Factors to check before subscribing for SME IPO

In India, BSE and NSE SME Index is a popular fund-raising platform for small and medium-sized enterprises through issuing IPO. In recent years, SME IPOs are gaining traction with increased participation from investors which is evident in the top-quality SME IPOs subscription figures. Not just retail investors are interested in the SME segment but also qualified investors like financial institutions are also applying for emerging startups.

However, investment in SME IPOs is risky as these companies are at the initial stages of growth. Further, given the higher minimum ticket size worth Rs 100,000, prospective investors must check their risk appetite and take extra care while subscribing to a SME IPO. Look at the top 5 key factors everyone must check before applying for SME IPO.

Investor’s Risk Appetite

SMEs or small and medium companies looking to raise capital for funding their future growth through the IPO route are considered risky. These companies are small in size, and at the early stage of growth, thus, subject to higher market risk. Additionally, unlike regular IPOs, SME IPO offer documents (DRHP and Prospectus) are not vetted by SEBI, as they only need the exchange’s approval.

If you are a potential SME IPO investor, firstly, you must check your risk appetite and apply if you have a high-risk tolerance capacity. Betting on a quality SME stock can even turn into a loss on listing based on poor subscription, market conditions, and negative investors’ sentiments. Therefore, SME IPOs are recommended to patient investors to realize good gains in the medium to the long-term investment horizon.

SME’s Financial Performance

Although the SME IPO eligibility criteria at BSE and NSE require startups to have positive earnings or profitability for at least 1 and 2 years respectively out of the last 3 financial years, it still makes sense for prospective investors to review the company’s fundamentals. Entities with growing revenue, total assets base, and profitability performance over the years may be quality SME stocks to bid. It signals that the company is performing well in the market and may deliver good returns to investors.

Business Model

Not all SMEs have a unique business model, many of them are engaged in common businesses such as chemicals, logistics, hotels, entertainment, FMCG, healthcare, finance, IT, etc. Betting on any SME stock will not be a big money-spinner, as a result, many SME counters who have delivered good debut day gains may eventually fizzle out. Therefore, investors must do proper research on the company’s business model to find its uniqueness and distinctiveness before subscribing to a SME IPO.

Company’s Valuation

Given that SME IPOs are high-risk bets, it is advisable that investors must check the company’s valuations before applying. Price to earning (PE) is the most recommended metric for business valuation. If PE is unavailable due to lower profits, investors can use other metrics like the price to book value (P/B), EV to EBIT, and Market cap to sales to get a clear idea about valuation.

Investors can further compare SME stock valuation with established mainboard players in the industry to get a clear perspective about where a SME stock stands. Quality SME IPOs at fair or decent valuation and good growth potential are good to subscribe for.

SME IPO Basics

Before bidding for SME IPO, an investor must have a basic knowledge of the SME IPO issue process. BSE SME and NSE SME are the two credible capital formation marketplaces for SMEs. The SME IPO process at both these exchanges is not as stringent as main board IPOs as SEBI has provided relaxed regulatory norms for companies desirous of listing on the SME Index.

Moreover, investors must be aware of the fact that SME IPO offer documents are observed only by exchange, and SEBI's approval is not required. Further, companies listed on the SME platform publish audited financial accounts every six months compared to quarterly reporting mandatory by a mainboard company.