Why and how should SMBs plan to take the IPO route

Over the past few decades, several factors such as a vibrant business ecosystem, encouraging government schemes and incentives, globalisation and exposure to vast geographical markets, availability of funds from banks and financial institutions, and more importantly - the passion and drive of Indian entrepreneurs - have contributed to the growth of SMBs in India. 

SMEs have emerged as a critical component of the economy, with significant contribution to economic development. 

That said, certain events, regulations, and COVID-19 have driven some MSMEs out of business across the world, particularly in emerging economies like India. The ability to raise funds is arguably the top factor that facilitates the continuity and growth of SMBs through investments in growth drivers such as technology, expansion, innovation, and research. This is so in normal as well as adverse conditions. The lack of access to capital makes it difficult for MSMEs to survive and scale.

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Options for raising capital

The two routes for companies to raise funds, in broad terms, are debt and equity. Despite various MSME schemes initiated by the government in India to make the availability of finance easy and cheaper, things have not been easy. 

The optimal capital structure - the composition of equity and debt - depends on multiple factors that include the type of industry and the size of the company. Nevertheless, equity capital is inevitable for any company for financial balancing reasons such as cost of capital, repayment obligation, restriction on follow-up capital raise, collateral requirements, etc. Debt and equity play a complementary role in the financial structure of a company. 

Equity funds are available to the companies through their internal accruals, sources of funds or from friends, family, venture capitalists, and private equity funds. While the above sources are leveraged in the initial stages of a company, IPO starts a new stage in its funding journey. Some of the reasons why a company decides to pursue an IPO route are: 

It helps companies raise a large amount of funds, otherwise not feasible, at a relatively cheaper cost.

• Existing investors can become shareholders of the company, making their investment more liquid and profitable.

• Going public provides companies with a huge amount of publicity and boosts market presence.

• Credibility of the company is enhanced because of the stringent conditions, including SEBI regulations, it has to comply with pre and post-IPO.

IPO is arguably the best option for raising equity capital for an emerging company. However, it was not easy for MSMEs to raise public funds through IPO because of restrictive regulations, apprehension of public issue failure, and lack of support, etc. 

In India, a new ministry named MSME was founded in its current form in 2007 to address issues faced by SMBs, including funding and other key matters.  

The need for an SME exchange

Indian regulators recognised the importance of equity capital for MSMEs and the fact that it would need a level-playing ground for them to compete for capital with large enterprises. SMBs needed a financial ecosystem that could provide opportunities and platforms to raise equity capital.

MSME schemes could facilitate debt financing for MSMEs to an extent, but public funding was still very remote for them. India’s market regulator, SEBI, developed a framework to permit setting up a dedicated stock exchange for SMEs, with favourable criteria and conditions to make it easy for MSMEs to go public.

Launch of SME platform

Prior to establishing SME platforms, any company that planned to go public through IPO had to meet certain basic criteria as per the SEBI guidelines. Most MSMEs found it difficult to meet these requirements and to solve this dilemma, SEBI came up with a framework that got finalised in 2012 and stipulated criteria that make SME IPO easy.

Following these guidelines, the BSE launched its SME platform - BSE SME - in 2012 after which NSE launched its SME platform – Emerge - in the same year. 

The SME Exchange is meant for companies that wish to raise equity capital and have them listed and traded on a recognised stock exchange in India, and cannot meet the criteria for a main board listing. The listing norms are specifically established to suit small and medium companies. 

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Migration to main board

The share of MSMEs that migrated from SME platforms to main boards of BSE and NSE  currently stands at 33 percent and 34.8 percent respectively. This shows an encouraging trend to indicate that the many MSMEs that went public through SME IPO listing grew to a level that allowed them to migrate to main board. We will take a look at the criteria for such migration to understand the level of companies post-SME IPO.

• SME listed companies whose post-issue face value capital is more than Rs 10 crore and up to Rs 25 crore may migrate to the main board after completion of two years from the date of SME listing; and
• Where the post-issue face value capital of a company listed on the SME Exchange is likely to increase beyond Rs 25 crore, it will have to mandatorily migrate to the main board/platform of the stock exchange.

The bottom line

According to the latest BSE SME data, SMEs listed so far have raised Rs 3,630 crore and have a combined market cap of Rs 36,005 crore. There are 231 companies listed currently with a market cap of Rs 13,410 crore. In nearly a decade, 345 SMEs have got listed on the BSE SME platform while 221 SMEs have been on the NSE Emerge platform.

The above statistics, along the fact that more companies have been listed on the SME platform than on the main board since the former’s launch, shows the growing confidence of MSMEs in the SME IPO and listing. SMBs must examine critically what should be their optimal capital structure based on the cost of capital, the quantum of funds required, post-IPO valuation, etc, to know the timing, issue value, premium, etc, before deciding on going IPO.

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