The Securities & Exchange Board of India (Sebi) has recently cleared the way for setting up exchange/ platforms for small & medium enterprises (SMEs). Given that Indian financial markets for SMEs are agonizingly anachronistic, dominated largely by debt instruments backed by collateral, with near-absence of institutional mechanisms for raising risk capital, it is a significant development.
SMEs typically begin with a combination of their own seed capital and equity, which they arrange through friends and relatives. Roughly, only five SMEs out of a 100 are able to leverage this equity further for raising debt from banks and financial institutions. But, this arrangement works only up to a point.
For scaling up operations, or raising more fund, substantial infusion of equity is required. Also, venture capital (VC) and private equity (PE) investors, which could provide the much-needed equity, need a fair mechanism for ?exit.? Only an efficient exchange can provide these.
In the past, at least two attempts were made in creating a separate platform for small companies. In 1991-92, Over The Counter Exchange of India (OTCEI) was established to provide a trading platform for SMEs. Then, in 2005, the government had set up the Indonext platform in partnership with the Bombay Stock Exchange to provide a trading platform to companies listed on the regional stock exchanges. Whereas OTCEI was ahead of its time?before Sebi–when the equity markets were not properly regulated in India, Indonext, because of poor market making, failed to enthuse investors and generated negligible trading volumes.
Worldwide, there has been a trend towards expansion of capital markets and investment listings designed to serve the risk capital needs of SMEs. From AltX of South Africa to Mercato Expandi in Italy, more than 50 SME alternative markets are thriving globally. In India, such an exchange remains a missing link.
Experience shows erecting unassailable entry barriers to listing?which increase the cost of compliance to unrealistic levels?will hold back companies, particularly SMEs. But, if certain standards of reporting and disclosures are not enforced, investors will not come forward. This calls for a well thought out strategy for facilitating ?market making? players, bound by a set of rules that are transparent, pragmatic and rewarding. Sebi?s move strives to strike a balance between the conflicting demands.
According to Sebi stipulations, for a company to be on the SME exchange/ platform, its paid-up capital should not exceed Rs 25 crore. The moment this ceiling is crossed, the company will have to move to the main stock exchange.
Merchant bankers?existing category, not a separate one for SMEs?are to play a critical role. They will file the offer document to Sebi, underwrite the issue (100%), offload the bulk of the equity to a category of strategic investors?comprising PEs, VCs, high-net-worth individuals and qualified institutional buyers?and will keep 15% equity with themselves, besides working as ?market maker? for three years, providing buy and sell quotes.
Sebi has sought to reduce the ?entry cost? by taking several path-breaking steps. Companies applying for a listing on SME exchanges would be exempt from the eligibility norms applicable to initial and follow-on public offers. Listed SMEs can file their financial results half-yearly, instead of quarterly for other companies. Listed SMEs are required to maintain a Web site, which can be used for disclosures to reduce the cost of printing and despatch.
Since the listing norms have been ?diluted? to reduce entry barriers, to protect the retail investor, Sebi has restricted the SME exchange window to ?informed buyers?, such as VCs, PEs, HNIs and QIBs. It has also kept the minimum application size and the trading lot to Rs 1 lakh to discourage small investors.
A couple of questions are still hanging. Whereas Sebi has mentioned a minimum paid-up capital of Rs 10 crore for BSE and NSE, it is not clear what is the corresponding capital requirement for an SME exchange.
Secondly, according to Sebi, while the offer document has to be filed with it and the exchange, it is not supposed to issue any ?observation?. Would this not affect the credibility of the offer document?
Thirdly, there are loose ends concerning transfer of stocks during the market-making process and its prescriptions on takeover.
Finally, a disappointment has been the regulator?s insistence on compliance of Clause 49 (corporate governance), which includes prescriptions on the number of external directors, committees, remuneration of directors and the like. This could be put-off for a large number of potential SMEs from listing.
For all its shortcomings, the Sebi initiative is a remarkable development for the SME sector. The exchanges will help SMEs raise equity capital and build a bridge between SMEs and venture capital, by giving the latter an exit route. Further, there are invaluable externalities that a public scrutiny of SMEs will generate in the realm of governing processes and practices. It is a paradigm shift and will trigger a new phase of entrepreneurial pursuits.
The author is secretary-general, Federation of Indian Micro & Small & Medium Enterprises