SME Capital Market – MSME Ecosystem and Funnelling Growth

Dr. Viibhor Agarwal

MSMEs play a crucial role in the growth and transformation of India with their maximum contribution towards sustainable growth, employment, and social stability with their limited economic resources. Despite being strategically important for India’s economic development, the MSME sector is experiencing multiple challenges, the most severe being lack of means of finance. The Government and regulators have time and again attempted to address concerns of MSMEs through various policy measures and capital market initiatives to help MSMEs grow. In this article, we discuss MSME growth opportunities and constraints, global trends, and contribution of the SME capital market towards strengthening the MSME ecosystem.

MSMEs are silent drivers of India’s GDP growth. The role of MSMEs in fostering inclusive growth is evident from its contribution towards employment generation, share in manufacturing output, value innovations, generating local demand, contributing to exports, and most importantly boosting entrepreneurial spirit. To achieve the aspirational goal of the Atma nirbhar Bharat, growth of MSMEs is essential.

To unlock the true potential of MSMEs and strengthening the MSME ecosystem, developing favourable access to finance is most essential. MSMEs are the engine of India’s economic growth and liquidity is the fuel, for the engine to run with interruptions, we must supply constant fuel.

ROADBLOCKS FACED BY MSMES

MSMEs play a crucial role in the growth and transformation of India with their maximum contribution towards sustainable growth, employment, and social stability with their limited economic resources. Despite being strategically important for India’s economic development, the MSME sector is experiencing multiple challenges, the most severe being lack of means of finance. The Government and regulators have time and again attempted to address concerns of MSMEs through various policy measures and capital.

market initiatives to help MSMEs grow. In this article, we discuss MSME growth opportunities and constraints, global trends, and contribution of the SME capital market towards strengthening the MSME ecosystem.

MSMEs are silent drivers of India’s GDP growth. The role of MSMEs in fostering inclusive growth is evident from its contribution towards employment generation, share in manufacturing output, value innovations, generating local demand, contributing to exports, and most importantly boosting entrepreneurial spirit. To achieve the aspirational goal of the Atma nirbhar Bharat, growth of MSMEs is essential.

 

To unlock the true potential of MSMEs and strengthening the MSME ecosystem, developing favourable access to finance is most essential. MSMEs are the engine of India’s economic growth and liquidity is the fuel, for the engine to run with interruptions, we must supply constant fuel.

A few central points of contention stay to be tended to appropriately and gauges yet to be taken in light of a legitimate concern for supportable modern turn of events.

These include,

  • Equity as a source of financing is underutilized and the prevalence of investment by venture capital and angel investors is low;
  • MSMEs face the problem of delayed payments from their buyers which adversely impacts their working capital as well as their next cycle of production;
  • MSMEs lack adequate information about various schemes and benefits available by the Government;
  • Financial institutions/banks face challenges in credit risk assessment of MSMEs;
  • The utilization of the available credit guarantee and insurance schemes by banks has been low

FINANCE HURDLE FOR MSMES

MSMEs are profoundly obliged by their issue of fund. A thorough analysis of the ‘vicious circle of finance’ encountered by the MSMEs and the financial ecosystem of the MSMEs is briefed here in below. The ‘vicious circle of finance’- Why is it such a big problem?

Financial constraints possess difficulties for MSMEs as conventional sources like bank finance have limitations. Private capital like funding through the sale of assets, ancestral capital, personal savings, loans from relatives, loans from an unregulated market is also inadequate. Most of the bank finance or private capital is utilised for the working capital requirement. Fixed interest-free equity funding is required for MSMEs to grow their business to the next level that enables them to execute on business plans; for example, to increase sales, expand the range of products or services, move into new premises, hire more staff, or expand internationally, etc

According to a study by International Financial Corporation overall addressable credit gap in the Indian MSME sector is estimated to be ₹ 25.8 trillion ($ 397.5 billion). The total addressable demand for external credit is estimated to be ₹ 36.7 trillion ($ 565 billion), while the overall supply of finance from formal sources is estimated to be ₹ 10.9 trillion ($ 167.8 billion). It further expresses that, by virtue of deficient value base, MSMEs frequently take advances from numerous banks overextending themselves monetarily and making them helpless against defaulting. Although the demand for funds by MSMEs is high, it remains rather un-satisfied as structural and institutional impediments prevail over bank lending decisions i.e. the willingness to lend is low. Equity as a source of financing is underutilized and the prevalence of investment by institutions, mutual fund, venture capital, and angel investors is low.

“Most of the bank store or private capital is utilised for the working capital need. Fixed interest-free equity funding is required for MSMEs to grow their business to the next level that enables them to execute on business plans; for example, to increase sales, expand the range of products or services, move into new premises, hire more staff, or expand internationally, etc.”

INDIAN SME CAPITAL MARKET

To address finance constraints and bring avenues for fundraising for SMEs, Prime Minister’s Task Force (2010) recommended setting up dedicated exchanges for SMEs. Following the proposal of the Prime Minister’s Task Force, to give a stage to raising development capital, SME Exchange stages were dispatched by (BSE SME) and (NSE Emerge) in 2012. Indian SME Capital Market has since come a long way, by providing a platform for SMEs to grow from strength to strength with the help of interest-free growth capital and lend confidence to entrepreneurs. A total of 533 companies have been listed within about 8 years raising a cumulative growth capital of over ₹ 6500 Crores.

SME CAPITAL MARKET ON GLOBAL ARENA

Almost all major capital markets have a separate exchange for the SME segment, for that matter, more than 30 countries have implemented separate SME bourses. The global trend in recent times is towards the creation of new forms of capital markets specifically designed to meet the funding needs of SMEs. These markets have tried to create an SME-friendly capital market ecosystem with adequate demand and supply-side balance. This model of separate SME exchange prevalent across the globe has been successful since its inception. SME trades or exchanging stages are pervasive internationally yet known by various names, for example, ‘Substitute Investment Markets’ or ‘development endeavours market’, ‘SME Board’ and so on. Some of the prominent SME exchanges include KOSDAQ from The Republic of Korea, ACE (Access, Certainty, Efficiency) Market in Malaysia, Catalyst in Singapore, Chi-next in China, Growth Enterprise Market (GEM) in Hong Kong, AIM (Alternative Investment Market) as part of London Stock Exchange.Below mentioned are some of the global SME exchanges and their Market cap to GDP comparison.

India’s SME Capital Market has huge potential and value unlocking capabilities that are still to be explored. This is evident from low SME Market Cap / GDP ratio than other global SME Markets.

GROWTH TRAJECTORY ON LISTING

Alternate Capital Market helps nation-building by shifting informal enterprises to formalisation. The majority of MSME organisations are firmly held family-run outfits described by difficulties like dispersed tasks, different elements including cost failures, spillages, charge evasion, and so forth. These businesses form part of the “unorganised” economy and are located through industrial clusters across small towns and villages. Post public offerings, public accountability makes it imperative for these unorganised businesses to inculcate high governance standards.

Robust performance: Post listing, SMEs get significant visibility and improved brand positioning. Enhanced governance standards, increased accountability and higher trust factor helps listed SMEs overcome hurdles as lessor efforts are required for acquiring business tenders and contracts. This is evident from the post listing financial performance of listed SMEs between FY 2017 and FY 2019. On investigation of 180 recorded SME, it has been seen that during this period their income has expanded by ₹ 16495 Crore and benefits by ₹ 639 Crore. SMEs have contributed significantly to tax revenues, an increase of ₹ 246 Crore between FY 2017 and FY 2019.

Comparative analysis of the increase in Revenue, PAT and Tax between 2017 & 2019

Migration to the mainboard: BSE SME and NSE Emerge provide an option to SMEs companies to migrate to the main board of the stock exchange on meeting the exchange criteria. Year on year we witness mature companies opting to migrate to the mainboard.

On migration, a retail investor with a limited capital base can also invest in SMEs as there is no lot size restriction, even a single share can be traded.

Handholding by the regulator: Regulators have been rational with SMEs in terms of compliance. Considering the beginning phase of the business life cycle, qualification measures for SME IPOs have been kept sufficient to equivalent with the size and size of organisations. Stock Exchanges have been playing the role of true enablers for hand-holding business during listing as also post listing. Post listing compliances involving costs and administration have been thoughtfully relaxed by the market regulator, SEBI.

Portfolio Diversification Tool:

SME investing appears to be a significant wealth creation opportunity. Regardless of their size, they have the potential to outperform their larger listed counterparts.It’s important to consider risk alongside returns. Sometime it could be perceived that SME investing is risky but if we dissect it with a granular approach, the outcome is indeed different. Considering the risk-return profile. SMEs generally offer attractive valuation multiples compared to mainframe companies.However, to understand, SME would require in-depth research and a detailed on-ground study with a lot of reference checks with customers/suppliers/competitors and other stakeholders along with quantitative parameters. Needless to mention to analyse an SME, it is very important to study & understand qualitative insights into the promoters – family, personal financial discipline, and organization health check.

“Recognise what you own, and know why you own it” – Peter LynchPositive post-IPO value execution and alluring valuation for keeping speculators connected with SME contributing are troublesome and there could be more landmines than goldmines.  But to say that these issues are specific only to SMEs and not to companies on other platforms would be unfair. Given market volatilities and corporate governance irregularities, investors have become more selective. To balance the risk and return matrix, portfolio allocation to SMEs is the best way to maximise returns.

Liquidity:

Liquidity level in an SME scrip should be looked at considering the small size of IPO and the number of investors involved. Regardless of whether a couple of exchanges happen in seven days, the rate exchanges may in any case be higher contrasted with a Main Board scrip having huge market capitalisation and speculator base. Further, the compulsory market-production goes about as a pad for financial specialists to get in and out of SME scrip paying little mind to the low liquidity leve.

However, it would be worthwhile for the regulator to review the norms and make it more investor-friendly to provide a fillip to the liquidity levels. There is a critical need to loosen up parcel size rules for the SME section which will pull in retail cooperation just as improve liquidity and will go far in the development of the SME market.

Under researched:

Mutual fund houses, ultra HNIs and QIBs invest in SMEs, both pre & post listing. However that covers just 1% of the total SME universe, hence a large portion of the market is still untapped. Very few research reports are available in the public domain and those available are just for handpicked stocks. Hence a lot of investment opportunities remain un-researched and untouched. This impacts tracking and liquidity significantly. In past, SME IPOs have witnessed up to 100x subscriptions and shares being traded daily in volumes. For a year there is subdued interest particularly in small-cap segments and its corresponding effect is seen in SMEs.

“Very few research reports are available in the public domain and those available are just for select stocks. Hence a lot of investment opportunities remain under researched”

ROLE OF GOVERNMENT

Growing SME platforms provide a growth platform for emerging SMEs which in turn contributes to developments of State economies. Various State Governments are taking several initiatives to support fast flourishing SME platforms.While Gujarat and Rajasthan State Governments provide subsidy towards IPO expenses, Maharashtra and West Bengal have set up dedicated funds to invest in MSMEs.If we look at the statistics, the highest number of SMEs listings and funds raised are from Maharashtra and Gujarat, compared to other states. Other State Governments should also unleash encouraging initiatives to support their SMEs for raising growth capital on SME bourses. With such development financing getting simple, SMEs are required to advance in their organisations quicker and thus, add to State economies.

CONCLUSION

Irrespective of listing status, COVID-19 has hit SMEs. However, it a matter of pride for all of us that India’s SME sector has emerged out stronger from this pandemic. They have not just survived but also thrived through the hard times and turned all tailwinds into a lifetime opportunity. Many of the listed SMEs have come out with anti-COVID products/businesses like first of the kind of machines to produce PPE kits, masks, sanitizers, various immunity booster neutral products, etc., to cite a few examples.The process of value unlocking is very important. Progressive businesses, who appreciate wealth creation and business valuation, have been able to raise funding at desired valuations.Governance structures, improved credit rating, reduced finance cost, easy finances, and branding are key benefits for listing on the SME platform. Besides, valuation has helped listed SMEs to achieve speedy growth systematically at an early stage of their respective business life cycle. Greater awareness needs to be created and a larger number of industries should be made aware so that the benefits of fundraising through capital markets can be enjoyed by maximum industries.

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