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SMEs: Too risky for banks but not retail investors?

It'sa season of bad initial public offers (IPOs). If not for promoters, definitely for subscribers. Most IPOs have tanked within the first few days of listing after rising for a day or two.

Now, there are rumors that PG Electroplast, a recently listed company could be investigated by market regulator, Sebi, for rigging prices in the share market.

With IPOs as small as Rs 50-60 crore failing miserably, it is getting increasingly doubtful how the exchange for small and medium enterprises (SMEs) would possibly work. The BSE, NSE and the MCX have all been gung ho about an SME exchange where small and medium-sized firms could raise funds. Lakshman Gugulothu, chief executive officer at BSE SME Exchange, told Financial Express that he expects at least 200 small and medium-sized firms to be listed on the exchange in the next two years. By the end of this year, 50 companies should be on the bourses, starting initially with around 10-15 IPOs.

That is ambitious and well meaning. But what does it mean for a retail investor? Should he risk investing in an IPO of a small company?

Financial risk

 SMEs: Too risky for banks but not retail investors?

An SME needs most of its fund for research and innovation and might not have the right credit history to be worthy of institutional credit. AFP

An SME needs most of its fund for research and innovation and might not have the right credit history to be worthy of institutional credit. Moreover, banks are not ready to give them loans for what they feel is too risky. So this risk will now be relegated to those subscribing for the primary issue. It can be argued, as some experts did in a seminar held by Federation of Indian Chambers of Commerce and Industry (Ficci) last month in Mumbai, that an investor is anyway putting in risk capital in the market. But here is a company which is not exactly taking capital to build assets. And their effort at innovation have high chances of not resulting into any sort of capital formation. There is also a chance that the business fails after raising public money.

Issue of Corporate Governance

SMEs are very small companies which do not have independent directors on board. One is still not sure how a small entrepreneur will accept the idea of including too many people on board and receiving too many ideas, hampering his own independence. In that case how such companies will be monitored in terms of performance or governance is difficult to gauge.

Less stringent listing norms

The SME listing norms are also much less stringent than for bigger companies. SMEs have to get their offer documents reviewed only by the relevant stock exchange and not by Securities Exchange Board of India (Sebi). They will disclose half-yearly results instead of quarterly results, and it will not be mandatory for them to publish results in newspapers. All of this is aimed at making the process easier for small companies which might not have the expertise to comply with very stringent norms. Fewer disclosures would mean even less information for the market.

Poor liquidity

There is another issue: poor liquidity, which prevents investors from buying and selling stocks when they want. To improve liquidity all issues will be 100 percent underwritten. Merchant bankers themselves will underwrite 15 percent of the issue. They will also undertake the responsibility of market making (buying if investors want to sell and selling if investors opt to buy) to ensure adequate liquidity.

Though a scrip will have a maximum of 5 market makers, they will compete with each other to ensure better price discovery, says the BSE website while listing down guidelines for SME listing. A market maker will have the option to deregister with a month's notice to the exchange.

But as explained, risks are plenty for a small investor as few disclosures means less transparency. Hence small retail investors with limited capital and risk appetite should ideally wait till a few initial listings are over. They would best look closely and carefully before they leap!

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Updated Date: Dec 20, 2014 14:56:41 IST