What is an SME IPO?

When you look closely at the stock market, you will notice that along with large well known companies, there are also many smaller enterprises. These companies are often referred as small and medium enterprises (SME).

In India, SME term is often used to describe small and medium-scale industrial businesses with an investment threshold not exceeding ₹50 crore. Similar to larger companies, SMEs often need to raise capital for various purposes like growth, working capital or debt repayment. 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, how they works, its advantages, risks, and how they differ from Mainboard IPOs.

What is an SME IPO?

To understand what an SME IPO is, it is important to first know what an IPO is and how it can help organizations.

When any organization needs to raise funds for their business purposes, it can opt for several options, such as raising capital from existing investors or taking on debt.

In an IPO ( Initial Public Offering), a private 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.

An SME IPO is when a small or medium-sized company raises funds by offering its shares to the public. SME IPO can help a company raise funds which can be used for various purposes like:

• Business expansion
• Working capital requirements
• To Repay debt
• Enhancing brand visibility through listing on 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 –

1. Selecting an Underwriter

SMEs looking to raise funds through an IPO must first appoint an underwriter. An underwriter is typically a merchant bank or financial institutions that has expertise in the market and which guide them through 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.

2. Creating the Draft Red Herring Prospectus (DRHP)

The draft red herring prospectus (DRHP) is one of the most crucial documents in the SME IPO process and it helps investors and regulatory authorities to understand the details which are as follows:

• Company Details
• Objectives of the IPO
• How the funds would be utilized
• Financial Information of the company

The underwriter creates the DRHP and submits it to the Securities and Exchange Board of India (SEBI) for verification and approval.

3. Advertising the IPO

Before an SME company goes public with an IPO, it must advertise the issue to attract potential investors.

This includes key details such as:

• Issue opening and closing dates
• Price band
• Lot size

which needs to be provided to the public.

4. Allotment and Listing

The final step of an SME IPO includes the allotment of shares. Once the subscription period of the issue ends :

• 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 ( like NSE or BSE SME ).
• The company becomes a publicly traded company, and trading of the company’s shares begins.

Eligibility Criteria for an SME IPO

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

• Incorporated under the Companies Act, 1956
• The face value of the post-issue paid-up capital should not exceed ₹25 crore
• The minimum value of net tangible assets should be ₹1.5 crore
• The company must have a operational track record of at least 3 years(including time as a partnership or proprietorship, if applicable)
• Company should have an positive operating profit or 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 For Investors 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 frequently, 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 in India

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

• Open a Demat Account: First, you need to have a demat account to apply for an SME IPO.Select the IPO that you wish to apply for.
• Select the IPO: You can find the upcoming IPOs on the BSE and NSE websites.
• Apply Online: You can apply for an IPO online through your bank’s or broker’s terminal.
• Blocking of Funds: 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.
• Allotment: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 IPOs vs Mainboard IPOs

Conclusion

SME IPOs open up exciting investment opportunities in high-growth, early-stage companies. However, the associated risks require careful analysis and a clear understanding of the company’s fundamentals. For SMEs, it’s a powerful tool to access capital markets and elevate their brand.

Whether you’re an investor or an entrepreneur, understanding the dynamics of SME IPOs can help you make informed financial decisions.