Differences Between SME IPOs and Regular IPOs: Risks and Considerations

When it comes to investing in an Initial Public Offering (IPO), the choice between a Small and Medium-sized Enterprises (SME) IPO and a regular IPO can be critical. This decision depends on factors such as the nature of the companies, regulatory requirements, market liquidity, and the associated risks. In this article, we will explore the key differences and risks between these two types of IPOs.

Nature of the Companies Involved

SME IPO: These IPOs are issued by small and medium-sized enterprises that are relatively newer or smaller in terms of business operations, revenue, and market presence. SMEs might be local businesses or companies with limited geographical reach, operating in niche markets. They are often in the growth or early-stage development phase and looking to raise capital to expand their operations.

Regular IPO (Main Board IPO): These IPOs involve larger, more established companies with a proven business model, significant market share, and strong revenue streams. Many of these companies are already recognized in the industry and may operate globally. They typically have a longer operating history and are more likely to have a well-established brand and market presence.

Regulatory Differences

SME IPO: The regulatory framework for SME IPOs is generally lighter in terms of compliance, disclosures, and governance. These companies are typically listed on separate platforms like the BSE SME or NSE Emerge platforms in India. The requirements for financial disclosures and public listing are less stringent, making it easier for smaller businesses to access capital markets. For example:

Post-issue paid-up capital of less than 25 crores Less rigorous eligibility criteria in terms of profitability and net worth Lower costs for listing such as fees, underwriting costs, and compliance

Regular IPO: In contrast, regular IPOs are subject to stringent regulations under market regulators like SEBI (Securities and Exchange Board of India) or the SEC (Securities and Exchange Commission in the US). Regular IPOs need to meet higher standards of corporate governance, financial performance, and disclosure to protect investors. These companies are listed on major stock exchanges such as the BSE, NSE, NYSE, or NASDAQ.

Larger paid-up capital and strong financials Higher standards for profitability, track record, and promoter credibility Greater scrutiny in the form of mandatory public disclosures, quarterly earnings, and compliance audits

Market and Liquidity

SME IPO: The SME segment is generally more illiquid compared to the main board. Since these companies are smaller, there is typically less interest from institutional investors, and trading volumes may be lower. This can lead to difficulty in buying or selling shares quickly, which may result in price volatility. Additionally, SME stocks might not attract as much analyst coverage, meaning there is less publicly available information to help investors make informed decisions.

Regular IPO: Shares listed on the main exchanges are much more liquid. These companies attract interest from large institutional investors, mutual funds, foreign institutional investors, etc., and retail investors. Due to higher trading volumes, it is easier to enter and exit positions, and prices tend to be less volatile compared to SME stocks.

Risk Profile

SME IPO: Higher Risk: SME companies are often in the growth stage, and their business models may not be fully tested or proven. This makes them inherently riskier. These companies may also be more vulnerable to market fluctuations, economic downturns, or operational challenges.

Less historical data available for analysis, making it harder to evaluate sustainable or profitable performance Volatile prices, with smaller trades potentially magnifying gains or losses Information asymmetry due to less analyst coverage and public information, making it harder for retail investors to gauge the real potential of the company

Regular IPO: Lower Risk: Regular IPO companies tend to be more stable and mature with a proven business model and established track record. While there is always risk in equity markets, these companies typically pose lower risk compared to SMEs.

Greater access to information through financial analysts and media coverage Longer history of performance that can be studied before making an investment

Listing Requirements and Compliance

SME IPO: Generally, SME companies have simplified listing requirements. For example, in India, companies must appoint a Market Maker who ensures that there is enough liquidity for the stock. Market Makers are required to maintain buy and sell orders for a specific quantity of shares which mitigates liquidity risks to some extent. The lock-in period for promoters is usually shorter for SME IPOs.

Regular IPO: Stricter compliance regulations with higher entry barriers. Promoters lock-in period is often longer to ensure stability post-IPO. For instance, the minimum lock-in period for promoters in regular IPOs may be around three years.

Investor Eligibility

SME IPO: SME IPOs may have restrictions on who can invest. Often, the minimum investment amount is higher than in regular IPOs to limit the participation to informed risk-tolerant investors. In some cases, only Qualified Institutional Buyers (QIBs) or High Net Worth Individuals (HNIs) may participate.

Regular IPO: Open to a wider range of retail, institutional, and high-net-worth investors. Retail investors can participate with smaller amounts, and there are no specific eligibility restrictions.

Risks in Applying to SME IPOs

Higher Failure Rate: Since SME companies are smaller and less proven, there is a higher chance of failure. Their limited operating history and lesser capital reserves make them more vulnerable to market downturns or internal business challenges.

Liquidity Risk: Low trading volumes can make it difficult to sell shares at the desired price. You might have to hold onto the shares for longer periods, and in times of need, it may be hard to liquidate them quickly.

Price Manipulation: Lower liquidity in SME IPOs can sometimes lead to price manipulation where a few large transactions can move the stock price significantly.

Economic Sensitivity: SMEs are more sensitive to changes in the economic environment. Factors such as inflation, interest rates, and economic downturns may disproportionately affect smaller companies.

Poor Corporate Governance: SME companies, due to their size and limited resources, may not always follow the highest standards of corporate governance, leading to management-related risks or conflicts of interest.

Conclusion

SME IPOs offer an opportunity to invest in small, high-growth potential companies at an early stage. However, they come with higher risks compared to regular IPOs, which are generally more stable and regulated. While the potential for returns can be higher in SME IPOs, they are not for everyone, especially not for risk-averse investors. Those applying to SME IPOs should be prepared for volatility, liquidity issues, and higher market risks. It’s crucial to conduct thorough due diligence and have a higher risk tolerance when investing in SME IPOs.

I hope this article helps clarify the differences between SME IPOs and regular IPOs and the associated risks. If you have any questions or feedback, please share your thoughts in the comments below.