SME IPO frenzy: Warning signs investors shouldn’t ignore

Resourceful Automobile’s IPO, for example, attracted ₹4,800 crore in bids for a ₹Issuance of 12 crore rupees and offer of travel and rentals received ₹7,075 crores for a ₹12.4 crore issue. HOAC Foods India and Magenta Lifecare saw oversubscription of 1,963 and 1,002 times respectively earlier this year even as their issue size was just ₹5.10 crore and ₹6.64 crore.

While investors are making huge profits on the stock market, you never know when the tide will turn.

In fiscal year 25, 104 companies raised ₹3,396 crore through IPO in August, compared to ₹5,971 crore was raised by 204 companies in FY24, according to Primedatabase.

“Increased activity in the IPO market is a sign that something may go wrong. We have not seen any major crash since 2015, except the Covid-19 crash of 2020. SME IPOs have offered an avenue to make quick money in this uptrend. Be careful with that,” says S. Ravi, former chairman, BSE. “Retail investors should do thorough research before subscribing in the SME segment. Company fundamentals and business model should be assessed before subscribing.”

The bubble can burst at any moment.

There are multiple examples of SMEs that go public and make huge profits, but eventually turn into penny stocks. Investing in them without doing fundamental research is a recipe for disaster, even if it seems like a dessert unless you know when to get out.

“I know many companies whose promoters go public and set up a private limited company. They raise money and put it in the private limited company by giving loans. The private limited company would appear insolvent and the listed company would write off the loan,” says Basant Soni (48), a veteran stock investor and garment manufacturer based in Jodhpur.

Read also | SME IPO: The craziest corner of the bull market is getting crazier

It is important to understand the nuances of what is happening in the SME space.

It should not be forgotten that SME stocks have a fairly low market capitalization, making them prone to market manipulation. Veteran stock market investor Vijay Kedia In a recent interview with to business channel He said nine out of 10 SME stocks are manipulated either by merchant bankers, landlords, promoters or even investors applying for IPOs.

Easy liquidity

Increased liquidity, thanks to the reduction in the period during which funds remain blocked in ASBA (Application Supported by Blocked Amount), has benefited investors. ASBA is a payment method for applying for IPOs in which the money remains in the bank account but is blocked for other purposes.

“Earlier, the money would remain locked in ASBA for a couple of weeks. However, now that Sebi has reduced the date of allotment period to three days after the issue closes, the money is unlocked soon after. This has led to a lot of people bidding for IPOs as the money can be easily transferred from one IPO to another,” says Vivek Bhauka, a veteran stock investor in New Delhi.

Some people with a good amount of money in their bank account opt ​​for the overdraft facility. They pledge their fixed deposits to access the loan easily. “The interest rates on overdrafts are too low – just 1-2% above the fixed deposit rates. Banks give 90% of the value of the fixed deposit as a loan that investors place in IPOs. The listing gains are usually much higher than the interest liability. For some, it is a double benefit as they can show the interest payment as an expense in their books,” says Anant Agarwal of Kota, who invests in SME IPOs.

A link between those in power

Last month, Sebi warned investors that promoters and merchant bankers are giving an “unrealistic picture” of companies. They create positive sentiment among investors through public announcements and corporate actions such as bond issues, share splits and preferential allotments.

“The above measures create positive sentiment among investors, prompting them to buy such securities. At the same time, this also presents an easy opportunity for promoters to offload their stakes in such companies at high prices,” Sebi said.

It is not surprising that the grey market premium (GMP) increases two to three times the IPO price.

“Merchant bankers tend to exaggerate the value of an issue. Recently, Sebi released a consultation paper to increase the net worth of merchant bankers, primarily to ensure that those with a good track record play a role in the securities market,” said S. Ravi, founder, Ravi Rajan & Co. Public comments on the consultation paper are expected till September 18.

Read also: SME IPOs are shining, but experts advise caution

Furthermore, unlike main board IPOs, where no entity related to the merchant banker can subscribe to the offering, in the SME Exchange the market makers work as partners of the merchant bankers.

“They are mostly people who are forced to surrender. Up to 5% of the issue volume ends up in their hands. So they not only control the market with a good amount of shares, but they also get a commission for it. This is a contradiction of the basic rule,” says Kejriwal.

There is no level playing field

The huge number of subscriptions to SME IPOs has made it difficult for genuine retail investors to get IPO allotments. Rohitt Kapur, CFO of a Gurgaon-based multinational company, has stopped applying for IPOs.

“I often got the allotment before, but things have changed in the last two years. I now try to buy shares in the pre-IPO market,” he says.

Unlike investors like Kapur, anchor investors and qualified institutional buyers (QIBs) are better placed to secure allotments in SME IPOs. Anchor investors can get up to 60% of the QIB portion and 30% of the total issue size. QIBs can subscribe for around 50% of the issue size of an IPO. “Smart investors are trying to set up alternative investment funds and bid for the IPO in the QIB category. Allotment of the anchor portion of QIBs is at the discretion of the promoters and lead managers at the expense of retail investors,” says Vivek Bhauka.

Kejriwal questions the need for institutional investors in SME IPOs. “We don’t need multiple sets of investors in these IPOs. It is enough to have two – retail investors and non-institutional investors (NII),” he says.

“Investors subscribing to the IPO through the anchor/QIB category are not actually institutional buyers. The lead managers are unnecessarily creating a buzz about institutional investment, though they could very well be a group of ordinary investors coming together to get an allocation in the QIB category. This system should be scrapped. It is a fraud,” Kejriwal said.

Rajasthan Global Securities, Varsu India Growth Story, Saint Capital Fund, NAV Capital VCC-NAV Capital Emerging Star Fund and Meru Investment Fund PCC-Cell are the top five anchor investors that have subscribed to 28-51 IPOs in the last one year, Primedatabase data shows.

Also, the more money invested in an IPO, the more chances there are of getting allotment due to the proportional allotment process. This also favours QIBs at the expense of retail investors. “If Sebi caps the application amount category-wise in SME IPOs like in the main board, we will see less subscriptions compared to present. Also, if there is a normal allotment process in the NII category like they have in the main board, there will be equal chances of everyone getting allotment,” says Anant Agarwal.

Don’t follow the herd. Sanjay Kapoor, MD of Mumbai-based Globel Business, applies for an IPO only after doing some field research. “I do my research by visiting the site, meeting the promoters and checking the channels. Even if I don’t get the allotment, I still buy shares after listing if I know the company is good. I avoid IPOs where I don’t see value. I am not in this to make profits from listing,” says Kapoor.

This is the way forward. The SME sector offers money-making opportunities, but you need to put in the effort to identify them instead of chasing easy money that can trap you and cause dire consequences.