The Securities and Exchange Board of India (Sebi) has unveiled a new set of regulations designed to tighten the framework for small and medium enterprise (SME) initial public offerings (IPOs). These measures introduce a profitability criterion and impose a 20% cap on offer-for-sale (OFS) components. This initiative aims to bolster investor protection while providing well-performing SMEs a platform to raise essential capital from the public.

Stricter Profitability Requirements for SME IPOs

Under the new regulations, SMEs aspiring to launch an IPO must demonstrate a minimum operating profit—specifically, earnings before interest, depreciation, and tax (EBITDA)—of ₹1 crore for at least two out of the last three financial years. This requirement ensures that only financially sound enterprises can access public funds, enhancing the overall health of the market.

Capping Offer-for-Sale Components

Sebi has also limited the OFS segment in SME IPOs to 20% of the total issue size. Additionally, it prohibits selling shareholders from unloading more than 50% of their existing stakes. This measure aims to create a more stable investment environment and minimize potential volatility during the IPO process.

Lock-in Period for Promoters’ Shares

To further safeguard investors, Sebi has introduced a phased lock-in period for promoters’ shareholdings. After one year, 50% of the excess shares will be released, while the remaining shares will be unlocked after two years. This gradual release is designed to prevent sudden market fluctuations and encourage long-term investment strategies.

Equal Treatment for Non-Institutional Investors

The allocation methodology for non-institutional investors (NIIs) in SME IPOs will now mirror that of main-board IPOs, fostering uniformity across the board. This change is expected to enhance transparency and fairness in the distribution of shares among various investor classes.

Increased Minimum Application Size

To curb speculative investments, Sebi has raised the minimum application size for SME IPOs to two lots. This change aims to protect retail investors from making impulsive decisions based on short-term price movements. “Such measures will safeguard less experienced investors who may be swayed by rapidly rising share prices,” explains Makarand M Joshi, founder and partner at corporate compliance firm MMJC and Associates.

Allocation Limits for Corporate Purposes

Sebi has set a cap of 15% of the total issue size or ₹10 crore, whichever is lower, for allocations designated for general corporate purposes (GCP). Additionally, the use of IPO proceeds to repay loans from promoters or related parties is strictly prohibited. This ensures that funds raised through the IPO are directed toward genuine business expansion rather than settling debts.

Public Participation in the IPO Process

The Draft Red Herring Prospectus (DRHP) for SME IPOs will now undergo a public comment period of 21 days. Issuers must publish announcements in newspapers and provide a QR code for easy access to the DRHP. This initiative will enhance transparency, allowing the public to voice their opinions and concerns regarding upcoming SME IPOs.

Continued Growth of SMEs in the Market

Interestingly, despite these new regulations, SMEs are still permitted to raise funds through further issues without transitioning to the main board, as long as they adhere to the existing Sebi (LODR) regulations applicable to larger entities. In 2024, approximately 240 SMEs managed to raise over ₹8,700 crore, nearly doubling the ₹4,686 crore raised in 2023, as reported by primedatabase.com.

These strategic regulatory changes by Sebi are set to reshape the landscape for SME IPOs in India, ensuring that only robust and financially sound enterprises can tap into public investment while simultaneously protecting the interests of investors.