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by Rajen Kumar

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Apr 2012

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SME Exchange

Mr. Lakshman Gugulotha, CEO, SME Exchange confirms: SEBI Approval comes finally - Docks Cleared for SME Exchange

SME WORLD Bureau
Oct 2011

Experts describe it a Diwali Gift to the Sector

The much-awaited BSE SME Exchange has got final approval from the capital market Regulator SEBI recently. It is learnt that the BSE SME Exchange will be launched after Diwali.

Earlier, BSE SME Exchange received in principle approval in May, 2011. BSE made the SME Platform ready immediately and SEBI has done the inspection in June, 2011.

BSE was waiting for the final approval of SEBI for last three months. In the meanwhile, BSE SME Exchange has launched country wide awareness campaign for the SMEs, did more than 40 Seminars and covered 15 major states.

About 50 companies have already shown interest for listing on BSE SME Exchange and half of them have already signed mandates with the merchant bankers (MBs). These MBs have to file the offer documents (RHP) with BSE SME Exchange and take approvals, before getting the issue subscribed by the public. The first batch of companies will be listed on the day of launch of the BSE SME exchange.

In the light of go ahead by SEBI, SME WORLD interacted with Lakshman Gugulothu, CEO, on the various aspects of the SME Exchange.

What is BSE's idea behind setting up a SME Exchange?.

India has about 30 million SME enterprises. Out of which, there are at least one million SMEs which have potential to get listed on the SME Exchange in next one to two years. There are only debt financing options without any access to equity capital for these SMEs so far. The need for SME Exchange was there for long. Many SMEs find it difficult to get listed on the Bombay Stock Exchange (BSE) main board, so the SME Exchange has been conceived. The Government of India is also keen on creating the dedicated stock exchange for the MSMEs.

How the BSE SME Exchange is formulated?

The successful SME Exchanges elsewhere in the World, like AIM (London), Canada (TSX V), Hong Kong (GEM), Japan (Mothers), Korea (KOSDAQ) and US (NASDAQ) were studied in detail to understand their salient features, best practices and their SME exchange model. The learning from the OTCEI, the capital market realities, and the problems of SMEs are taken into account in formulating the SME Exchange in the Indian context.

What are the Regulations governing the BSE SME EXCHANGE?

SMEs with post issue face value capital up to Rs. 10 crores has to invariably list on the SME Exchange.
The SMEs with post issue paid capital between Rs. 10 crores and Rs. 25 crores are given the option to list either on SME Exchange or on the main board.
Beyond Rs. 25 crores paid up capital, the companies have to list on the main board.
The minimum application and trading lot size shall not be less than Rs. 1, 00,000/-.
There has to be minimum 50 investors at the time of IPO.
IPO Grading is made compulsory.
The merchant bankers to the issue will undertake market making for three years through a stock broker who is registered as market maker with the SME exchange.
The market makers are required to provide two way quotes for 75% of the time in a day. There will not be more than 5 market makers for scrip.
There is provision for migration from SME Exchange to the Main Board

How the BSE SME Exchange is different from the BSE Main Exchange?

Three years profit making track record is mandatory on the BSE Main Exchange. This is not necessary for the listing of SMEs and waived off, so that more and more SMEs can list on the SME Exchange.

The major differentiator for the SME Exchange is that there is 100% underwriting of the issue and the IPO issue will be 100% success, irrespective of whether it is fully subscribed or not. There is guarantee of listing, unlike on the main board. This is encouraging the SMEs to come forward in a big way, as the uncertainty of failure of IPO is no longer there.

Generally, SMEs need small capital. Considering this, the regulations have been made accordingly. The SMEs will need at least 50 investors each investing at least Rs 1 lakh at the time of IPO and the size of IPO can be as low as Rs. 50 lakhs.

SMEs need capital at short notice, say within couple of months. Considering this, the listing norms have been simplified so that this is possible. Getting listed on the main board could take at least 8-9 months, and generally more than a year. The four important processes on filing of Draft Red Herring Prospectus (DRHP), obtaining in-principle approval of exchange, obtaining in-principle approval of SEBI, and issuing public notice are waived for listing of the SMEs. This saves at least 6 months time for bringing the IPOs on the BSE SME Exchange, compared to the main board. SEBI approval is not needed and intimation would be sufficient. Normally, the merchant banker can file RHP with due diligent certificate with the SME Exchange and its approval would be sufficient.

Here, the IPOs can be brought within a couple of months.

SMEs find it difficult to make recurrent compliances as provided in the main exchange. Considering this, Regulations on the compliance norms for listed SMEs are simplified. Financial results shall be submitted on half yearly basis instead of on quarterly basis. SMEs need not send printed hard copy of the full annual reports to the shareholders. SMEs may send the abridged version of the annual report of few pages consisting of the summary of annual report, details of the profit & loss account and balance sheet to the shareholders. The SMEs can make the soft copy of the annual report available on their website. They can send the soft copy to the Exchange, regulators and ROC also. This is going to bring down the recurrent cost of compliances substantially for the listed companies on the SME Exchange.

Many scrips on the main board are illiquid, especially small caps ad mid caps. Then, it will be even more difficult for the listing SMEs. Considering these issues, market making support for three (3) years in the secondary market is given and this will help in creating the liquidity for the listed SMEs. The investors can invest in these SMEs in the secondary markets through any of the branches and franchises of more than 1500 members of BSE. The investor base improves for the listed companies in medium to long term, and will help the company in valuation and wealth creation.

The SMEs listed on the SME Exchange can migrate to the BSE Main board without bringing a fresh IPO, if the paid up capital of the listed SME is above Rs. 10 crores and the non-promoter shareholders approve the migration by 2/3rd majority. This is a bonus for the listed SMEs.

In the context of the failure of OTCEI, what steps is BSE taking for sustainability of the SME Exchange?

The most important distinguishing factor for the BSE SME Exchange is that it is an integrated exchange with the main exchange of BSE. We are leveraging the entire infrastructure and network of equity platform for the purpose of BSE SME Exchange. The infrastructure is shared and there is no need of additional infrastructure on the part of members and market makers. There is provision for migration from the SME Exchange to the Main board and vice versa. The listed SMEs will be part of the existing equity platform BSE BOLT SYSTEM and the listed SMEs will be traded in the 'M' and 'MT' groups. However, the listed SMEs will be listed and traded as per the regulations of the SME Exchange. As this an integrated exchange platform, there is hardly any risk of failure of the SME Exchange. OTCEI was a stand alone and a parallel infrastructure and it could not succeed on its own efforts.

There are many companies listed under BSE small cap whose paid up capital is less than 10 crores and willing to move to SME exchange. How will this help those companies? And how will this impact new entrants?

Some of these companies are illiquid on the BSE main board. If they are migrating to the BSE SME Exchange, they will have following benefits. First, there will be liquidity support for three years by way of market making and liquidity will be there in the secondary markets. Second, the cost of recurrent compliances from time-to-time and year after year will come down drastically. Third, the listing fees come down also. There will be no impact on the new entrants as the companies moving to the BSE SME will follow the same regulations as that of the new entrants.

What can be the size of IPOs ?

There is no restriction on the size of the IPO on the BSE SME Exchange. As per ICDR Regulations, the company desiring to come with the IPO has to offer a minimum of 25% of the post-issue paid-up capital, to the investors. Few exemptions have been given for the finance companies. The size of the IPOs will depend on the premium the shares could get and the equity that the promoter is ready to divest or extent of additional shares the promoter is willing to issue as part of the IPO. Major of the IPOs in pipeline are in the range Rs. 5 crores to Rs. 50 crores. Theoretically, there is no limit on the maximum. However, practically the maximum size of the IPOs can be over Rs. 100 crores also.

What can be the minimum size of IPOs ?

Regarding the minimum size of the IPO, the following can be said. There is need for 50 investors and each shall invest Rs. one lakh, amounting to Rs. 50 lakhs. This is post IPO paid up capital on lower side. This includes the promoter shareholding, besides the investments by the investors. Hence, it can be concluded that the minimum size of the IPO can be less than Rs. 50 lakhs also. SME Exchange is a platform and we do not discourage the listing of the companies, if they are within the parameters of the regulations. As a exchange platform, we do not differentiate between big SMEs and small SMEs. The merchant bankers, the market makers and the investors should be comfortable with the listing SMEs.

What is your advice to SMEs preparing for listing and IPO on BSE SME Exchange?

The following documents have to be kept ready by the SMEs, if they are planning to go for IPO within a year.

• Keeping the Annual Reports on accounts ready

• Documenting the Past performance

• Due diligence on the applicability of various regulations

• Due Diligence on the various approvals required from regulatory bodies

• Documenting the Risk factors associated with the company

• Documenting the External environment effecting the company

• Listing out of litigations and documenting its magnitude and ramifications

• Documenting the Business activity

• Documenting the Material contracts and agreements

• Detailed report on promoters & management

The most important thing for IPO is the selection of Merchant Banker (MB). He should understand the vision, growth model and plans of the promoter. They should gel together for at least three years as mandated by the SME Exchange Regulations. Generally, these business relations last for very long time and hence they should have matching wavelength.

Due delegance is the important duty of the merchant banker as part of preparing the offer document (RHP). The legal due delegance and financial due delegance have to be properly addressed by the merchant bankers. Restructuring of the capital and valuation are also very important aspects of the IPO process. An SME needs to transform itself into a public limited company. For this, first one has to convert the firm into private limited company. Second, convert private limited company into public limited company. SMEs are also required to restructure capital so as to comply with regulations and requirements of raising equity capital through IPO. Valuation of SME needs to be done to arrive at the financial strength of the company, decide the size of IPO, and pricing of the IPO.

The IPO and listing is all about:

Effective equity story supplemented by proper research and documentation
Presentation to the investors and the analysts, and take feedback
Regular interaction with Member brokers, Sub brokers, CAs, CSs, CFOs and FIs.
Positioning of company through sustained media efforts including visual media
Selection of potential bidding centers to get investors
Creating sustainable valuation and sustainable shareholder base
Effective communication for better results

The cost of listing could itself be seen as a roadblock by the SME.

How do you propose to address this issue?

The fees of top merchant bankers (MBs) are very high and hence they are not keen on working for listing of SMEs. Medium MBs were largely doing IPOs for mid caps and small caps. SME Exchange is more suited to them. Keeping this in view, we have mobilized large number of medium MBs and small MBs to work for listing of the SMEs in BSE SME Exchange. This has helped bringing down the cost of IPOs, compared to the issues by large merchant bankers.

The merchant banker's cost of bringing IPOs of the issue can be classified as statutory and non-statutory costs. There is nothing that can be done to reduce statutory cost, unless the Government makes amendments. The non-statutory cost can be further divided into pre-IPO and post IPO expenses. The post-IPO expenses can be met from the money raised through IPO. Only the pre-IPO expenses and statutory expenses need to be paid by the promoters of the listing SMEs. We are trying to make pre-IPO expenses as minimum as possible, so that the listing is not burden for the SMEs. Many of the SMEs have signed the mandate with the merchant bankers show that the cost of IPO on SME Exchange has come down significantly and it is affordable to the SMEs.

What would be the approx cost of raising say Rs 10 Crs on the exchange in terms of one time and listing fees?

The cost of raising the IPO of Rs. 10 crores on the main board is about 7 to 8%. There is a cost reduction in the SME Exchange on account of printing forms, advertisement and marketing. However, there is additional responsibility given to the merchant bankers and it involves additional cost for 100% underwriting, sub-underwriting and responsibility of market making for three years.

Considering all these, the overall merchant banker cost may be couple of percentages higher than the IPO of similar size on the main board. However, we at BSE SME are working with the market intermediaries to bring down the cost of legal due delegance and rating by the CRAs. We are also exploring the ways and the means by which the cost of bringing on SME Exchange is brought down.

In addition, there is also the premium to be paid to the market maker for market making for at least three years. This is the additional cost to the listing companies in case of SME Exchange, as compared to the BSE Main board. There are various risks involved in market making and the duration of 3 years is also long, and this makes the premium to be paid for market making high. It will be difficult to quantify the cost, but it is likely to be more than the merchant banker fees and costs involved in bringing the IPO. If the period of market making is brought down, then the cost on account of market making can be brought down, enabling more and more SMEs to go for the listing on SME Exchange.

What is the cost of raising equity capital compared to the debt capital?

Generally, the SMEs require capital for very long period, say at least 10 years. If they are opting for debt, they need collaterals for taking debt from the Banks. They have to pay interest of about 15% per annum and service the debt for all these long years. After that, they should return the principal capital. If the promoter of SME is not able to pay the debt, his assets will be attached and the debt will be recovered from him.

The investor of equity capital is like a partner for the SME. There is no burden on the promoters and the investors cannot compel him like in debt funding. If the company performs and grows, the investor also reaps benefits. The equity capital has only one time cost of raising it. If this cost is apportioned over the long period, the cost of capital for each year is insignificant. Thus, raising equity capital is very cost effective and it does not make the promoters liable for the capital.

When are you going to launch the BSE SME Exchange?

BSE SME Exchange has just received the final approval from the Regulator SEBI. We will soon start receiving the offer documents (RHP) of the SMEs from the MBs. The exchange will process and give the approvals for the IPO. After that, the listing SMEs will have to get the issue subscribed by the public. The first batch of companies will be listed on the day of launch of the BSE SME exchange. We will be launching the BSE SME exchange after Diwali festival.

(The author of the article can be contacted through email on Lakshman.g@bseindia.com/ laksh123@gmail.com/ bsesme.info@bseindia.com )

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