Regulatory moves to address the special concerns of small and medium enterprises are welcome but their success will depend on many factors beyond the SEBI’s control.

Securities and Exchange Board of India’s move seeks to address the special needs of this vital sector in raising resources

Two recent decisions by the Securities and Exchange Board of India Board have far reaching implications for the capital market. One of these seeks to address the special concerns of small and medium enterprises (SMEs) in raising resources. The second decision allows the auctioning of shares in a public issue subject to certain conditions.

The common problems faced by SMEs in raising resources are well known and begin with the initial public offer itself. As a share offering by a medium enterprise cannot obviously be large, the high issue expenses become particularly burdensome. Certain pre and post issue expenses are fixed in nature and do not vary with the issue size. Whether an IPO is for Rs. 1 crore or Rs. 100 crore, expenses under certain heads such as advertisement, travel or stationery will be almost the same.

In fact a smaller company may have to spend proportionately more on advertising and publicity to gain ‘visibility’. The point is SMEs face relatively high entry barriers to the capital market. Even after listing a smaller company’s stock will more likely be illiquid. Merchant bankers, who generally get their fees as a percentage of the issue size, are naturally less enamoured of the SME business. There have been other reasons as well for policy to aim at facilitating capital market entry for SMEs. Banks will remain the traditional source of funds for them but a stock exchange listing is desirable and sometimes even necessary. Whenever small enterprises receive venture capital or any other form of equity support including from State government organisations a listing helps in the exit of these investors later. A stock market quotation, in any case, is an invaluable benchmark.

SEBI’s bold initiative

Policy makers, alive to the special needs of SMEs, have tried to simplify the procedural requirements, thereby reducing certain costs. The preferred route has been to create a niche market or a separate exchange for them. The OTC Exchange of India (OTCEI) set up in 1990 was the first exchange to deal exclusively with smaller sized companies. It had as its twin objectives helping smaller companies raise capital in a cost effective manner and providing the investors with an efficient and transparent method of trade. The OTCEI has been a pioneer in introducing screen-based trading and market making. Yet it failed to take off probably because it was ahead of its time.

SEBI is now addressing the issue by exempting companies listed on the SME exchanges from eligibility norms applicable for IPOs. SME companies for the purpose of these new regulations will have a paid-up capital of not more than Rs. 25 crore. They can list on the main boards of NSE/BSE with a minimum paid-up capital of Rs. 10 crore. In what is by far the most noteworthy of the current measures, the minimum IPO application size will be Rs. 1 lakh. This way the regulator hopes to have informed financially sound and well-researched investors with some risk taking ability. Yet the high minimum requirement will shut out many small investors. It will also reduce the number of shareholders. How far that will impact on liquidity of the company’s stock remains to be seen.

Merchant bankers have been given special responsibility in market making (for a minimum period of three years) and underwriting the issue. Guidelines have been laid down for procedures to be followed when the paid-up capital of the listed company exceeds Rs. 25 crore and when an investor’s holding falls below Rs. 1 lakh.

It remains to be seen whether SMEs and the capital market intermediaries will be sufficiently enthused by the new measures.

Will a potential investor who is not averse to capital market investment be attracted to an SME issue in preference to other market instruments?

The decision to permit auctions as an additional method of book building in public issues is welcome. Bidders would be free to bid at any price above the floor price. Allotments will be top down, that is, the highest bidder will first get the shares. Obviously shares will be allotted at different prices. Retail investors will be allotted at the floor price.

Two advantages are claimed for this method. One, it will help the issuer get a higher price for its shares as there is no upper price band. At the same time, retail investors will get shares at the lower floor price. Two, there will be no oversubscription. In traditional book building, because of uncertainty of firm allotments, institutional investors make large applications to stand a better chance of getting allotments. In book-building, shares are allotted proportionately.

On the flip side, the auction method can trigger what is known as a ‘winner’s curse’, a scenario in which certain investors bid recklessly high.

It is also possible that the relatively uninformed investors will be the winners in the auction.

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