When the Over the Counter Exchange of India, or OTCEI, started in 1991, young entrepreneurs were thrilled. At last, small and medium enterprises, or SMEs, had a way to raise capital other than pleading with banks and rich relatives. Too bad it failed. Beset with poor bandwidth and dwindling participation, OTCEI was an idea ahead of its time, and now exists in name only. "It was like a brilliant airport, but with no road to take you there," says an official of the Bombay Stock Exchange, or BSE, who asked not to be named.
Among the first 80 to 90 companies to list on OTCEI was Anglo-French Drugs and Industries, a Bangalore-based maker of vitamins and antioxidants. Within six months of trading, as the number of brokers shrank drastically, so did the hopes of the promoters of Anglo-French Drugs and Industries. "Trading volumes were very small, and brokers could not generate quotes," says the company's Chairman and Managing Director, Abhay Kanoria. Trading ground to a halt and companies started moving to BSE. Anglo-French Drugs is still listed on OTCEI, though the exchange is defunct.
But now that the Securities and Exchange Board of India, or SEBI, has agreed in principle to let BSE and the National Stock Exchange set up a trading platform for SMEs, small and medium-sized companies may again get their own exchange. NSE has not yet announced plans. BSE has plans to launch an SME exchange, but is awaiting final approval from SEBI.
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So why would a new SME exchange succeed where OTCEI failed? For one, infrastructure issues such as bandwidth are no longer a problem. Secondly, market-making by merchant banks, which OTCEI pioneered - along with electronic trading - will be compulsory for three years on the BSE's platform. OTCEI required only a two-year commitment.
How it will work
On OTCEI, the shares of small companies were bought and sold through market makers, or entities that quote both buy and sell prices for a stock, and earn money from the spread between the two. These market makers were appointed by merchant bankers. But the system floundered as low trading volumes made it hard for brokers to determine share prices.
Market-making is a best practice of SME exchanges worldwide, such as London Stock Exchange's Alternative Investment Market, or AIM. "It's not available on the BSE main board, but has been introduced on the SME platform, to generate liquidity," says Lakshman Gugulothu, CEO of BSE's SME Exchange. "We're preparing a large number of BSE members to be market makers."
The BSE official quoted earlier suggests that volumes are not a big worry. "BSE trading volumes, which may have been Rs 150 crore a day in 1991, are now around Rs 2 trillion a day, so we expect better trading volumes for the SME Exchange too," he says (a trillion is 100,000 crore). BSE has pulled out all the stops to attract new companies to the SME Exchange, and also to encourage small- and mid-caps listed on its main board to switch to the new platform.
So, for instance, the listing fee for the SME Exchange will be about half that for the BSE main board. Also, compliance norms will be softer: SMEs will need to publish results electronically, and only every six months, rather than the quarterly requirement for companies listed on the main board. SMEs who want to list need not show profitability. They only need to fulfil SEBI requirements.
Any company whose post-issue capital has a face value of between Rs 50 lakh and Rs 10 crore can list on the SME Exchange. Companies with post-issue capital exceeding Rs 10 crore but less than Rs 25 crore can choose to list on either the SME Exchange or the BSE main exchange. Companies with capital of over Rs 25 crore will have to list on the main board.
Will investors bite?
SMEs are, almost by definition, companies that are not well-known. So how will they draw investors? "Larger companies typically spend three to four per cent of an issue on advertising it and as fees to merchant bankers," says Vivek Gautam, Associate Director, SPA Merchant Bankers. "But for small companies with issues of Rs 5-10 crore, the cost of merchant bankers and publicity will be higher."
| What has changed|
- When OTCEI was launched in 1991, the daily trading volume on the Bombay Stock Exchange was Rs 150 crore. Today, it is Rs 2 trillion
- OTCEI required a two-year commitment by market makers. BSE's new SME exchange will require three years
- Investors are better informed today than they were in the early 1990s
- Compliance norms are simpler for the new SME Exchange than for the BSE main board. Profi tability is not a condition for listing
The minimum application and trading lot size will be Rs 1 lakh. This is likely to attract only well-informed investors who know the promoters and the industry, and who are risktolerant. But if the BSE's exchange can do that, so can others. Jubilant Energy, an oil exploration and production company, listed on AIM because the investor base that understands this sector is wider in the UK. "And investors there understand the India story," says the company's CEO, Ajay Khandelwal.
Another challenge is that liquidity has often been an issue for hundreds of mid- and small-caps on BSE. One of the main reasons is that many SME promoters hold such a huge chunk of their company's shares that there is little left to trade. They are unwilling to dilute their stake. For example, promoters hold 75 per cent of the shares of Orient Ceramics, a company that listed on BSE in 1993. "Trading activity is scarce for our scrip," says CEO Vijay Shankar Sharma. "So we have not been able to attract institutional investors ever since we listed."
Aditya Nataraja, Investment Manager at venture capital firm Ventureast, says: "Suppose I hold 20 per cent equity in the company I invested in, and it's valued at Rs 6 crore. If I want to offload my shares on the exchange, I'll have to find enough buyers. Who's going to put a huge amount of money into a single company?"
Many SMEs have great products, but limited bandwidth in terms of their ability to manage, strategise, grow or raise funds. Many are familyowned and traditionally run, and the inflection point comes only when the next generation takes over. According to Mukul Gulati, Managing Director at Zephyr Peacock, a private equity fund which focuses on fast-growing SMEs, accounting standards are often poor. "Governance in listed companies is as poor as, and sometimes even worse than, private companies," he says.
However, Gugulothu says that going public will spur SME managements to do more. "Transparency and governance will improve manifold once the companies are listed, as they will have to adhere to SEBI guidelines," says Gugulothu. Merchant bankers' challenge
Merchant bankers will have to underwrite issues 100 per cent. Attracting subscribers will take ingenuity, because small companies have smaller budgets to publicise their issue than big corporations. The fees that merchant bankers can expect will also be smaller. "To bring out a small issue of, say, Rs 10 crore, we'd get a fee of up to two or three per cent of the issue," says Gautam of SPA Merchant Bankers. "So a fee of Rs 20-30 lakh for responsibility of Rs 10 crore looks unattractive to us."
Even so, Gugulothu is confident that merchant bankers will be interested. "Except for a few top ones, they're keen on the SME platform, and are already preparing offer documents for listing SMEs," he says.
In venture capital circles, too, there have been mixed reactions to the SME Exchange. Many venture capitalists say it would be great if companies in their portfolio were listed, as it would make exits easier. Gaurav Saraf, Director, Epiphany Ventures, says: "Anyway, we spend months to understand the company and promoter. If we invest in a company on the SME Exchange, the same level of due diligence will be required. But exits will be easier if the company is doing badly."
Others are concerned about valuations. "With small companies, there are balance-sheet concerns," says Nataraja. "They have a lot of revenues under accounts receivable. They may have no assets, and no brand value. How will such companies be valued on the exchange?"
Some are not even sure whether early exits are a realistic expectation, at least for early-stage investors. "I must remain on board the company for five to seven years before it turns profitable," he says. "I don't see an early exit here." Same or different?
The new SME Exchange is bound to evoke a sense of deja vu, given the similarities with OTCEI, and scepticism, given that OTCEI was a failure. Yet, there is also hope. "In 1991, market intermediaries were not comfortable with the online platform, which was the main reason why it failed," says the BSE official. Now, he adds, online trading is the norm. "Besides, capital markets have matured in terms of trading volumes. We're well positioned to launch the SME platform. We will review and take corrective action if required."