It has taken several years of policy efforts to create an ecosystem for small and medium enterprises (SMEs) to raise equity from the markets. BSE has till date seen 566 companies raise ₹9,075 crore on its SME platform, while the NSE has seen 594 companies raise ₹15,981 crore. Therefore, as the Securities and Exchange Board of India (SEBI) looks to tighten regulations for SMEs to protect investors, it needs to ensure that genuine SMEs are not altogether deterred from going public.
Having substantially raised eligibility criteria for SME IPOs in December, SEBI is now said to be considering changes to disclosure and governance norms to bring listed SMEs on par with larger companies. Such parity may not be feasible for firms which operate at a fraction of the latter’s size. While SEBI’s original regulations for SMEs were light-touch, there have been recent instances of some SMEs diverting IPO proceeds to related parties, booking fictitious sales and engaging in pump-and-dump activity to drum up interest in their shares. When such cases were brought to light, SEBI initiated prompt enforcement actions. In December, SEBI introduced strict criteria for SME IPOs, with an outright ban on using IPO money to repay related party loans, a minimum ₹1 crore operating profit in 2 of 3 previous years and extended promoter lock-ins. To deter small investors, the lot size for participation was raised from ₹1 lakh to over ₹2 lakh. These moves, along with the market fall, have already thinned out SME listings.
SEBI seems to be considering further amendments to its LODR rules applicable to already listed SMEs. The proposals include a stipulation that SMEs obtain prior shareholder approval for related party deals above certain thresholds and submit quarterly compliance reports on Board composition, conduct of meetings and committee proceedings. Most significant though, SME companies may be asked to file their financial results, shareholding patterns and statement of deviations on use of IPO proceeds, on a quarterly basis with the exchanges. While SEBI may be right to insist on robust Board composition and checks on related party deals for SMEs in the interest of good governance, the requirement of quarterly results filings may be an overkill.
There is a valid view that high-frequency financial disclosures force top managers of listed companies to focus too much on short-term profit maximisation and tactical gains, at the cost of strategic vision and long-term value creation. Given that SME firms operate with limited managerial resources, the compulsion to file quarterly results can work against efforts to deliver sustainable shareholder value. As for the argument that tighter regulation of SMEs will better protect retail investors, SME firms are unsuitable for retail investors in the first place, with their high business risks, earnings volatility and low survival rates. If retail investors choose to take a punt on SMEs, they should operate on the maxim of ‘caveat emptor’.
