• In Conversation

Entrepreneur (E): Of the 26 million SMEs in India, how many would be eligible for listing on the SME exchange?
Lakshman Gugulothu (LG): I would say more than a million SMEs can aspire to get listed on the exchange within a year or two. However, the enterprises would have to do a lot of restructuring and documentation for the IPO process.

E: Why should an SME be interested in getting listed on the exchange?
LG: SMEs till now have been looking at debt options only to raise funds. But, they cannot leverage debt beyond a point as they exhaust collaterals. SME exchange will help such companies raise equity capital as the debt and equity ratio is very important in financial markets. The ratio has to be as per financial market norms. The exchange will help enterprises encash many opportunities. SMEs need money to achieve economies of scale. Amongst various equity expansions, listing on the exchange is the best since it brings all classes and types of investors together. Capital market already has about two crore investors and the SME platform will bring in FII, PE, VC, angel, HNI, banks, QIBs and the entire gamut of the investment community. It is a good opportunity to showcase a business model and gain advantage from it.
Listing on an SME exchange will also attach credentials with a company. It creates visibility and transparency and, thus, corporate governance of a company improves manifold. Faith associated with a listed company is also very high. Domestic as well as foreign investors trust the enterprises and, thus, it becomes easier for these enterprises to find an alternative source of raising funds. Companies can come out with follow on issues and raise more capital. In medium to long term, the exchange will give a better valuation and help these SMEs in wealth creation, for themselves and investors.

E: One of the highlights of the SME exchange is that for three years merchant bankers will be responsible for market making. Do you think merchant bankers will be interested in putting their time and effort into such an activity?
LG: Market making is difficult for traditional merchant bankers as their role is limited to primary market issues. Handling additional responsibilities of secondary market will be a big challenge for them. However, if you see the scenario of merchant banking in India, many banks have different offerings under one roof. For example, ICICI has a merchant banking division, investment banking division, broking arm spread across the country, HNI clientele and NBFCs tie ups, all under one roof. Market making becomes easier in such a scenario. It might be difficult for standalone merchant bankers but it is important for them to identify the right partners, network with them and create a system where activities can take place under one roof.
Considering the potential of SMEs that can be listed on the exchange, it is a huge opportunity for market intermediaries–merchant bankers or market makers. Like merchant bankers, members can command fees for market making out of issue expenses. Members are already enquiring about some SMEs they have identified and are ready to do market making for these enterprises. We at BSE are trying to involve all market intermediaries, professionals, sub-brokers and stake holders in promoting the exchange as everyone has a business interest. Exchange is a facilitator and all stake holders have a huge role in mobilizing the SMEs to find an opportunity to list.

E: While to list on the exchange a company needs to file its red herring with SEBI, the market regulator will have no comments when it comes to SME exchange. Does this leave a gap from where undeserving companies can slip through?
LG: There is a limit to which the regulator can cope up with load. There has to be a time when some work is delegated—to exchanges and market intermediaries. In this case, merchant bankers have been assigned a primary role in doing the due diligence. Ours is a disclosure-based, and not merit-based, regime. Processes have only been simplified. Filing of DRHP, getting in-principle approval from the exchange and SEBI and filing a public notice for a month are some steps that have been waived off since these were time consuming. However, the regulator has not stated that the standards have been diluted. The offer document has to be the same as that of the main board standard and similarly there is no relaxation in terms of corporate governance. In SME exchange, the merchant banker has more responsibility in terms of pricing the issues and giving returns to secondary market investors. In this case the merchant has to do a conservative pricing of the IPO so that returns are good for both primary and secondary market investors. I do not see fraudulent company coming through as I do not see why a merchant banker would allow this to happen. A merchant banker will have to purchase all the shares if investors do not buy these. We have a fairly robust system in India and I do not see a problem.

E: These days, a company may release results on its website and is not required to publish it. Then what is the rationale behind allowing SMEs to publish results every six months and not every quarter?
LG: The idea is to bring down recurring expenditure. For an SME which is not used to capital market practices, it becomes difficult to churn out numbers every quarter. Considering this, it has been mandated that these enterprises release results every six months. If any SME wants to do it every quarter, it is welcome. Since almost everybody has access to internet these days, we have allowed results to be filed on the website. An abridged version can be sent to investors and shareholders.

E: For SME exchange, SEBI has done away with the clause that an enterprise should be profitable for three years prior to listing, as mandated for the main board. What is your take on it?
LG: SME exchange is trying to bridge the gap between growing companies which find it very difficult to get listed on the main board, need funds to grow and become profitable and, at the same time, have the potential to do well. We are trying to manage the transition that companies may have between the SME exchange and the main board. Management in many of these SMEs may not understand financial results, annual results and many financial terms since it is more promoter centric. If we really wanted to help these companies, waiving off the profit-making criterion was necessary. Having said that, it does not mean any company can get listed as it has to have something to offer to the investors.

E: Another rule talks of the shares on the exchange being traded in lots. Will this not bring down liquidity?
LG: Most investors investing in SMEs are foreign investors, VCs, PEs, institutional investors and banks. At the same time we need to give opportunities to retail investors.
Given that investors in retail category can invest upto Rs.2 lakh in an IPO of a main board company, they can easily invest Rs.1 lakh in our exchange. Also, it is not good exposing small investors since it is a new exchange and an evolving concept. In India, we are very protective about the interest of small investors and feel that only informed investors should make investments in the SME exchange where minimum investment is of Rs.1 lakh. This may affect liquidity but we will limit investors this way and it will be easier to find and manage them.

E: What challenges are you facing and which ones are likely to crop up in future?
LG: There was a lot of apprehension and resistance from market intermediaries. We have successfully overcome these in the last seven to eight months via one-to-one sessions and explanations of the model that the exchange will operate on. We have a bigger challenge of educating promoters of SMEs. The number runs into millions; in every nook and corner of the country. Reaching out to these people and making them aware of the capital market issues is a big challenge. It will take some time and here I think professionals such as CAs and CSs have a big role to play. The other challenge that I foresee is for the investors. In India, retail investors are more use to short-term investments and returns and the good habit of staying invested for long is diminishing. We need to educate investors again that if they are interested in wealth creation, they should go for medium- and/or long-term investments.

E: What has been the response so far? We heard that 1,400 small firms barred from trading on BSE for various compliance issues may find their way to this exchange. Is this true?
LG: So far, about 50 firms have shown interest to be listed on the exchange. They are from across the country and across different industries and sectors. Suspended firms are not allowed to list on the SME exchange. A firm under main board, even if suspended, continues to be under main board and it cannot be under both the exchanges at the same time. We have given an option to the main board companies, which have a paid up capital of less than Rs.25 crore, to migrate to the SME exchange after taking necessary approvals. For suspended companies, these have to first comply with main board norms, get their suspension revoked, get two-third of the shareholders to back the move and then apply to the exchange. They also need to appoint a merchant banker and go through the market making process.

©Entrepreneur October 2011

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BSE, CEO, Lakshman Gugulothu, Pranbihanga Borpuzari, SME, sme exchange