We will decode what SEBI is trying to do to curb the SME IPO bubble and prevent a potential wealth burst.

What happened?

SME IPOs have been in the news for the last few months. Retail investors are jumping on them & why not after all? They are delivering shockingly higher returns led by high demand and low supply.

Recent reports suggest that SEBI is acting against over six investment banks handling SME IPOs.

Why investment banks and not the companies?

For that, we need to look at how investment banks help companies to raise money.

The role of investment banks in IPOs:

Say, for example, PowerUp Money wants to go public. Now we may be good at what we are doing–helping people become financially smart, but‌ taking the company public is unfamiliar territory.

It involves a lot of regulations and legal matters, so we hire an expert for that: an investment banker to conduct all the process–from finalizing the share price to ensuring that our IPO is subscribed fully.

They act as a dealer between companies and investors and make money by helping companies raise funds. Investment banks normally charge 2% to 3% of funds raised as their fee.

How investment banks can manipulate the valuation?

If they help a company raise ₹100 crores, they would make ₹3 crores.

What if, by projecting a bright future for their client company and timing the IPO in trending markets (which they often do), increase the valuation to ₹200 crores? They would make twice in fees.

And it’s a win-win for both–the company and the investment banker.

This is specifically true for SME IPOs, where institutional investors (mutual funds, insurance companies, etc.), which are often referred to as smart money, are not allowed to participate.

So it’s just retailers like us and High Net-Worth Individuals (HNIs), easiest to manipulate.

Coming back to the SEBI, it reportedly found that these investment banks catering to SMEs for their IPO were charging 15% fees, which is five times higher than the normal market range to ensure that IPOs are oversubscribed.

Oversubscription creates more buzz around the company and likely leads to a surge in stock price after the listing, potentially helping company insiders to profit from it.

In conclusion

Even if you’re a risk-seeking investor, it’s important to proceed with caution and check the following factors before investing in any IPO:

1. Financials are the first and foremost
Check if the company is generating enough cash flows from its core operations.

2. Read the prospectus
Understand how the company plans to use the IPO funds and its overall business model—this will give you a clearer picture of what you’re getting into.

3. Do not follow the hype
For SMEs, metrics like oversubscription and Grey Market Premium (GMP) can often be completely fabricated.

Bottom line: Be informed & don’t get swayed by noise.