IPOs from small and medium enterprises (SMEs) have started attracting increased attention of investors and superlative returns of some fresh listings like Ice Make Refrigeration, Jash Engineering and Share India Securities have brought this often neglected part of the market in attention span. It is clearly visible in the way SME IPOs in India are getting oversubscribed. Noteworthy, it is not just retail investors who are getting interested in this section of the market, even financial institutions are seen applying for some of these public offers.
Without a doubt, the success of SME IPOs is not a fluke and needs closer attention and study. Nevertheless, it is in times like this when investors tend to go overboard and end up getting into something they regret later. It is, therefore, important to understand the potential downside of SME IPOs before taking the plunge. Here are some key points regarding the differences between mainboard and SME IPOs:
SMEs are usually very early in their lifestages when they hit the primary markets. This means that investors get a chance to pick potential multibaggers fairly early in SME IPOs but this seeming advantage comes with the inherent downside of losing money in offers where fundamentals aren’t strong or business deteriorates in future. Needless to say, this is a risky combination and represents a double-edged sword.
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Big application and lot size
SME IPOs typically involve applications in excess of INR100,000 which is quite high when compared to INR14,000-15,000 for mainboard IPOs. This high entry barrier is not just limited to initial allotment of shares but is also applicable during subsequent trading in these shares. For example, an SME IPO with a bid lot of 2,000 shares will retain this lot size and investors can only trade in the multiples of this lot size.
In other words, an investor cannot buy or sell in fractions of lot size which makes these stocks highly illiquid. This is different from mainboard IPOs where the concept of lot size is limited to primary market only and subsequent trading can happen in multiples of one share.
SEBI not in picture
Unlike IPOs on the mainboard exchanges where market regulator SEBI plays an active role right from vetting prospectus to give observations, SME IPOs are mostly managed by stock exchanges. As such, draft prospectus of an SME IPO candidate is not examined by SEBI.
The sole responsibility of examining and approving the IPO is on the relevant stock exchange. “The Equity Shares offered in the Issue have not been recommended or approved by SEBI, nor does SEBI guarantee the accuracy or adequacy of this Prospectus,” is a common line one can find in the filings of SME.
Different rules about profitability
SME IPO hopefuls are required to show profitability in at least two of the immediately preceding three financial years with each year being a period of at least 12 months. If this condition is not met, the company’s net-worth shall be at least INR3 crore. The requirement for mainboard aspirants is stringent and SEBI needs companies to have a minimum of INR15 crore in average pre-tax operating profit in at least three years of the immediately preceding five years.
Net Worth requirements
SEBI requires mainboard IPO companies to have a net worth of at least INR1 crore in each of the preceding three full years but the requirement for SMEs is INR1 crore as per the latest audited financial results.
SME IPOs need to be underwritten
SME IPOs are required to be 100% underwritten which is not the case with their mainboard counterparts.
Risky but retail investors are welcome
Above mentioned points make it amply clear that SME IPOs are only meant for investors with high risk appetite. Nevertheless, SME IPOs aim to allot at least 50% of the shares to retail investors. In case of healthy demand (as it is these days), more allotment may be made.
This is a radically different scenario from mainboard IPOs where retail investors get maximum 35% in the case of companies with profitable track record. On main exchanges, companies with profitability of less than three years in the last five years are considered risky and retail investors exposure is limited to just 10% in such cases.
All in all, SME IPOs tend to not only entail a higher element of risk in absence of stringent disclosures and profitability requirements but also present a real possibility of investors getting stuck with illiquid stocks. The double whammy in case of SME IPOs is that investors can get trapped with high amount of capital if sentiments change post listing. If not more, we are talking about at least INR100,000.
Capital perseveration is one of the very first principles in wealth creation and should not be overlooked at any cost. One might get a feeling of being left out while looking at SME counters after listing but let’s not forget that no one loses anything by forgoing paper profits.
By no means this article is to discourage investors or drive them away from SME IPOs. It is rather an effort to show a clear picture of potential downside. Eventually, everything boils down to comfort levels. If you are fine with big lot size and limited liquidity in SME stocks, may the force be with you.