How Varanium Cloud rigged its own SME IPO

The Story of SME IPO

Companies raise funds through initial public offerings (IPOs). They sell their shares to the public for cash and list the company on the stock exchange. However, not all companies may do this on traditional stock markets such as the NSE (National Stock Exchange) and BSE (Bombay Stock Exchange).

You must ensure that your company passes the severe standards set by the market regulator SEBI (Securities and Exchange Board of India). You may need to have a corporation with a net worth that exceeds a specified threshold. You may need to have a profitable track record*. You may be required to perform another task in addition to those listed by India’s leading stock exchanges.

That is precisely why going public is a difficult task, particularly for small businesses or SMEs (Small and Medium Enterprises) looking to develop, grow, and thrive.

However, things changed about a decade ago when the NSE and BSE launched separate listing platforms for SME IPO. They reduced the laws, making it simpler for small enterprises to enter the market.

These businesses did not have to meet onerous requirements. Their IPO documents did not even require SEBI approval. A positive response from the stock market would suffice. And it worked. Since then, around 950 startups have raised approximately ₹14,700 crore.

What’s more impressive?

These small and medium-sized enterprise IPOs have recently gained popularity.

In FY24, for example, the number of companies using the SME IPO platform reached 205. That is 64% higher than the previous year’s figures. They raised roughly three times more money than SMEs that went public in FY23. Listing gains were impressive, often exceeding 300%.

That is why the S&P BSE SME IPO index increased by more than 170% in the past year. This index, by the way, tracks the performance of over 60 small and medium-sized enterprises listed on the Bombay Stock Exchange. And it’s no surprise that investors are buying into the hype.

But hold on… There is a catch. These high rewards, however, come with significant hazards. The most significant is one that SEBI recently identified and is well-known to most SME IPO investors. Here, IPOs are frequently manipulated.

It could be people within the firm, such as promoters, who run the business and eventually rig the IPO, or false investors buying these stocks to artificially increase the price, only to dump them on blind retail investors later. Alternatively, a new approach involves creating a business on paper without a genuine business strategy.

We’re talking about Varanium Cloud, an SME that went public in 2022 and was shut down by the SEBI last weekend.

Varanium Cloud is a small technology business that appears to be involved in a variety of projects. Varanium Cloud offered it all, including multimedia streaming, online payments, digital education using tech platforms, and tech-related services for other startups and SMEs. At least, that’s what the website says.

Over a year ago, it successfully raised ₹33 crores by listing on the SME platform. However, things began to unravel as investors became suspicious that something was wrong. Several media investigations soon called into doubt the integrity of the company’s financial statements. Finally, SEBI got involved by launching a formal probe.

SEBI initially wanted to address a simple question: how did Varanium Cloud use the IPO proceeds?

You’d expect the company to use the money to grow its operations. Varanium Cloud confirmed this in its prospectus. It established a few data centers, created more digital learning centers, and purchased additional assets to extend its activities.

Where was the proof?

Varanium Cloud avoided the query by indicating that the invoices were submitted to the GST department as part of a GST (Goods and Service Tax) audit but would be provided later.

SEBI did not want to remain idle in the meantime. So it examined how much cash the company had made since its IPO in FY23. So what did it find out?

Varanium Cloud did not have any substantial revenue-generating operations. Dividend payouts and investments were backed by IPO proceeds.

But SEBI discovered deeper still. And this is what came of it.

Varanium Cloud invested in shares of companies in which its MD (Managing Director), Harshawardhan Sabale, served as a director for a brief period before or during the year. Not only that. It obtained cost estimates from Avance Technologies for the establishment of additional data centers. That expense, which would increase Avance Technologies’ revenue, amounted to more than 100% of the company’s total revenue for the fiscal year! That did not look suitable.

It’s simple. Marketing!

Varanium Cloud made sure to make frequent announcements that sugarcoated revenue projections. And because investors are unable to observe what is going on behind the scenes, they are easily duped.

Indeed, these announcements were so effective that the number of owners increased from about 1,000 to more than 10,000 between September 2022 and December 2023, causing the stock price to rise in parallel. Harshawardhan Sabale sold his stock and earned ₹122 crores! That doesn’t even include the money he made through network businesses that had a promoter stake in the company.

So, that is exactly why SEBI barred both the business and Sabale from the stock market.

But it is keeping a close eye on these SME IPOs. It understands that corporations are openly exploiting this listing approach to extract massive profits while leaving cautious investors holding the bag. And it may soon impose stronger laws to combat their misbehavior.

Could this backfire on proper SMEs looking to grow their business? We hope not. But time will tell. Until then.

*Non-profitable companies can also go public under stringent conditions.

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