Listing on the SME Stock Exchange is undoubtedly a significant milestone for SMEs, but going public is not easy, subject to various challenges. Not only the legal and regulatory complexities surrounding the SME IPO process pose challenges for SMEs, but the dynamic market environment, internal corporate governance issues, compliance and disclosure requirements, and even post-listing norms are the key obstacles for SMEs.
Are you a founder of an SME and planning to take your company public? If yes, you need to be aware of the challenges and risks that may come up ahead. While these challenges are inevitable, if you follow the right path and strategy, you can effectively manage the associated risks.
Potential Challenges and Risk Mitigation Strategy during SME IPO Listing Process
1. Regulatory Compliance – The biggest challenge for SMEs
SME promoters planning to go public, the first thing that comes to their mind is compliance with rules and regulations. SME IPO process requires companies to comply with regulatory standards specified by SEBI, SME exchange (NSE SME or BSE SME), and Companies Act.
What are the key regulatory and compliance requirements for SMEs?
- Paid-up capital of the SME cannot go beyond Rs 25 crore
- SMEs preparing for IPO must have a minimum 25% public shareholding.
- SME must be operational for at least 3 years and should be profitable (operating profit) in any 2 out of the last 3 years.
- SME IPO must be fully (100%) underwritten
- SME public issue must have at least 50 allottees.
- Market making for a minimum of 3 years after listing on SME exchange
- Other criteria, includes having audited financial statements, positive net worth, no regulatory misconduct or violation, etc.
- SMEs going public are subject to certain disclosure norms and standards, respect to financial reporting, required disclosures, corporate governance and internal accounting compliance, etc.
SMEs must comply with applicable regulations and norms throughout the SME IPO journey, i.e., compliance with due diligence, filing prospectus, getting exchange approval, and more. Non-compliance with regulatory standards can lead to severe penalties and halt brand reputation.
How to ensure regulatory compliance?
The best way to adhere to regulations is by seeking expert professional assistance. Merchant banker/s assist the issuer companies to comply with due diligence and regulations. SME owners can also hire professionals, including legal and financial advisors to get expert assistance in necessary documentation and other compliance matters.
2. Financial Reporting Challenges
Every publicly traded SME has to maintain a high level of financial transparency for true and reliable financial reporting.
Listed SMEs have to submit their half-yearly financial results and audited annual statements to the designated exchange, which requires companies to ensure effective and detailed financial reporting.
Even, financial reporting should not be the focus area only in the event of an IPO, but it should be in the DNA of every business from the moment it is established.
How to maintain correct financial reporting?
Ensure robust internal accounting and financial reporting mechanisms. Also, regular audits - interim audits and annual audits should be done to identify red flags in advance.
Hire a financial management expert or financial consultant to get expert advice to streamline the internal processes. So each and every business transaction should be recorded properly in books to represent true financial results.
3. The cost of SME IPO issue is another worry
The high cost associated with the SME IPO issue process is another concern of SMEs. The process of going public and listing on the SME exchange has many expenditures associated.
The issuer company incurs costs on underwriting fees, merchant banker fees, market maker fees, auditor fees, legal expenses, initial listing fees, annual listing fees, and ongoing compliance expenditures. Additional costs include expenditures in preparing documentation, marketing and advertising expenses, promotional activities, roadshows, traveling, etc.
SMEs before IPO must carefully examine whether they have sufficient funds and financial resources available to manage the cost or not.
How to manage SME IPO issue cost?
The issuer company with professionals should draft a budget outlining the possible expenditures on various IPO activities. Once done, the company should explore various funding options available to pay off the IPO front-loaded expenditures.
4. Market Timing: Is it the right time for you to go public?
The market is volatile in nature and timing an IPO is of huge importance. When an IPO is launched in a negative market, it adversely affects public demand, investors’ sentiments, IPO subscription, and ultimately the IPO listing success.
How to time the IPO?
A thorough market research must be done to navigate market fluctuation is important. The issuer company with merchant bankers must analyze the prevailing market situations, economic environment, and investors' sentiments to find a suitable time for the SME IPO. Avoiding going public in an unfavorable market can be beneficial.
Even after securities get listed on the exchange, market fluctuations affect SMEs' share prices significantly. Thus, SMEs need to be well-prepared for the market's ups and downs.
5. Investor Demand and Investor Relationship Management
How well an SME receives investors’ responses is another risk.
A well-managed growth promising SMEs are able to attract investors to participate in the IPO while companies who do not receive good public response face challenges of lower valuation. To drive demand for the public issue, merchant banker brings in their valuable connections, conduct roadshows, and meet with investors to showcase SME business potential to investors.
Even post-SME listing, Proactive engagement with investors is critical. Companies have to maintain transparent communication with investors. In this regard, listed SMEs must provide investors with regular updates and foster open communication.
6. Post-listing challenges for SMEs
- Publicly traded companies come under regulatory scrutiny and, many private companies do not go public because of the necessity to disclose their financial results to the SME exchange and public.
- Liquidity challenges: SME shares are less traded than mainboard companies, so liquidity remains a big challenge. SEBI regulations require every listed SME to have market makers for at least 3 years to maintain liquidity in SME stocks.
- Listed SMEs are analyzed by different parties – investors, analysts, and regulators. So, an increased level of analyst coverage is another challenge for them.
- Pressure to meet market expectations, yes, public companies may feel pressure to show profitability performance according to the investors’ expectations.
Wrapping up
SMEs face many challenges when going public, and to deal with them, the right approach and planning are important. Strengthening corporate governance, maintaining transparency in SME operations and financial reporting, engaging expert advisors and consultants, and regular communication with investors are the ways to overcome these hurdles.
