DSIJ Mindshare

INDIAN SMEs: WHAT’S THEIR PLAYING PITCH LIKE?

India’s SMEs are the one of the most important participants for growth of the economy. According to various estimates, the Indian SMEs contribute almost 45 per cent of the manufacturing output and more than 40 per cent of India’s exports. The government also has been taking proactive steps in supporting the SME sector through a priority sector status to SME lending and various other subsidies. Recently there has been good interest seen in SMEs from private equity funds too. However, the sector is struggling to overcome a large number of NPAs from banks and exit difficulties for private equity funds.

The macro-economic situation has had its impact on the SMEs and there is also the baggage of earlier challenges. Fortunately though, the macro-economic environment seems to have changed in the recent past with success factors shifting to achieving business excellence. Interestingly, the depth of management talent and resurgence of entrepreneurial desire in managers in India has created a seasoned environment for attracting professional talent in the SMEs. Further, the high valuations offered to well-governed companies with management depth by private equity funds has created substantial incentives for the SMEs to elevate them to high standards of governance and managerial decision-making. This has started the flow of risk capital to the SMEs in a big way.

This very fact should enhance the SMEs’ ability to grow and attract talent significantly and lead to building a fruitful cycle of investments and growth. In the recent past, along with private equity, even venture capital companies have started showing interest in the SMEs. Several high street bankers and boutique investment firms have begun to discover opportunities in the Indian SME segments. There are various SME-dedicated funds launched by various leading banks, venture capital firms, investment bankers, etc.

Dedicated Platform Required

Considering the immense potential of the Indian economy, the SMEs have better chances to grow and scale their operations due to their smaller, and controllable, sizes. Thus private equity players get an early stage opportunity and huge appreciation through investments in the SMEs. If you look at historical traces, the size of Reliance Industries was just Rs 2.80 crore when it launched an IPO in 1977. Infosys was Rs 33 crore at the time of its IPO in 1993. Though there are immense benefits of public listing, the SMEs were not able to access the capital market through the mainstream stock exchanges due to various factors such as stringent regulatory, disclosure and financial requirements.

With the Indian economy becoming liberalised and globalised, the SMEs possess tremendous opportunities along with some serious challenges. With a host of business opportunities in new markets, the challenges faced by the SMEs are playing at an inferior status due to their scale of operations, technological obsolescence, inability to access institutional credit, and intense competition in marketing.

Critical Key Challenges

Some of the key factors obstructing the rapid growth of the SMEs include:

• Lack of availability of adequate and timely credit.

• High cost of credit.

• Collateral requirements

• Limited access to equity capital

• Procurement of raw material at competitive cost

• Problems of storage, designing, packaging and product display.

• Lack of access to global markets.

• Inadequate infrastructure facilities, including power, water, and roads, etc.

Emergence of Platforms

There are various reforms undertaken by the government to boost capital funding for the SMEs. The government has introduced policy measures to help the SMEs grow, including implementation of the MSME Act 2006, National Manufacturing Competitiveness Programme, PM’s Task Force on MSMEs, Rajiv Gandhi Udyami Mitra Yojana, VAT waiver for MSMEs, etc. However, to tap the capital market, the establishment of a separate platform for the SMEs was on the government’s agenda and regulator for quite some time. Finally in March 2012, an SME Exchange was launched so that a dedicated stock exchange for SMEs would allow them to access the capital market easily, quickly, and at lesser costs.

The opening of the dedicated SME Exchange has facilitated various benefits to the SMEs such as:

• Access to equity financing opportunities to grow their business through ways of expansion and acquisitions

• Expansion of the investor base for further equity financing from the secondary market or private placement.

• Lowering of debt burden by way of equity financing resulting in healthier balance-sheet and lower financing cost.

• Increasing visibility through coverage from analysts and media that can add to the credence and image of the SMEs, thereby leading to benchmarking their fair value.

• Increasing participation by venture capital players as they would have a ready, transparent and tax-efficient exit route.

• Making use of ESOPs and other stock base compensation plans to reward and retain their employees.

• Distributing the risk efficiently by transferring risk to those who are best able to bear it.

Journey So Far

After the market regulator’s permission, India’s leading stock exchanges, BSE and NSE, launched a dedicated platform for the SMEs in March 2012. BSE has launched BSESME and NSE has launched NSE Emerge. Both the platforms are aimed to raise equity capital through venture funds, private equity, and wealthy individuals. Interestingly, BSE has won the race with 78 companies listed on its SME platform while NSE Emerge has only six companies on board.

In two years’ time many SMEs have experienced multifold increase in their valuation after this listing. On the BSESME platform, the market capitalisation of the listed 78 companies collectively amounts to more than Rs 8,500 crore now. The issue price of Channel Nine was fixed at Rs 25 and it is currently trading at Rs 525. Similarly, Eco Friendly Food Processing Park and Sunstar Realty Development that priced their shares at Rs 25 and 20 each are now trading at Rs 450 and Rs 326 respectively. On an average, around 25 to 30 companies see a handful of trades every day on this exchange On November 25, 2014, these listed companies saw a total of 479 trades with the turnover pegged at Rs 9.87 crore.

Not a Cakewalk Though!

The returns yielded by these SMEs on the bourses may excite you and motivate you to invest in the companies through these platforms. However, investing in these companies carries immense risk and any investment without thorough diligence is not advocated. The SMEs lack good credit history and hence have difficulties in accessing finance for expansion and technological advancement. Further, the capital raised through primary markets may be not used for building assets and there are maximum possibilities of not resulting in any capital formation. There are also chances that a business will fail after raising public capital. Further, these SMEs also face some serious issues such as poor corporate governance, less stringent listing norms, poor liquidity on exchanges, etc. Hence the risks associated are numerous considering as far as small investors are concerned since fewer disclosures means less transparency.

Considering the protection of small investors from these high risky bets, market regulator SEBI has kept these investors out of this segment by setting a minimum lot size of Rs 1 lakh. The regulator has also created merchant bankers to maintain sufficient liquidity through compulsory market making for a period of three years after listing. Having said that, overall the SME platform is certainly a good initiative by the SEBI and the exchanges help raise equity capital in an easy way and take advantage of attaining the listing status.

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