NSE tightens SME listing norms. How will this impact the microcap market?

The National Stock Exchange (NSE) has tightened approval norms for initial public offerings of small and medium enterprises (SME IPOs) amid growing concerns over the quality of companies raising funds through the SME platform, potential manipulation and high valuations in this segment.

In the latest order issued on Thursday, the NSE added the condition of positive free cash flow (FCF) for at least two years out of the three financial years preceding the application. The NSE allows SME companies to list on its platform, NSE Emerge, from where they can later migrate to the main board after meeting certain conditions.

The additional criteria will be applicable to all draft documents submitted from September 1. The exchange added that the data will be considered on the basis of audited balance sheets. It is recalled that SME applications are approved by the stock exchanges – BSE and NSE – and not by capital market regulator Sebi.

Welcoming the new measure, market participants said it was a significant step towards increasing investor protection and ensuring the financial health of SMEs seeking a public listing. They believe it could encourage SMEs seeking a listing to focus on improving their financial performance and stability.

Requiring positive free cash flow to equity is a prudent measure of a company’s financial health and its ability to generate cash from operations. It means that the company generates enough cash to fund its growth and operations without excessive reliance on external financing, Goel, co-founder and chief global strategist at Pace 360.

“By mandating positive free cash flow, the NSE aims to mitigate the risk of investing in companies that may have unsustainable business models or may be in financial distress. This can help protect investors from potential losses. Stricter norms can add credibility to the SME market by ensuring that only financially sound companies are allowed to list,” he said.

The NSE move signals more stringent regulation in the SME segment to protect investor interests and enhance market stability. Many startups and new-age enterprises often do not have positive cash flows. Their priority is to scale and gain market share, which results in negative cash flows, Wadhwa, MD and CEO, SKI Capital Services.

The total number of listings on NSE Emerge crossed the 500-mark in July, with 22 new listings in the previous month. July witnessed the highest number of listings in a month, with fund mobilisation of Rs 1,030 crore on NSE’s SME platform. Earlier, the leading exchange had imposed a cap on the opening price of SME listings at 90 per cent higher than the issue price.

Kresha Gupta, director and fund manager at StepTrade Share Services, said this is a cautious measure taken by the NSE to filter out the best SME companies in the levy. “These stricter criteria are likely to raise the bar for listing on the NSE, making it difficult for some companies to qualify,” she said.

SME IPOs are typically subject to less scrutiny compared to larger entities, but both stock exchanges and Sebit are implementing stricter regulations to protect investors. Companies that are genuinely qualified to raise equity capital should not face any issues, while preventing misuse of the listing platform, Gupta added.

To be listed on the SME platform of NSE, a company registered under the Companies Act 1956/2013 must not have a post-issue paid-up capital of more than Rs 25 crore. It must have a track record of at least three years and its net worth must be positive for two years out of three without any pending petitions in the NCLT, among other things.

“There may be a need to strike a balance between encouraging listing of financially sound companies and not stifling the potential of innovative startups. This development could enable startups to explore alternative funding avenues such as private equity, venture capital, and even dual-track processes while preparing for an eventual IPO when their finances are stronger,” SKI’s Wadhwa added.