SME IPOs: Sebi finds 'systemic risks' with instances of diversion of funds, inflated revenue

FILE PHOTO: The logo of Securities and Exchange Board of India (SEBI) is seen on its headquarters in Mumbai, India, September 6, 2024. REUTERS/Francis Mascarenhas/File Photo

Capital market regulator Sebi's discussion paper on SME IPOs has red flagged an overwhelming increase in retail investor participation in the segment, with FY24 seeing a 245x increase in the applicant to allotted investor ratio, which was only 4x in FY22.

Sebi has raised concerns over the fact that the SME public offerings have limited presence of PE or sophisticated investors, who act as a check on an overwhelming influence of promoters in the companies. The SME listed entities are promoter-driven of family businesses, thus, have a very high concentration of promoter entities.

Read More: Sebi's SME IPO discussion paper - Key highlights 

The regulator also observed instances when revenue were inflated through circular transactions with related parties or shell companies. That's not all, some companies have also resorted to diversion of issue proceeds to related or connected parties, which has prompted Sebi to tighten oversight. In some SMEs, funds raised through IPO and Rights Issue were 'diverted' to shell companies controlled by promoters, Sebi said. The regulator mentioned that in one instance, the company booked 'fraudulent sales and purchases' through circular transactions via related parties.

"By doing so, such companies try to create a positive sentiment to induce investors into purchasing such securities," the discussion paper said. The capital market regulator has in the recent past has cracked down on such companies and passed orders against them.

The tendency to undertake related-party transactions (RPT) is overwhelming, Sebi said. It analysed the FY23 annual report disclosures of top 50 SMEs listed on BSE and NSE to conclude that 50% of the entities have been involved in RPTs of over Rs 10 crore, and 20% of them have undertaken such transactions to the tune of over Rs 50 crore. In fact, as percentage of turnover, one out of seven SMEs have undertaken RPTs of more than 50% of their consolidated turnover.

The concerns have prompted Sebi to look at the issue as a 'build up of systemic risks', in managing the funds raised by listed SMEs. "There is a need for greater scrutiny of RPTs which may be misused as instruments for fund diversion," the regulator said, adding that there are "risks relating to siphoning of funds."

Sebi's discussion paper also noted that there were two pure OFS SME IPOs in FY24, and one so far this fiscal. Since last year, there have been 52 issues with the OFS component, leading to promoters diluting stake in the companies. This, Sebi said, was not the objective of the SME platform. Hence, among the recommendations is the proposal of restriction on the OFS part of SME IPO to 20% of the issue size.