SMEs planning to raise funds through an IPO must comply with various regulations such as obtaining regulatory approval from SME exchange, submitting due diligence reports, complying with listing requirements, and more.
Regulatory compliance is challenging and requires promoters to keep up with the latest regulations. Also, compliance is not a one-time thing, and even after listing, SMEs have many ongoing compliance requirements to meet, such as filing financial results and more.
Let's discuss why compliance is important and explain the legal and regulatory requirements for an SME IPO. Compliance serves as a guide for a successful SME IPO process.
Why is Regulatory Compliance important for SMEs planning for IPO?
SMEs wishing to go public must comply with the applicable regulations for the following reasons;
- Compliance with legal requirements, regulations, and SME stock exchange standards
- Compliance strengthens investor confidence and trust
- It expands the company’s investor base and builds good relationships with investors.
- Compliance prevents legal consequences, litigation, and reputational damage. Non-compliance can even result in expensive fines.
- Preserves the integrity of internal business processes, protects stakeholders' interests, and ensures that the company operates ethically.
What are the Legal and Regulatory Requirements for SME IPO?
Launching a successful SME IPO requires companies to comply with various regulatory requirements.
SMEs planning to go public to raise funds for expansion must adhere to the following regulations;
1. Financial Requirements of SME Exchange to issue SME IPOs
According to the SME Exchange, all SMEs must have three years of annual financial statements audited before preparing for an IPO. Companies should also exhibit positive operating results in 2 of the last 3 financial years.
Both the BSE and NSE SME exchanges have clearly defined criteria in terms of the company’s net tangible assets, net worth, and leverage ratio. SMEs need to meet the set financial benchmark to qualify for IPO.
Check SME IPO Eligibility Criteria
SEBI Listing Requirements for SMEs
- To list on the SME platform, the company’s paid-up capital shall not be more than Rs 25 crore.
- SME IPO requires a 100% underwriting agreement with 15% of the issue to be underwritten from the merchant banker’s account.
- SME IPO has standard lot sizes ranging from 100 to 10000 shares depending upon the SME IPO price.
- SMEs seeking IPO must have at least 25% public shareholding.
- SMEs going public must have a minimum of 50 subscribers for the IPO.
2. Sound internal control mechanisms and robust corporate governance
Internal controls are the internal business processes and rules that are followed to ensure operational efficiency and compliance with laws and regulations.
Segregation of duties, restricting access to resources such as cash, inventories, etc. to the appropriate authorities, management reconciliation, and review of business transactions, etc. are the common methods of maintaining a sound internal control system.
Effective internal control and corporate governance are important, but why?
SMEs going public must have strong internal controls with clearly defined roles and reporting lines to uphold ethical principles, prevent the occurrence of fraud and errors, and ensure reliable financial reporting.
Similarly, compliance with corporate governance standards relating to independent members in the board of directors, audit committee, etc. ensures transparency within the company and also boosts confidence among investors.
3. Obtain Regulatory Approval from the SME Exchange
SMEs who are IPO ready prepare and submit Draft Red Herring Prospectus (DRHP) to the respective SME exchange to obtain in-principal approval. It works as an IPO registration document that provides a comprehensive business overview, financial results, plan of the IPO investment, utilization of fund proceeds, and more. DRHP is filled along with a due diligence report so before filing a draft prospectus, Merchant bankers conduct a comprehensive due diligence check for SMEs which includes;
- Financial Due Diligence
- Secretarial Due Diligence
- Legal Due Diligence
- Restatement of the company’s financial accounts
- Compiling important business documents
Drafting of SME IPO prospectus must follow the applicable regulations including;
- Companies Act 2013
- SEBI ICDR Regulations
- SEBI LODR Regulations
- BSE SME Listing Norms
Once the DRHP is reviewed, the exchange will issue an in-principal to the IPO issuer company.
4. SMEs must comply with Disclosure Requirements
Companies intending to issue SME IPO must disclose comprehensive business information in the IPO Prospectus. The SME Prospectus must contain a detailed disclosure of business operations, promoters & promoters group, management, company financials, capital structure, objective of IPO issue, transparent disclosure of risks associated, and full disclosure of outstanding litigation against the company.
As DRHP and RHP are available to the public thus, a comprehensive understanding of the business helps potential investors make the right investment decision.
5. Compliance with Industry-Specific Regulations
Does not matter whether you want to raise funds through an SME IPO or not, you must comply with industry-specific laws and regulations.
For example, companies must comply with Labor Laws, Health and Safety laws, Environmental Laws, Tax laws, Intellectual Property Rights, Investor Protection Laws, and more. Different regulations may apply to SMEs operating in different industries.
You must comply with all regulations to avoid legal complications, otherwise, non-compliance can lead to fines lawsuits, and reputational damage.
6. Additional Regulatory Requirements for SME IPO
- SME IPO needs 100% underwriting with 15% from the merchant banker’s account.
- SME IPO needs a market-making arrangement for a minimum of 3 years to infuse liquidity in stocks after they get listed on the exchange.
- The minimum investment amount for an SME IPO is Rs 1 lakh.
- SEBI has standardized the trading lot size for SME issues depending upon their IPO issue price.
- Even post-listing, SME stocks are traded in specified trading lots only. However, the minimum investment will vary based on the share’s market price. If the market price is lower than the offer price, say the market price is Rs 45 and the issue price is Rs 50, then given the trading lot size of 2000 shares, now the investment will be Rs 90,000.
- The company’s post-issue market capital cannot exceed Rs 25 crore, if it happens, the company will have to migrate to the mainboard exchange.
7. Ongoing Compliance Requirements after Listing on SME Exchange
Once an SME becomes a listed company, it is subject to various ongoing compliance requirements such as;
- Submission of annual reports
- Half-yearly financial results
- Material events or important corporate announcements i.e., change in director, etc.
- SME’s shareholding pattern
- Timely communication with shareholders through conducting meetings and maintaining an investor grievance redressal mechanism
Know more on SME IPO ongoing compliance
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Legal counsel provides hands-on support and guidance on SME IPO regulations and compliance, risk assessment, disclosure requirements, and spot red flags in internal processes.
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