SME stock exchange – bad idea

There is a lot of talk going on about a stock exchange for small and medium enterprises (SMEs). Much of it is politically right (in the short term), but bad economics. While it is true that small companies often have access only to bank loans and equity investment by friends and relatives, giving access to the public capital markets is a poor idea for many reasons.

Investors will lose massive amounts of money out of genuine failure as is common in much of small business. This will then be erroneously named fraud and people running these companies persecuted. At the same time investors will be disillusioned because this new beast of an exchange will have 95 failures for every 5 successes. Even private equity investments which not only do a thorough due diligence, but also sit on the investee company’s board and even get them business lose their entire investment in 9 out of 10 investments (they do hope to make it up in the 10th company though).

Without deviating from the recognition that SMEs have a crucial importance to the Indian economy, it would therefore be a bad idea to introduce a classic exchange for SME companies. Even introducing a minimum lot size of say Rs. 10, 00,000 (1 million rupees) as investment will not take away the stigma such an exchange will pose – though much of the losses will be suffered indirectly by mutual funds and insurance companies. It will thus be a bad political move to introduce such an exchange – in the medium to long term. The equity infusion in small companies will necessarily have to continue from traditional sources and governments should aim to improve access to bank loans to such enterprises besides giving whatever incentives are needed to grow the private equity and venture capital industry.