Small and medium enterprises (SMEs) are not only the largest contributor to job creation and economic output, but also to economic dynamism. Unlocking their potential is critical to India's sustainable growth prospects. But they are constrained on all the three factors of production.
Land in any reasonably developed agglomeration has become so exorbitant that it's unaffordable to SMEs. There's an acute scarcity of skilled workers and good quality managers, and those available come at an exorbitant price.
Finally, there's capital, the subject of this post. Debt is both expensive and inaccessible to entrepreneurs and risk capital chronically scarce. Investors prefer to put their money in either fixed deposits, gold, land, and public markets (bonds, mutual funds and stocks). This means that the equity requirements for small businesses remain unmet.
How do we unlock more risk capital to invest in local SMEs? This is arguably one of the biggest requirements for broad-basing economic growth and thereby making it sustainable.
As a disclaimer, in the absence of hard data and any literature, this post is largely drawn from experiences and stories. To this extent, it’s only a hypothesis. But it’s a plausible hypothesis with several compelling examples and anecdotes, which therefore merit serious engagement by journalists, researchers, and commentators.
The year 2023 was spectacular for SME IPOs. Sample this
According to data from Trendlyne, 234 companies have raised funds from Indian markets so far in 2023, with a significant portion of 176 companies falling within the SME category. In comparison, CY22 witnessed 103 SMEs entering the market; the number was 52 in 2021, 31 in 2020, and 31 in 2019. Out of the 176 SME stocks listed this year, 62, or 35%, are trading with gains ranging between 100% and 1000%. Zooming out, 126 stocks are currently trading above their respective issue prices.
And this
The SME platform saw a record 168 offerings, with an average size of ₹25.6 crore, mopping up ₹4,305 crore. This is higher than the combined amount raised in the previous four years and nearly twice the previous record of ₹2,287 crore garnered in 2018. The amount collected by SMEs is roughly a tenth of the ₹44,882 crore collected by mainboard IPOs this year.The total market capitalisation of firms listed on BSE’s SME platform crossed ₹1-lakh crore this month. The total number of SME issuances since 2012 now stand at 887.
SME segment saw 166 companies raising an aggregate of ₹4,472 crore by listing on both BSE SME and NSE Emerge. The most interesting aspect of SME IPOs was the subscription rates. Fifty one of the 166 companies witnessed subscription rates of more than 100 times, with 12 companies seeing over 300 times subscription, according to FYERS Research.
And this
Amidst the hype we should not overlook that the total amount mobilised in all this is slightly more than half a billion dollars, a tiny amount by any yardstick for an economy of India's size. The high IPO subscription rate is also deceptive since it's most likely that the same set of investors have been recycling their capital hoping to strike it rich by landing shares during the IPO and selling them immediately after listing to capture the easy gains from the possible listing premium.
On similar lines, the hype about the tens of billions of private equity and venture capital inflows into India should not blind us to the reality that domestic equity capital raising in India remains very small. While there are no reliable estimates, the base and fund raising from domestic LPs appears too small to even merit a separate mention in annual reports of consultancies like Bain & Company. In fact, most of the fund raising by even the Indian PE funds have been from foreign LPs. Further, anecdotal evidence suggests that Indian high net worth individuals put their risk capital in the public markets and have limited exposure to the Indian private equity markets. It remains to be seen whether the current generation of start-up founders who have just struck rich will exhibit a greater risk appetite than their predecessors and choose to become LPs for domestically focused private equity funds.
The availability of risk capital is one of the most important requirements for economic growth. The public debates and policy focus in this regard is confined to fund raising through public market IPOs and different forms of private capital like venture capital and private equity. But such fundraising which mainly covers large enterprises, the largest among medium enterprises, and technology entrepreneurs in the metropolitan cities form only a small part of the demand for risk capital.
There's a large unmet demand for risk capital from among new entrepreneurs and SMEs especially outside the largest cities and in non-tech sectors like agri-processing, metal works, engineering goods, textiles, mining and processing, pharma and chemicals, trading, dealerships, clinics and hospitals, diagnostics, schools and colleges, hotels and restaurants etc. They generally find the public markets and private capital providers out of bounds. Instead they are forced to rely on own savings and capital mobilised from close relatives for equity to start new businesses. In case of existing entrepreneurs, in addition to the above, equity for expansion comes from surpluses ploughed back.
It would be interesting to study the profile of businesses in the SME loan book of our commercial banks and other sub-national lenders. An analysis of the equity sources of SMEs that access State Finance Corporations for working capital and other loans reveal that they have bootstrapped with their own money and at most from relatives. This is the case for even those entrepreneurs who have been in business for decades and have an excellent track record of performance. Another interesting aspect is that these businesses have very low debt:equity ratio. Besides they also remain small and show limited growth appetite.
In a very large economy like India where SMEs form the major share of job creation, economic output, and economic dynamism, the businesses mentioned above outside of the largest cities are critical to the country's long-term economic growth prospects. If these entities are left with own sources as virtually the only means to mobilise risk capital, then it should be a matter of great concern.
How would today’s developed economies met their risk capital requirements during their development trajectories? I'm inclined to believe that this risk capital scarcity for SMEs would have been the case with today's developed countries too in their own development stages. But their industrial base and capital base would have been much broader than what India faces today. This makes the constraint more binding on SMEs in India.
But this scarcity for formal risk capital co-exists with a well-established practice of informal financial intermediation where businesses and brokers mobilise equity capital from local wealthy people for local investments. This is common in the real estate sector and also found in hospitals, colleges, retail malls, automobile and consumer durable dealerships etc., in Tier II and Tier III cities. Each of these cities have a few local well-heeled who have the money and the interest in making investments. But their investment horizons are often limited to the local area and prefer tangible assets.
Local entrepreneurs sometimes mobilise equity informally for their projects from these local well-heeled. There are also local intermediaries who are good at spotting investment opportunities and mobilising capital from the local wealthy. The intermediary uses relationships and networks to raise money, typically in the range of a few crores (say, Rs 1-10 Cr), to invest in upcoming local real estate projects or hospital developments or a dealership. In the typical medium-sized Indian town/city there are perhaps 10-20 such individuals/households with the finances to invest in such projects. While there are no studies or estimates, anecdotal evidence suggests that such informal GP/LP relationship is common in at least some parts of the country outside of the largest cities.
There are several well-known reasons why such investors, entrepreneurs, and intermediaries prefer such transactions to stay informal. It's interesting that one reason appears to be that these wealthy people in the smaller cities trust the informal non-legal personal relationship-based transactions more than the formal contract with a distant and institutional fund manager.
But this does not detract from the need to encourage institutional platforms that allow for mobilisation of funds from local high net worth individuals and their investment in promising local business opportunities. Such financial intermediaries could register as alternative investment funds (AIFs). But current regulations are too onerous and restrictive for these small intermediaries. Accordingly, if we are to attract such risk capital, perhaps the eligibility conditions and terms of AIF Category II funds will have to be relaxed along with simpler compliance and reporting requirements.
Here, the SEBI could take a leaf out of its own experiment with the BSE and NSE's SME trading platform. The platform, functional since 2009, is a very good innovation and has allowed SMEs access the public markets. It allows for firms with even Rs 1 Cr paid up capital (compared to Rs 25 Cr paid up capital requirement for the regular exchange listing) and lower listing compliance requirements and post-listing reporting requirements.
This is the kind of private equity that India needs more of, atleast as much if not more than the kind of PE that public policy currently engages with. Unlike the big ticket PE capital which are mostly invested in brownfield assets and in technology intensive sectors with limited job creation, these investments are made locally and in local job creating assets. Apart from several other benefits, they are also an indirect means to capture black money that would otherwise have remained and rotated within the informal economy.
In this context, if we dig deep we'll find that atleast some of the SMEs who issued IPOs in 2023 have their origins in such local informal financial intermediation.
No comments:
Post a Comment