The Securities and Exchange Board of India (SEBI), in its board meeting on December 18, 2024, strengthened the regulatory framework for Small and Medium Enterprises (SME) Initial Public Offerings (IPOs). This step has been taken to safeguard investors’ interests, addressing concerns over companies misusing IPO proceeds by diverting funds to shell entities and manipulating financials through related-party transactions.
SEBI has introduced significant amendments to the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR”) and Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR”), which include enhanced compliance requirements for related parties of listed SME companies, lock-in period for promoter shares, restrictions on the utilization of investor proceeds for general corporate purposes, restriction on selling shareholders of the SME companies in the IPO and revision in the materiality threshold of related party transactions etc.
Following are the amendments introduced by SEBI in ICDR and LODR for SME IPO:
- Profitability Restriction: An issuer planning for an SME IPO (“Issuer”) will be eligible for such IPO if it has an operating profit before interest, depreciation and tax of INR 1 Crore from operations for any past 2 out of 3 financial years at the time of filing the Draft Red Herring Prospectus (“DRHP”).
- Restriction of Selling Shareholders: Selling shareholders of the Issuer are now prohibited from selling more than 20% of the total issue size. Additionally, every selling shareholder of the Issuer has also been restricted to sell more than 50% shares in an SME IPO.
Illustration 1:
If the total issue size is INR 10 Crores, selling shareholders collectively cannot sell shares worth more than INR 2 Crores (20% of INR 10 Crores).
Illustration 2:
If a selling shareholder owns 1,00,000 shares, they can sell a maximum of 50,000 shares (50% of their holding) during the SME IPO.
- Promoter Lock-in:
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- As per the current Chapter IX of the ICDR, the Issuer’s promoter is required to hold at least 20% of the post issue capital in the Issuer as Minimum Promoter Contribution (“MPC”).
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- In the event the promoter holds shares in excess of MPC (“Excess Shares”), such shares of the promoter shall be locked-in for a period of 1 year from the date of allotment in the IPO.
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- In the latest amendment, the Excess Shares will be released in a phase manner wherein 50% of such shares will be released after 1 year from the date of allotment in the IPO and the balance 50% will be released after the end of second year from the date of allotment in the IPO.
- Use of Funds for General Corporate Purpose: The Issuer is now restricted to allocating a maximum of 15% of total investor proceeds or INR 10 Crores, whichever is lower, towards general corporate purposes.
- Use of Proceeds for Loan Repayment: Issuer will be ineligible for the SME IPO if it intends to use the IPO proceeds, directly or indirectly, to repay loans taken by the promoter, promoter group, or any related party.
- Public Announcement of DRHP: The Issuer is required to make a public announcement of the DRHP filed with the stock exchange, including a QR code for easy access. The DRHP must be made available to the public for a period of 21 days to invite comments and feedback.
- Allocation of Non-Institutional Investors (NIIs): Under the revised framework, SEBI has decided to standardize the process for allotting shares to NIIs in SME IPO. Going forward, the methodology for share allocation in SME IPO will be aligned with the process used in main board IPOs.
- Related Party Transactions (RPTs): As per Regulation 23 of LODR, an entity listed on the Main Board, which means a recognised stock exchange having nationwide trading terminals, other than SME exchange, has to obtain approvals from audit committee and shareholders prior to engaging into an RPT along with disclosing such RPTs on its website. Through the latest amendments, SEBI has mandated the SME listed entities to comply with Regulation 23 of the LODR for RPTs. Additionally, SEBI has also introduced material threshold of RPTs for SME entities which will be 10% of annual consolidated turnover of the SME listed entities or INR 50 Crores, whichever is lower.
- Migration to the Main Board: SME listed entities are now eligible to undertake a Further Public Offering (FPO) without migrating from the SME Exchange to the Main Board, provided they comply with the provisions of the LODR applicable to Main Board-listed companies.
These changes, coupled with the harmonization of compliance requirements between SME and Main Board entities, mark a significant milestone in aligning the SME capital market ecosystem with broader market practices. As these reforms take effect, they are expected to bolster investor confidence, promote fair market practices, and facilitate the long-term growth and sustainability of listed SME entities in India.
For more information about the aforesaid developments you may write to us at: solutions@bridgeheadlaw.com.
Karan Narvekar | Partner
Sunny Nirmal | Associate
Views expressed are personal to the authors and do not constitute as legal advice.
