.

Things to Consider Before Applying for SME IPOs

Although an SME IPO has the potential to generate substantial returns, as an investor, you need to be aware of the risks associated with it.

• Since an SME is a smaller company, there is a higher risk associated with it. Usually, there is not enough operational and financial history, making it difficult to gauge its future performance.
• SME IPOs can also face liquidity issues. Shares of these companies may not be traded that often, and investors might find it difficult to buy or sell shares.
• Analysing and selecting the right SME IPO to invest in can be a challenging and time-consuming process.

How to Apply for an SME IPO

Here are the steps one needs to follow to invest in an SME IPO in India:

• First, you need to have a demat account to apply for an SME IPO.
• Select the IPO that you wish to apply for. You can find the upcoming IPOs on the BSE and NSE websites.
• You can apply for an IPO online through your bank’s or broker’s terminal.
• When you apply for the IPO, the investment amount based on the number of lots you have decided to apply for will be blocked from your bank account through application backed by a block amount (ASBA) or through UPI.
• Upon receiving confirmation, you can check the allotment status of your IPO subscription online on the allotment date.
• On successful allotment, the shares will be credited to your demat account and available for trading from the listing day.
• In case, you did not receive the allotment, the amount that was blocked earlier during the subscription period will be unblocked and available to you.

SME IPO vs. Mainboard IPO

Here’s how SME IPOs and Mainboard IPOs differ from each other -