The Securities and Exchange Board of India (SEBI) has introduced stricter regulations for SME IPOs to enhance investor protection and market stability. These new rules focus on profitability requirements, promoter shareholding restrictions, and tighter controls on fund utilization to ensure only financially sound companies access public markets.

Stricter Profitability Criteria for SME IPOs

To strengthen the quality of SME listings, SEBI now requires that small and medium enterprises (SMEs) must have recorded an operating profit (EBITDA) of at least ₹1 crore in two of the last three financial years. This threshold ensures that only companies with a sustainable business model and financial viability can raise funds through an IPO.

Previously, SMEs with weak profit margins or inconsistent earnings could still go public, often leading to heightened investment risks. By enforcing this profitability benchmark, SEBI aims to protect retail investors from volatile IPOs while fostering long-term capital market stability.

For instance, in 2023, several SME IPOs witnessed extreme volatility due to weak financials, causing concerns about speculative trading. With the new regulations in place, only businesses with resilient earnings and growth potential will qualify for SME listings, enhancing investor confidence.

New Restrictions on Offer-for-Sale (OFS) to Curb Excessive Promoter Exits

SEBI has introduced a cap on the offer-for-sale (OFS) component in SME IPOs, limiting it to 20% of the total issue size. This measure is designed to prevent excessive share dilution by promoters and early investors, ensuring that IPOs are primarily used for business expansion rather than just an exit strategy.

Previously, some SME IPOs were structured to offer large portions of shares from existing investors, often leading to reduced promoter commitment post-listing. By restricting OFS participation, SEBI ensures that promoters remain invested in their companies for sustainable growth.

The move also aims to discourage speculative IPOs that prioritize promoter exits over long-term company performance. With this revision, retail and institutional investors can participate in SME IPOs with greater confidence, knowing that the company’s leadership remains aligned with its future success.

New Lock-In Periods for Promoters and Stricter Fund Utilization Rules

SEBI has also tightened regulations around promoter shareholding and fund utilization to ensure long-term commitment and transparency in SME IPOs. Under the new framework, promoters are required to retain at least 50% of their holdings, which will be subject to a phased lock-in period. This means that only half of the locked-in shares can be sold after one year, with the remaining portion available for sale after two years. This regulatory change addresses concerns over promoter exits that might destabilize stock prices post-listing.

In the past, some SME promoters took advantage of lenient exit provisions, leading to sharp declines in newly listed stocks. By enforcing these phased restrictions, SEBI aims to reassure investors that promoters will remain committed to the company’s long-term growth. This helps in aligning management interests with those of public shareholders, reducing speculative trading and enhancing overall market stability.

Another significant regulatory shift involves the tighter restrictions on IPO fund utilization. Companies can no longer use funds raised through IPOs to repay loans taken from promoters, directors, or related parties. This rule is designed to prevent misuse of public money and ensure that capital raised from investors is directed toward business expansion, R&D, and operational improvements.

For example, several SME IPOs in previous years faced scrutiny for utilizing raised capital to clear debts owed to their own leadership rather than reinvesting in the business. With the new guardrails in place, SEBI ensures enhanced corporate governance and investor protection, making the SME IPO market more transparent and reliable.

How These Changes Impact the SME IPO Market

The impact of these regulations is already visible in recent SME IPO trends. Previously, many individual and institutional investors aggressively subscribed to SME offerings, with some IPOs witnessing extreme oversubscription levels of over 2000 times. However, since the implementation of SEBI’s stricter regulations, subscription figures have moderated significantly. The highest subscription for an SME IPO in the past two months was just 44 times, reflecting a shift toward more cautious and informed investor participation.

This recalibration in demand signals a transition from speculative IPO frenzies to a more carefully curated market where financially robust SMEs drive sustainable growth. While some companies may find it more challenging to go public under these new rules, those that qualify will likely attract long-term investors who value stability and compliance.

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