India may get its first SME (Small and Medium Enterprises) exchange shortly, which is going to be launched by Bombay Stock Exchange (BSE). National Stock exchange (NSE) in collaboration with SIDBI is also working on launching of second stock exchange for SMEs. These two stock exchanges will bring India at par with many advanced economies of the world (Korea, Canada etc.), which boast of SME exchanges. These two exchanges are expected to help around 26 million SMEs working in India and need capital for their future growth and expansion. As per SEBI regulations, SMEs having post issue face value of paid up capital of upto 25 crores can list on these exchanges. BSE has made it mandatory for companies having paid up capital till 10 crores to list on the SME exchange. Companies have been paid up capital between 10 to 25 crores have been given the option to list on any of the two exchanges i.e. SME exchange or main exchange.
The long awaited exchange meant to provide access to equity capital to small enterprises has been subject of debate for long time now. Started as a white paper discussion in 2008, the modalities of exchange operations have almost been finalized. The key objectives of SME exchange was summed up by the CEO of SME exchange MR. Lakshman Gugulothu in an interview to a leading financial daily," A dedicated exchange for SMEs will help them find a solution to their financial requirements for expansion. Listing on the exchange gives better valuation to a company. Debt and equity ratios will improve and the balance sheet will look much healthier. Transparency and corporate governance will improve manifold".
Though setting up of SME exchange is a good idea, there are several aspects of its proposed operations which raise question on its viability. Let us look at the requirements which have been framed for listing on SME exchange. To list on SME exchange, a SME needs to have profitable track record of three years. Many small enterprises, especially in the start up phase, do not make profit but still need capital. For such small enterprises raising capital through SME exchange won't be possible. Hence many small enterprises won't be really able to benefit SME exchange. The reason for this requirement of profitability is to protect investor's interest. However, what is surprising is that the exchange will not be accessible to the common investor as an investor needs to invest atleast Rs.1,00,000 as investment in the public offer by a SME. Also atleast 50 investors need to invest in public issue of a SME in the proposed exchange as per SEBI regulations. Considering the risky nature of SME business, it is indeed unfair to assume that an investor would invest a lump sum amount of Rs.1,00,000 in a SME business which is not always transparent.
Second but most fundamental question is how beneficial raising of equity capital going to be for SMEs. Considering that equity generally has higher cost of capital compared to debt, will small enterprises be really willing to go ahead and add equity in their balance sheet. A profitable SME generally has the option of raising capital from banks, financial institutions and through government approved schemes of NSIC, SIDBI and CGTSME. This process is less cumbersome and many banks offer loans to profitable small and medium enterprise without collateral also. Why will such a SME like to raise capital through an exchange? The paper work and compliance requirement of a SME will increase many fold after listing and SMEs are found to be averse to paper work involving transparency.
The next area of concern is usage of market making concept in SME business. The market making concept to be used in functioning of SME exchange raises several questions. In the initial three years, there will be a market maker for public issue who will support the sustenance of public offer by providing a two way quote. Practically a market maker will hold certain number of shares of a particular SME and facilitate trading in that security. After a buy order is received the market maker will immediately sell from its own inventory or seek an offsetting order. This process will facilitate transactions in SME securities and provide liquidity to the securities. However, this will not come free of cost to SMEs. There will be a fee charged for this by the market makers which will obviously increase the cost of raising equity.
Apart from this, there are additional fees to be paid by the SMEs. These fees are related to underwriting and sub-underwriting of the issue. As per the proposed norm on SME to be started by BSE, all the issues need to be underwritten. As per underwriting norms, an investment banker will underwrite 15% of the issue using its own resource while it can bring take help of external investors in underwriting remaining 85% of the issue. This is another area of concern as far as functioning of SME exchange is concerned.
National Stock Exchange which is planning to start another SME exchange has handled the process of market making in much more organised way. In order to ensure that the market making mechanism does not fail in case of SMEs, SIDBI has worked out on some tenable solutions. SIDBI Chairman and Managing Director S. Muhnot in a press conference recently mentioned that," We will create funds for the market makers. We will launch Nominated Investors Liquidity Fund which will help these market makers". As per him this fund will have corpus of 60 crores. Going ahead two funds of 500 crores and 300 crores are also proposed. No doubt this is better move than the one proposed by BSE and will go in long way in assuring liquidity but the key questions of accessibility of capital for small enterprise, not making profit or start up ventures, is not being addressed by this exchange as well.
Both NSE and BSE are banking on the fact that many venture capitalists and foreign funds have shown interest in Indian SMEs and hence they will be keen to invest in these SMEs through exchange. In the current global scenario which has seen massive flight of capital from emerging economies, this is an unfair assumption in short run. From stock exchange perspective also SME exchange seems to be a long term proposition. It will take around 5 years for an exchange to break even. Mr. Lakshman Gugulothu accepted this is in his interview to the financial daily. This further puts question mark on the viability of SME stock exchange.
Success of SME exchange will indeed open a new window for small enterprises. However considering the challenges, viability of these exchanges is under question mark. There is a fear that we may be heading towards an another OTCEI ( Over the Counter Exchange of India) which could not deliver the desired result. It is pertinent to note that OTECI was created to take care of capital requirements for small enterprises.
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