The Rise of SME IPOs and Investor Concerns
The Indian stock market has long been a hub of excitement, risks, and opportunities. However, there’s a growing narrative that regulators, brokers, and other key players may not be doing enough to protect retail investors—especially in the world of SME IPOs. As we delve into the nuances of SME IPOs, their implications on BSE, NSE, and the Indian stock market, it becomes apparent that retail investors may be unwittingly stepping into a minefield designed for risk-takers. In light of recent developments, particularly the BSE’s deferment of Trafiksol ITS Technologies’ listing, it’s high time we revisit and analyze how this segment of the market operates, and why it demands greater scrutiny.
Over the past decade, Small and Medium Enterprise (SME) Initial Public Offerings (IPOs) have become a popular avenue for raising funds on the Indian stock market, particularly through the BSE SME and NSE Emerge platforms. These offerings have allowed SMEs to access public capital, giving investors the opportunity to invest in smaller companies with high growth potential. However, despite their growing popularity, SME IPOs come with risks that many retail investors are unaware of, particularly due to opaque practices by certain promoters and a lack of stringent regulatory oversight.
In this analysis, we explore the mechanics of SME IPOs, their rapid growth, and the dark side of these investments. We’ll also uncover how certain stakeholders manipulate these offerings, often leaving unsuspecting retail investors with heavy losses.
What Exactly is an SME IPO?
An SME IPO is a public offering of shares by small and medium-sized enterprises that seek to raise capital. These companies typically do not have the financial clout or track record to list on the main platforms of BSE and NSE. Instead, they list on SME platforms designed specifically to provide opportunities for emerging businesses.
Key Features of SME IPOs:
- Eligibility Criteria: SMEs must have a post-issue paid-up capital between Rs 1 crore and Rs 25 crore.
- Lower Compliance Requirements: Compared to large companies, SMEs have less stringent regulatory and financial disclosure requirements.
- Investment Opportunity: These IPOs present an opportunity to invest in companies with high growth potential but come with higher risks due to the nascent stage of these businesses.
The Surge in SME IPOs
The SME IPO market in India has seen rapid growth over the last 12 years. The rise of SME IPOs in India is marked by significant trends that warrant attention. The annual listings of SMEs on platforms like the BSE and NSE have increased four-fold over the last five years, from 46 in 2019-20 to 196 in FY2024. Additionally, the amount of capital raised through these IPOs has surged twelve-fold, from Rs 495 crore to Rs 6,096 crore. Currently, the market capitalization of SME companies has grown to approximately Rs 2 lakh crore.
Reasons Behind the SME IPO Boom:
- Accessible Capital: SME IPOs offer businesses a way to raise funds without going through the rigorous requirements of main-market listings.
- Speculative Opportunities: Investors are drawn to the potential for high returns. It is not uncommon for SME IPOs to be oversubscribed by several hundred times.
- Market Exuberance: The Indian market has been buoyant in recent years, fueling optimism for both small businesses and investors looking to capitalize on growth.
However, this meteoric rise comes with hidden risks. Many SME IPOs are driven by speculative trading, often led by promoters and insiders who know how to manipulate the stock prices to their advantage. While some investors make significant profits, many others—especially retail investors—lose their hard-earned money.
The Dark Side of SME IPOs:
The growth of SME IPOs has not been without controversy. As is well known in investment circles in Mumbai and Gujarat, many SME stocks are traded primarily by dummy stakeholders. These insiders, often connected to the companies, engage in stock price manipulation that artificially inflates the value of shares.
How Stakeholders Manipulate SME IPOs:
- Artificial Demand: Promoters often make optimistic corporate announcements—such as stock splits, bonus issues, or preferential allotments—that create an inflated picture of the company’s financial health.
- Insider Trading: While insider trading is illegal, in reality, it continues to occur behind the scenes. Insiders and market players have a deep understanding of when the stock will rise or fall, allowing them to profit while leaving retail investors at a disadvantage.
- Promoter Dumping: Once the stock price is inflated through artificial demand, promoters offload their shares at higher prices, causing the stock to crash once retail investors enter the market.
An SME owner from a Tier 2 city, speaking anonymously, shared, “Merchant bankers from all over India call you once you register for an SME IPO. They prepare a 3-5 year plan, showing you ways to manipulate balance sheets, and the company secretary takes care of the rest.”
Trafiksol ITS Technologies: A Case Study in SME IPO Manipulation
One of the most recent and high-profile examples of concerns surrounding SME IPOs is Trafiksol ITS Technologies Ltd., whose listing on BSE was deferred due to “unresolved queries.” The company’s IPO, which closed on September 12, 2024, was oversubscribed by 321.51 times, and shares were set to be listed on September 17.
The IPO garnered massive interest due to the company’s strong financials. Trafiksol’s profit surged from Rs 2.05 crore in FY2022 to Rs 12.09 crore in FY2024, and its revenue almost doubled over the same period. However, despite these impressive numbers, BSE raised concerns and delayed the listing.
The case of Trafiksol reflects deeper problems in the SME IPO market, where companies often manipulate their public image to attract investors. This episode also raises questions about the ability of the exchanges to detect and act on such irregularities in real-time.
Why the Deferral?
The BSE’s notice merely mentioned “certain queries” that required resolution, leaving market participants and retail investors in the dark about what exactly had gone wrong. Such vagueness only adds to the suspicion that SME IPOs may not be subjected to the same rigorous scrutiny as larger IPOs.
With the IPO size set at approximately Rs 45 crore and a price band of Rs 66-70 per share, Trafiksol appeared to be a lucrative opportunity for investors. However, the BSE’s decision suggests that something was amiss, reinforcing concerns about the transparency of SME IPOs.
Investor Interest and Over subscription
The over subscription of IPOs, such as Trafiksol’s, reflects the growing investor appetite for SME listings. In the first five months of the current financial year alone, around 108 SME companies have raised Rs 3,548.17 crore through share listings, according to Prime Database. However, this trend raises concerns about the sustainability of such high levels of investor enthusiasm.
The Hidden Risks of SME IPOs
1. Over subscription and Market Sentiment
While high over subscription rates can indicate strong demand, they can also create unrealistic expectations. Investors may feel pressured to jump on the bandwagon, neglecting to conduct thorough research on the underlying companies. This can lead to inflated stock prices and subsequent losses when the market corrects.
2. Regulatory Concerns
The lack of robust regulatory oversight in the SME segment poses significant risks. The Securities and Exchange Board of India (SEBI) has raised concerns about certain SMEs and their promoters engaging in practices that misrepresent their operational status. Such actions can artificially inflate stock prices, leaving retail investors vulnerable.
3. Market Manipulation
Many SME stocks are reportedly traded primarily among their stakeholders, raising questions about the authenticity of trading volumes. This can lead to market manipulation, where prices are artificially sustained or inflated, resulting in losses for uninformed investors.
4. Historical Precedents of Scandals
The absence of accountability in the SME IPO sector draws parallels to past scandals involving figures like Harshad Mehta and Ketan Parikh. Without identifiable scapegoats, investors may feel increasingly at risk, unsure of whom to trust in this environment.
Lurking in the Background?
While SEBI (Securities and Exchange Board of India) is the primary regulatory body for Indian capital markets, SME IPOs are somewhat of an anomaly. SEBI does not directly regulate these offerings. Instead, the responsibility falls on the stock exchanges—BSE and NSE. This fragmented regulatory oversight has allowed irregularities to slip through the cracks.
Just last month, SEBI raised concerns over SME companies and their promoters resorting to questionable practices to project a rosy picture of their operations. SEBI’s findings revealed that many SME promoters engage in corporate actions, such as bonus issues, stock splits, and preferential allotments, that artificially inflate the stock price. This creates a positive sentiment among investors, encouraging them to buy the stock, while promoters quietly offload their shares at inflated prices.
Regulatory Oversight: Is It Really Enough?
Despite the rapid growth in the number of SME IPOs, regulatory oversight remains insufficient. While the BSE and NSE are tasked with overseeing SME listings, their role in scrutinizing these IPOs has come into question. More concerning is the fact that SEBI (Securities and Exchange Board of India), the primary market regulator, is not directly involved in the regulation of SME IPOs.
Why is SEBI’s Involvement Limited?
- Limited Oversight: SEBI focuses its attention on larger IPOs and leaves much of the responsibility for monitoring SMEs to BSE and NSE.
- Overburdened Stock Exchanges: The sheer volume of SME IPOs means that stock exchanges often struggle to perform thorough audits of every company.
In a statement, SEBI warned that some SME companies and their promoters are creating an unrealistic picture of their financial health. Public announcements, stock splits, and preferential allotments often mislead investors, pushing them to buy into these companies at inflated prices. These actions create an “easy opportunity for promoters to off-load their holdings at elevated prices.”
The Dangers for Retail Investors:
“Is Investment in the Share Market Subject Only to Risk?”
One of the most concerning aspects of SME IPOs is the high risk faced by retail investors. The traditional warning that “investment in the share market is subject to market risk” seems to no longer capture the true nature of these investments. For small investors, especially those unfamiliar with the intricacies of the Indian stock market, the risk is often far greater than they anticipate.
Why SME IPOs Are Not for Small Investors:
- High Volatility: The price fluctuations of SME stocks can be extreme. While promoters and insiders often know when the stock will rise or fall, retail investors are left guessing.
- Thin Trading: Many SME stocks are thinly traded, making it difficult for investors to exit their positions without significantly affecting the stock price.
- Lack of Transparency: Companies often provide limited financial disclosures, making it difficult for investors to assess the true value of the stock.
As one investor put it, “This game is not for small investors. They should stay away from SME IPOs because the market is dominated by players who know the inside information.”
Are We Witnessing a Repeat of Past Manipulations?
The SME IPO segment in India, though filled with potential, has unfortunately become an insider’s playground. It’s an open secret that many SME stocks are traded primarily by insiders and related parties, particularly in investment hubs like Mumbai and Gujarat and other regions.. While some market players make fortunes, retail investors are often left exposed, losing their life’s savings to these manipulative tactics.
In the 1990s, the Indian stock market was rocked by the Harshad Mehta and Ketan Parikh scams, where promoters and brokers manipulated stock prices at the expense of retail investors. Today, while no one individual has been scapegoated in the SME IPO market, the risks and irregularities are eerily similar.
Despite occasional uproar in the media, regulatory bodies and the government seem to be asleep at the wheel. SME IPOs continue to be manipulated by market players, and retail investors continue to bear the brunt of these irregularities. There is a growing need for SEBI, BSE, and NSE to step up and take responsibility for ensuring that the SME IPO market remains transparent and fair.
The Need for Reform
If the Indian government and regulatory bodies aim to make the SME IPO market a viable option for investors, particularly retail participants, immediate and comprehensive reforms are essential. Here’s a detailed look at the necessary changes:
1. Increased Scrutiny
Enhanced Regulatory Oversight:
- Periodic Audits: Regulatory bodies like SEBI should mandate regular audits of SME companies, focusing on financial statements, compliance with disclosure norms, and corporate governance practices. These audits should be conducted by independent third-party firms to ensure objectivity.
- Accountability for Stock Exchanges: BSE and NSE need to be held accountable for their oversight of SME listings. This could involve the establishment of a dedicated regulatory task force within these exchanges specifically tasked with monitoring SME IPOs, ensuring adherence to compliance requirements, and addressing any irregularities swiftly.
- Real-time Monitoring: Implementation of real-time surveillance systems that track trading volumes and price movements can help identify unusual trading patterns that may indicate manipulation. This would allow regulators to take immediate action against suspicious activities.
2. Mandatory Disclosures
Comprehensive Financial Reporting:
- Detailed Financial Statements: SMEs should be required to provide detailed quarterly and annual financial statements that go beyond basic requirements. This should include cash flow statements, profit and loss accounts, and balance sheets that offer insights into operational efficiency and liquidity.
- Operational Strategies: Companies must disclose their business models, revenue generation strategies, and market positioning. This would help investors understand how the company plans to grow and navigate market challenges.
- Risk Factors: SMEs should be obligated to present a comprehensive list of risks, including market competition, regulatory changes, and internal operational challenges. This would equip investors with the necessary information to make informed decisions.
- Related Party Transactions: Disclosure of transactions with related parties should be mandatory. This will help investors identify potential conflicts of interest and assess the integrity of the company’s financial practices.
3. Educational Initiatives
Investor Education Programs:
- Workshops and Webinars: Regulatory bodies and exchanges should organize regular workshops and webinars focused on educating investors about the nuances of SME IPOs. These programs could cover topics such as market dynamics, understanding financial statements, and recognizing red flags in company disclosures.
- Online Resource Centers: Establishment of dedicated online platforms where investors can access educational materials, articles, and case studies about the SME IPO market. This could include tutorials on identifying market manipulation tactics commonly used by insiders.
- Collaboration with Educational Institutions: Partnerships with universities and business schools to develop curricula focused on financial literacy, investment strategies, and understanding the risks associated with investing in SME IPOs.
- Public Awareness Campaigns: Launch campaigns through various media outlets to inform potential investors about the risks and characteristics of SME investments. This should include stories of both success and cautionary tales to paint a balanced picture.
4. Strengthening Regulatory Framework
Clear Guidelines for Market Conduct:
- Insider Trading Regulations: Strengthening existing laws regarding insider trading, making it more difficult for insiders to exploit non-public information for personal gain. This could involve harsher penalties for violations and improved mechanisms for reporting suspicious activities.
- Corporate Governance Standards: Establishing minimum corporate governance standards for SMEs that align with larger companies. This includes the formation of audit committees, independent directors, and transparent shareholder meetings.
5. Engaging Stakeholders
Involvement of All Market Players:
- Industry Consultations: Regulators should conduct regular consultations with stakeholders including SMEs, merchant bankers, investors, and academic experts to gather insights and feedback on proposed regulations and market practices.
- Creating a Grievance Redressal Mechanism: A dedicated platform where investors can report grievances related to SME IPOs and market manipulation. Quick resolutions to these complaints can foster investor confidence and accountability.
Conclusion: The Future of SME IPOs and Investor Protection
The rapid rise of SME IPOs in India presents both opportunities and challenges. While these offerings have enabled small and medium enterprises to access capital and fuel growth, they have also exposed significant regulatory gaps that need to be addressed. The lack of transparency, coupled with the manipulative practices of certain promoters and insiders, poses a significant risk to retail investors.
If reforms aren’t implemented soon, the SME IPO space risks losing the trust of the very people it claims to serve—small, retail investors. For now, it’s better for the small investor to steer clear of SME IPOs. As it stands, investment in the Indian share market isn’t just subject to market risk; it’s subject to insider risk, where the small guy is almost guaranteed to lose.
For the Indian stock market to maintain its integrity, regulatory bodies must take a more proactive role in monitoring SME IPOs. SEBI needs to get more involved, and BSE and NSE must tighten their auditing processes. Until these changes are made, investors should approach SME IPOs with caution, fully aware of the risks involved. Investment in the Indian stock market should come with the warning: “Investment in SME IPOs is subject to high risk.”
References:
Disclaimer: The opinions expressed in this article are based on my personal observations, discussions, and readings. I am not a stock market expert, nor do I have any financial interests in any large or small company. This article is intended solely for informational purposes and reflects my individual perspective. I do not intend to blame any regulators, governance bodies, or the exchanges, but I urge them to reflect on their roles in safeguarding the interests of retail investors.
For more insights on SME, Startup and Businesses, visit BharatiyaMedia.com. For editorial inquiries, email sharma.maayank@yahoo.com, and for advertisements and other enquiries, contact us at contact@entrepreneur.org.in.
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