Investing in SME IPO: What It Is and How to Apply

An Initial Public Offering (IPO) is the process where a private company goes public by offering its shares to the general public. This can involve both new, young companies and older companies deciding to be listed on a stock exchange. Through an IPO, a company can raise capital by issuing public shares. After the IPO, the company's shares are listed on a stock exchange and become freely tradeable in the market. In recent years, IPOs have seen significant interest from investors in India, with many IPOs experiencing remarkable oversubscriptions.

The definition of Small and Medium Enterprises (SMEs) can vary with changes in financial laws and regulations. Currently, small enterprises are defined as those with investments between Rs. 1 to 10 crores and a turnover of Rs. 5 to 50 crores. Medium enterprises are those with investments ranging from Rs. 10 to 20 crores and a turnover of Rs. 50 to 100 crores.

What is SME IPO?

An SME IPO (Small and Medium Enterprise Initial Public Offering) provides SMEs with a streamlined entry into the stock market. This process allows promising small and medium enterprises to attract investments by offering their shares to the public for the first time. When an SME undergoes an IPO, its shares are listed on platforms like BSE SME or NSE Emerge.

In India, companies eligible for an SME IPO must have a minimum post-issue capital of Rs 1 crore and a maximum of Rs 25 crores. To date, around 360 SMEs have listed on the BSE through SME IPOs, while approximately 247 SMEs have done so on the NSE platform. This route offers a valuable opportunity for SMEs to secure funding and enhance their market visibility.

How does it work?

As previously mentioned, an SME IPO differs from a mainboard IPO in India. Stock exchanges have dedicated segments specifically for SME IPOs. Unlike mainboard IPOs, where the Securities and Exchange Board of India (SEBI) approves applications, the stock exchange itself reviews and approves the prospectus and IPO application for an SME. 

Investing in SME IPOs carries higher risks compared to mainboard IPOs. Not all SMEs possess strong fundamentals, which can lead to potential investment risks. Consequently, investors should carefully consider these factors before investing in SME IPOs.

Features of SME IPOs

SME IPOs possess distinct characteristics that set them apart from mainboard IPOs. Investing in SME IPOs involves different rules and considerations. Here are some key features of SME IPOs that investors should be aware of:

Minimum Post-Issue Paid-Up Capital

In India, the minimum post-issue paid-up capital for an SME is INR 3 crores. This means the company must have at least INR 3 crores in contributed capital after the SME IPO.

Profitability Requirement

According to the Companies Act 2013, SMEs must demonstrate profitability for two out of the previous three financial years to qualify for launching an IPO. Importantly, this profitability measure excludes other income. Companies that fail to meet this criterion may be denied the opportunity to launch an IPO.

Application Size

For mainboard IPOs, the application size is usually smaller, whereas the minimum application size for an SME IPO in India is INR 1,00,000. This higher amount elevates the investment risk, making SME IPOs more appropriate for investors who have a greater tolerance for risk.

Benefits of SME IPOs

Access to Capital

A major advantage of SME IPOs is that they provide a way for small and medium enterprises to raise capital without taking on debt. Unlike traditional loans, which come with interest payments, equity funding through IPOs doesn't impose a repayment burden on the business. This is especially beneficial for SMEs looking to fund their growth, development, and research projects.

Increased Visibility and Credibility

Listing on a stock exchange boosts an SME’s visibility and credibility. This increased profile draws in potential investors, business partners, and customers. A successful IPO shows that the company has met strict regulatory standards and has growth potential, enhancing its market reputation.

Liquidity for Investors

SME IPOs give existing shareholders the opportunity to sell their shares in the open market, providing much-needed liquidity. This is especially beneficial for early investors and employees who hold equity in the company, as it allows them to fully capitalize on their investment's value.

Valuation and Growth

Going public helps in the proper valuation of an SME, providing a market-determined price for its shares. This market valuation serves as a benchmark for future fundraising efforts and can attract additional investment, facilitating further growth and development.

The Process of Listing an SME IPO

Listing your SME on a stock exchange can be an excellent way to raise capital and elevate your company's profile. Here’s a detailed breakdown of the SME IPO listing process:

Engage an Underwriter

The initial step in the IPO process involves engaging a merchant banker, often referred to as an underwriter. This expert understands market dynamics and plays a key role in drafting IPO-related documents, including details about the face value and selling price of shares. The underwriter ensures the information provided by the SME is accurate and reliable.

 Draft the DRHP

Potential investors require comprehensive information about a company's operations and prospects before it goes public. The underwriter prepares a Draft Red Herring Prospectus (DRHP) to offer potential investors detailed financial data and market evaluations, enabling informed investment decisions.

 Submit the DRHP

In contrast to regular IPOs, where the Draft Red Herring Prospectus (DRHP) is submitted to the Securities and Exchange Board of India (SEBI), SMEs are required to submit their DRHP to the relevant stock exchange for verification and approval.

Market the IPO and Set the Launch Date

After the stock exchange approves the DRHP, the underwriters finalize details such as the IPO opening and closing dates and the issue price. They then announce the launch date and begin promoting the IPO. At this stage, the underwriters, banks, and the stock exchange are informed of the company’s plan to go public, setting the stage for a successful launch.

How to Invest in SME IPOs

Investing in SME IPOs offers a unique chance to back emerging businesses. Here’s a distinct guide to help you through the process:

 Confirm Eligibility:

- Ensure you have a Demat account set up. If not, you can open one through your bank or a brokerage firm.

- Verify the minimum application amount required for the IPO, typically around Rs. 1 lakh for retail investors.

Select Your Platform:

- Apply for the IPO through your broker’s online platform or mobile app.

- Some platforms provide direct access to SME exchanges such as BSE SME or NSE Emerge.

Complete the Application:

-  Go to the “SME IPO” section and select the IPO you want to invest in.

- Indicate the number of lots you wish to apply for; each lot corresponds to a specific number of shares.

- Carefully review and confirm the details of your application.

- Complete the payment using your linked bank account, typically through UPI.

Understand Allotment and Trading:

- Once the IPO period concludes, the allotment results will be published. Shares are allocated based on demand and availability.

- If allotted, your shares will be credited to your Demat account. You can then decide to either hold or trade them on the SME exchange through your broker.

FAQs

Q. Is it good to apply for SME IPO?

A. Investing in SME IPOs offers a chance to diversify portfolios and tap into the growth potential of small and mid-sized companies. SME indexes have outperformed established benchmarks, showing a CAGR of 39% over 2 years. India's pro-SME policies create opportunities for exponential gains.

Q. Who is eligible for SME IPO listing?

A. The company should be registered in India under the Companies Act 1956/2013. The post-issue paid-up capital should not exceed Rs 25 crores. The company should have a track record of at least three years. The company should have positive net worth in at least two out of three financial years.

Q. What is the risk of applying in SME IPO?

A. SMEs are usually in their initial business stages when they may go for an IPO. These companies may show a huge potential for development in the future and this lures the investors to finance these ventures. However, they pose a great amount of risk since there is no guarantee whether the business will actually grow.

Q. What is the disadvantage of SME IPO?

A. However, we caution investors to understand the risk in SME stocks due to the larger lot size, less liquidity, small scale of company operations, and limited financial performance track record.

Also Read: Top High Dividend Paying Stocks to Boost Your Portfolio