SEBI’s New SME IPO Rules for 2024

The Securities and Exchange Board of India (SEBI) has announced a series of comprehensive measures to enhance market integrity and safeguard investors, specifically focusing on Small and Medium Enterprise (SME) Initial Public Offerings (IPOs), insider trading regulations, and merchant banking norms. These initiatives, approved on December 18, 2024, are designed to create a more transparent and robust ecosystem for SMEs while aligning them closer to the regulatory standards of mainboard IPOs.

Tighter Regulations for SME IPOs

To strengthen the financial stability of SMEs and provide a safety net for investors, SEBI has introduced stricter listing norms. The measures include:

Profitability Requirements:
- SMEs must demonstrate operating profits (“Earnings Before Interest, Tax, Depreciation, and Amortization” or EBITDA) of at least ₹1 crore in two of the three preceding financial years to be eligible for an IPO. This ensures that only financially sound SMEs enter the public market.
Cap on Promoter Offer for Sale (OFS):
- SEBI has restricted the OFS by SME promoters to 20% of their shareholding during the IPO process.
- Individual shareholders are also restricted to selling a maximum of 50% of their holdings.
- To ensure continued promoter commitment post-listing, phased lock-in periods have been introduced:
  - Half of the promoter holdings exceeding the minimum required contribution will be unlocked after one year.
  - The remaining half will be unlocked after two years.
Public Review of Draft Red Herring Prospectuses (DRHPs):
- A 21-day public review period for DRHPs has been mandated. This enables greater scrutiny and public feedback, fostering transparency.
Restrictions on Loan Repayment Using IPO Proceeds:
- SMEs are prohibited from using IPO proceeds to repay loans taken from promoters, promoter groups, or related parties. This minimizes risks associated with fund diversion.
Cap on General Corporate Purposes (GCP):
- The allocation for GCP is capped at 15% of the total raised amount or ₹10 crore, whichever is lower. This restriction ensures that funds are primarily used for growth-oriented activities rather than discretionary spending.

Revised Allocation Methodology for Non-Institutional Investors (NIIs)

SEBI has revamped the allocation process for NIIs in SME IPOs to prevent misuse and ensure equitable distribution of shares.

Previous Proportionate Allotment System:
- Under the older system, shares were allotted proportionately to NIIs based on the size of their applications. While this method ensured high participation, it also led to excessive leveraging among investors, creating risks of market mispricing.
New Draw-of-Lots System:
- The new system aligns SME IPOs with the mainboard IPO framework, wherein shares are allocated through a draw-of-lots system. This process reduces the influence of leveraged bids and ensures fairer access for all investors.

Extension of Related Party Transaction (RPT) Norms

To further align SME regulations with those of mainboard companies, SEBI has extended the RPT norms applicable to listed entities on the Main Board to SME-listed entities. Key changes include:

Material RPT Threshold:
- Transactions will be classified as material if they exceed 10% of the annual consolidated turnover or ₹50 crore, whichever is lower.
This measure strengthens corporate governance and reduces the potential for conflicts of interest in SME operations.

Enhanced Eligibility Criteria for NSE Emerge Listings

Following SEBI’s amendments to the SEBI (ICDR) Regulations, 2018, and SEBI (LODR) Regulations, 2015, the National Stock Exchange (NSE) has tightened its listing norms for SMEs on its NSE Emerge platform.

Implementation Timeline:
- The new eligibility criteria will apply to all DRHPs filed on or after December 19, 2024.
Profitability and Transparency Requirements:
- SMEs must adhere to SEBI’s profitability threshold of ₹1 crore EBITDA in two of the past three financial years.
- Public review mechanisms, restrictions on OFS, and usage caps on GCP funds are mandatory compliance requirements.

Benefits of SEBI’s Measures

Enhanced Investor Protection:
- Stricter eligibility and transparency norms ensure that investors have access to credible and financially stable SMEs.
Reduced Risk of Fund Diversion:
- Restrictions on loan repayment and caps on GCP allocations minimize the misuse of funds raised through IPOs.
Better Corporate Governance:
- Extended RPT norms and phased lock-in periods for promoters foster accountability and reduce risks associated with insider dealings.
Fairer Share Allocation:
- The draw-of-lots system for NIIs curbs excessive leveraging and promotes equitable distribution.

Conclusion

SEBI’s newly announced measures mark a significant step forward in enhancing the regulatory framework for SME IPOs in India. By focusing on profitability, transparency, and governance, these changes aim to build investor confidence while providing SMEs with a structured and credible pathway to access public markets.

The emphasis on public feedback, stricter norms for fund utilization, and the alignment of allocation methodologies with mainboard IPOs create a more equitable environment for all stakeholders. These measures, combined with NSE’s stricter eligibility criteria, are poised to elevate the Indian SME ecosystem to new heights of integrity and trustworthiness.