NSE tightens SME listing norms; how this will impact microcap market?

The National Stock Exchange (NSE) has tightened the norms for the approval of primary offerings of small and medium enterprises (SME IPOs) amid the rising concerns over quality of the companies raising funds through SME platform, potential manipulation and rich valuations in the segment.
 

In its latest order released on Thursday, NSE has added the condition of positive free cash flow (FCF) for at least two years out of three financial years preceding the application. NSE permits the listing of SME firms on its platform, NSE Emerge, from which they can later migrate to the mainboard upon fulfilling certain conditions.
 

The additional criteria will be applicable to all draft documents filed from September 1 onwards. The exchange added that the figures will be considered from audited balance sheets. Just to remind, SME applications are approved by exchanges- BSE and NSE- and not by the capital markets regulator Sebi.
 

Welcoming the new measure, market participants said tha is a significant step towards enhancing investor protection and ensuring the financial health of SME companies seeking public listing. They believe that it can encourage listing-bound SME players to focus on improving their financial performance and sustainability.
 

The requirement for positive free cash flow to equity is a prudent measure to gauge a company's financial health and its ability to generate cash from operations. It indicates that the company is generating sufficient cash to fund its growth and operations without relying heavily on external financing,  Goel, Co-Founder and Chief Global Strategist at Pace 360.
 

"By mandating positive free cash flow, the NSE aims to mitigate the risk of investing in companies that may have unsustainable business models or may be struggling financially. This can help protect investors from potential losses. The stricter norms can enhance the credibility of the SME market by ensuring that only financially sound companies are allowed to list," he said.
 

NSE's move signals towards more stringent regulations in the SME segment, aimed at safeguarding investor interests and enhancing market stability. Many startups and new-age businesses often do not have positive cash flows. They prioritize scaling up and capturing market share, resulting in negative cash flows,  Wadhwa, MD & CEO at SKI Capital Services.
 

The total number of listings on NSE Emerge had crossed 500 as of July, with 22 new listings in the previous month. July saw the highest number of listings in a month, with fund mobilisation of Rs 1,030 crore on the NSE's SME platform. Prior to this, the leading bourse imposed a cap on the opening price of SMEs at 90 per cent higher than the issue price.
 

The move by NSE is aimed at boosting investor confidence by filtering out companies with questionable financial practices, said Hashim Yacoobali, Director of South Gujarat Shares And Sharebrokers. "I see this as a proactive step to protect investors and maintain the integrity of the market," he said.
 

Launding the move, Kresha Gupta, Director and Fund Manager at StepTrade Share Services said that it is a prudent measure taken by NSE for filtering out the best SME companies in the funnel. "This stricter criteria is likely to raise the bar for listing on the NSE, making it more challenging for some companies to qualify," she said.
 

SME IPOs typically undergo less scrutiny compared to larger entities but both exchanges and Sebit are implementing stricter regulations to safeguard investors. The companies who are genuinely qualified to raise equity capital should not face any trouble, while also preventing misuse of the listing platform, Gupta added.
 

To get listed on NSE's SME platform a company registered under the Companies Act 1956/2013 does not have a post issue paid-up capital of more than Rs 25 crore. It must have a track record of at least three years and its net worth must be positive in two years out of three with no pending petitions in the NCLT among others.
 

"There may need to be a balance between encouraging the listing of financially sound companies and not stifling the potential of innovative startups. This development can enable startups to explore alternative funding routes, such as private equity, venture capital, or even dual-track processes while preparing for an eventual IPO when their financials are stronger," Wadhwa from SKI added.