SEBI Mandates Profitability for SMEs IPOs: A New Era of Transparency and Investor Protection

Posted On - 19 March, 2025 • By - Aurelia Menezes

The Securities and Exchange Board of India (“SEBI”) with an aim to increase transparency, safeguard investor interests, and harmonize Small and Medium Enterprise (“SME”) listing criteria with general market standards, has implemented stringent regulatory adjustments for SME Initial Public Offerings (“IPO”). The establishment of a profitability criteria for SMEs seeking to raise money through the IPO route is one of the most significant changes.

Legal Basis for Regulatory Changes

SEBI, as the legal regulatory authority under the SEBI Act, 1992, is empowered to monitor the securities markets and safeguard investor interests. SME IPOs are regulated under Chapter IX of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR Regulations”). The latest amendments to these regulations have established stricter eligibility standards and improved disclosure requirements, which further strengths SEBI’s oversight over SME public listings.

Key Amendments to SME IPO Regulations

In order to strengthen the framework for public issues by SMEs and to ensure that only SMEs with a sound track record have an opportunity to raise funds from the public and get listed on stock exchanges, and to protect the interests of investors in the SMEs, the SEBI’s board approved necessary amendments to the SEBI (ICDR) Regulations, 2018 and SEBI (Listing Obligations and Disclosure Requirements ) Regulations, 2015 (“LODR Regulations”) which inter-alia includes the following[1]:

  • An issuer can only make an IPO if it has an operating profit (earnings before interest, depreciation, and tax) of at least Rs. 1 crore from operations in two out of the three preceding financial years, at the time of filing its Draft red herring prospectus (“DRHP”). This provision ensures that only financially profitable SMEs can access public markets, reducing the risk of unsustainable listings. Companies that do not meet this threshold will have to consider alternative financing mechanisms or improve financial viability before filing a prospectus.
    • The Offer for Sale (“OFS“) component in an SME IPO is now limited to 20% of the total issue size. Additionally, SEBI has provided that existing shareholders would be restricted from selling more than 50% of their pre-issue shareholding through the IPO. This restriction aims to prevent undue dilution of promoter stakes, ensuring that promoters remain committed to the company’s long-term growth post-listing. Non-compliance with these rules could lead to regulatory scrutiny, penalties, or the rejection of the IPO application by SEBI. Companies need to carefully plan their shareholding structure and the issue size to comply with the limits set.
    • Further, SEBI provides that the lock-in on promoters’ holdings that exceeds the Minimum Promoter Contribution (“MPC”) will be phased. Specifically, 50% of the promoters’ holdings above the MPC will be unlocked after 1 year, while the remaining 50% will be unlocked after a period of 2 years.[2] This phased release of promoter holdings builds investor trust by ensuring promoter accountability. Any attempt to bypass the lock-in requirement through indirect share transfers or restructuring could result in regulatory action and penalties.
    • The allocation method for Non-Institutional Investors (“NIIs”) in SME IPOs will be aligned with the methodology used for NIIs in main board IPOs.[3] This amendment removes preferential allocation practices that previously benefited specific investors. SMEs must revise their public offering documentation to reflect the updated allocation methodology.
    • The amount allocated for General Corporate Purpose (“GCP”) in an SME IPO shall be limited to 15% of the total amount raised by the issuer or Rs. 10 crores, whichever is lower. The cap is put in place to reassure investors that the funds raised are primarily being used for growth-oriented purposes, rather than for vague or unproductive corporate needs. It therefore ensures adherence to regulatory guidelines designed to safeguard investors.
    • The board approved that SMEs issues will be prohibited if the funds are intended for repaying loans from the promoter, the promoter group, or any related party, either directly or indirectly. This ensures that the funds raised through the IPO are directed toward business growth rather than internal financial restructuring. Any misrepresentation of fund utilization in the prospectus could lead to penalties under SEBI regulations and the Companies Act, 2013.
    •  The DRHP of an SME IPO, submitted to the Stock Exchanges, must be made accessible to the public for 21 days to solicit feedback along with a public notice in a newspaper. This measure promotes transparency by allowing the public to review and provide feedback before finalization of the IPO terms. Companies must adhere to all disclosure requirements, as any misstatements in the DRHP could result in regulatory action under SEBI regulations.
    • SME companies will be permitted to raise additional issues without needing to migrate to the Main Board, as long as the issuer agrees to comply with the SEBI (LODR) Regulations, 2015, in the same way that companies listed on the Main Board are required to do.
    • Related party transaction (“RPT”) regulations, applicable to the main board listed entities will now also apply to the entities listed on the SME platform. However, the threshold for classifying RPTs as material will be set at 10% of the annual consolidated turnover or Rs. 50 crores, whichever is lower.

    SEBI’s revised regulations for SME IPOs foster improved accountability, transparency, and financial discipline in the listing process. Although these rules may lead to higher compliance requirements, they also strengthen investor confidence and contribute to the integrity of the market.

    [1] Securities and Exchange Board of India Board meeting bearing Press Release Number: PR No.36/2024 dated December 18, 2024

    [2] Consultation paper on Review of SME segment framework under SEBI (ICDR) Regulations, 2018, and applicability of corporate governance provisions under SEBI (LODR) Regulations, 2015 on SME companies to strengthen pre-listing and post-listing SME provisions, Pg no 13, dated November 19,2024

    [3] Review of SME framework under SEBI (ICDR) Regulations, 2018, and applicability of corporate governance provisions under SEBI (LODR) Regulations, 2015 on SME companies, Pg no 5.

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