Nurturing Growth: The Evolving Role Of AIFs And VCs In India’s SME Landscape

In India’s dynamic economy, the journey from a budding startup to a publicly traded company is evolving. Traditionally, startups rarely ventured onto the SME exchange for capital. However, a notable shift is occurring, with profitable startups now eyeing the SME exchange as a viable platform for raising capital. 

This change aligns with the broader economic narrative, where SMEs form an essential part of India’s economic fabric, contributing around 30% to the GDP and employing over 120 Mn individuals. 

Further, the landscape of investment is transforming. Traditional VCs and SME-focused Alternative Investment Funds (“AIFs”) are exploring the SME exchange as fertile ground for investments. This interest marks a strategic pivot, recognising the SME exchange not just as a funding avenue but as a platform offering growth and visibility to emerging businesses.

SMEs: The Economic Powerhouses of India

SMEs stand as the backbone of the Indian economy, with their importance echoed in the substantial contributions they make towards GDP, exports, and employment. The Indian government, acknowledging its pivotal role, has implemented supportive policies and initiatives, aiming to streamline growth and operational sustainability for these enterprises.

With SMEs employing over 120 Mn individuals and contributing significantly to India’s GDP and exports, their importance in the economy is undeniable. The recent interest from AIFs and VCs in the SME exchange highlights a growing confidence in the market’s potential. 

As of the latest reports, the total assets under management by AIFs in India have seen a substantial increase, indicating a robust interest in alternative investments and reflecting the growing maturity of India’s investment landscape.

Growth In SME IPOs

The SME Exchange in India has seen substantial growth, with more than 800 companies launching IPOs since the inception of SME stock exchanges and about 40% of these graduating to the mainboard exchange. These firms have experienced a notable mean absolute return of 210% and a mean CAGR of 45% post-migration. On average, companies list on the SME board with an issue size of about INR 15 Cr. 

In 2023, the Indian SME Exchanges observed a record-breaking number of IPOs, with about 162 companies going public. Impressively, out of these, about 75% of the IPOs concluded with positive outcomes. 

Further, out of the public issues in 2023, more than 35% of the issues saw participation by Qualified Institutional Buyers. Further, an IPO, on average, received 80,238 applications and was subscribed 87 times, reflecting strong investor interest. 

The mean issue size has grown to INR 26.5 Cr, indicating a rising trend in capital raised, underlining the SME Exchange’s vital role in providing growth capital and market visibility for SMEs. This remarkable performance not only underlines the robustness of the SME sector but also indicates the growing investor confidence and the maturity of the market.

Legal Framework And The SME Exchange

SEBI oversees the SME exchanges, providing a regulatory framework designed to support small to medium-sized companies in accessing public funds. The recent trend of profitable startups considering the SME exchange for capital raising signifies a shift in the market dynamics. 

This is underscored by the fact that these startups, with their innovative business models and profitability, are now aligning with listing criteria prescribed by the SME exchanges, opening new pathways to leverage public markets for growth. 

Here’s a brief overview of the broad eligibility criteria:

Paid-up Capital: Companies seeking to list on the SME exchange should have a minimum paid-up capital as specified by the exchange. This criterion ensures that only companies with a certain level of financial stability and scale of operations can go public.

Track Record: Applicants are often required to demonstrate a track record of operational and financial performance. This includes profitability metrics over a specified period, showcasing the company’s ability to generate sustainable income.

Underwriting: A unique aspect of listing on the SME exchange is the requirement for underwriting. A certain percentage of the issue (often a significant portion) must be underwritten by an SEBI-registered merchant banker. Additionally, the merchant banker is required to take on a portion of the issue for themselves, underscoring their confidence in the company’s prospects.

Net Worth: Companies are generally required to have a positive net worth at the time of application. This criterion ensures that the companies are financially healthy and have a solid foundation for future growth.

No Default: Applicants must not have defaulted in the repayment of loans to banks or financial institutions at the time of filing the application. This condition emphasises the importance of financial discipline and credibility.

Shareholding: There are also specific requirements regarding the distribution of shares pre and post-IPO. This includes conditions on the minimum number of allottees and the maximum shareholding by individual shareholders, aimed at ensuring a wide distribution of shares and avoiding excessive concentration.

The Changing Dynamics Of AIFs And VCs

The evolving interest of AIFs and VCs in companies listing on the SME exchange is pivotal. These entities are broadening their investment horizons, looking beyond traditional private equity rounds to the potential held by publicly listed SMEs. 

This strategic shift not only diversifies funding options for startups but also enriches the investment landscape for AIFs and VCs.

Particularly, AIFs have been instrumental in preparing startups for the transition to public listings. By offering capital, strategic guidance, and operational expertise, these institutional investors ensure that startups are not only ready to face the public market’s scrutiny but are also positioned for sustained growth post-listing.

Summary

The changing dynamics of India’s SME exchange and the startup ecosystem signify a new chapter of growth and opportunity. The strategic pivot of profitable startups towards public listings, coupled with the enhanced interest of AIFs and VCs in the SME exchange, reflects a maturing market poised for innovation and expansion.

As this trend continues to unfold, it is expected to catalyse significant economic impacts, driving innovation, job creation, and sustainable growth, thereby reinforcing the vital role of SMEs in India’s economic narrative.