Smaller companies have to pay heavily to raise money from the capital markets due to stricter regulatory requirements and heavy expenses for marketing the issue.
Some of the small and medium enterprises (SMEs) that have raised capital by way of initial public offerings (IPOs) have shown ‘issue-related expenses’ of as much as 13.5 per cent of the total issue size, shows information available in the final offer documents filed with the Registrar of Companies.
For instance, Jupiter Infomedia raised a little over Rs 4 crore through the Bombay Stock Exchange’s SME platform in August and had to spend Rs 55 lakh, or 13.5 per cent, on issue-related expenses. The SME issues of Thejo Engineering, BCB Finance and Sangam Advisors had to spend between eight and 10 per cent of the issue size.
| HIGH COSTS An average 8% of the funds raised are spent on expenses in SME IPOs | |||
| In Rs cr | Total expenses | Issue size | Expenses as % of issue size |
| Jupiter Infomedia | 0.6 | 4.1 | 13.5 |
| Thejo Engineering | 1.8 | 19 | 9.5 |
| Sangam Advisors | 0.4 | 5.1 | 8.3 |
| BCB Finance | 0.7 | 8.8 | 7.9 |
| Max Alert System | 0.6 | 8.0 | 7.5 |
| Source: Offer documents | |||
Issue-related expenses include merchant banker fees, underwriting commission, legal fees, printing and advertisement expenses and listing fees payable to the stock exchanges, among others.
Market experts say the actual costs incurred by these companies could be much higher than what is reflected in the offer documents. “There are additional regulatory requirements like market making and underwriting in SME IPOs. To fulfill these requirements, merchant bankers need to have capital in their own account, adding to the costs,” said Rajesh Dubey, founder of SME BOTS LLP, a firm advising smaller companies on IPOs. “Of the SME IPOs that have hit the market so far, only one issue had a reputed banker. So, it's possible that bankers and issuers can have some offline arrangement.”
The average issue-related expenses incurred by the eight SMEs that have raised money through IPOs so far is about 8.4 per cent. More than half these costs are spent on merchant banking fees. Also, other costs like those on printing of prospectus and the mandatory pre- and post-issue advertisements are high, relative to the funds raised.
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“As the risk associated with SME IPOs are more, expenses, like merchant banking fees, are higher,” said B Madhuprasad, vice-chairman, Keynote Corporate Services. “Unlike a book building IPO, financial closure is guaranteed in SME IPOs, as bankers have to offer 100 per cent underwriting. So, if the issue fails to garner full subscription, it gets devolved on the merchant bankers.”
Besides underwriting, merchant bankers handling SME issues have to also provide compulsory market making for three years. This facility provides liquidity to a stock, as bankers provide both buy and sell side quotes. However, it puts them at risk of diluting their holdings at lower market value.
Dubey believes the high expenses involved in SME issues is a big deterrent for issuing companies and one reason why the platform might not be a success. “If the company has to spend 10 per cent of the capital it raises on expenses alone, the real purpose of an offering gets defeated,” he said.
Madhuprasad, however, believes although the cost of doing an IPO is high for issuers, there are other benefits.
“The cost is front-loaded in SME issues. If a company goes for a term loan, that also has to be repaid in five years and interest rates are high. So, if you look at IPO costs over a five-year horizon, it is just two per cent every year. Also, companies can leverage their equity to raise debt in the future,” he explained.