SMEs: The next frontier of wealth creation

India’s small and medium enterprise (SME) ecosystem has expanded rapidly over the past decade. Since the launch of SME exchanges in 2013 and 2014, more than 1,400 companies have listed on these platforms, collectively raising around Rs32,000 crore, while their combined market capitalisation has crossed Rs3.5 lakh crore.

On average, every fourth company listed on SME exchanges has delivered over 30 per cent CAGR, and roughly one in four eventually migrates to the main board. The typical transition period is around three-and-a half years.

There is little doubt that India’s fast-growing SME equity segment is emerging as one of the most powerful wealth-creation engines in the market, significantly outperforming both large-cap and traditional small-cap indices over the past five years, analysts say. The performance of the SME segment is particularly striking from a long-term investment perspective. An investment of Rs1 crore in the NIFTY SME index five years ago would have grown to about Rs7.5 crore today — a return of roughly 750 per cent, experts point out.

In comparison, the same Rs1 crore investment in the small-cap index would have grown to about Rs1.5 crore, while a large-cap investment tracking the NIFTY would have reached around Rs87.5 lakh over the same period. This implies that SMEs have delivered nearly five times the return of small caps and almost eight times that of large caps in the past five years. On a compounded annual growth rate (CAGR) basis, the SME index has generated returns of about 53 per cent, compared with roughly 20 per cent for small caps and around 13 per cent for large caps. For high-net-worth individuals (HNIs) and ultra-HNIs seeking higher returns, the SME segment deserves closer attention. However, the same core principle that applies to equity investing elsewhere holds true here — patience.

The philosophy remains unchanged: stay invested for the long term. Investors should ideally have a horizon of five to seven years. Notably, on a rolling five-year basis, SME indices have not delivered negative returns.

There are also investment products in this segment that make participation more manageable. While regulations typically mandate a minimum investment of Rs1 crore, some offerings allow investors to deploy capital gradually over two and a half years instead of committing the entire amount upfront.

For instance, an investor can invest about Rs10 lakh every quarter — Rs40 lakh in the first year, another Rs40 lakh in the second year, and the remaining Rs20 lakh across the ninth and tenth quarters. This staggered approach offers flexibility and reduces the psychological burden of a lump-sum investment. Despite the strong returns, careful due diligence remains essential in the SME space. A structured four-pillar framework — Legal, Financial, On-field, and Technology (LFOT) — can be particularly effective. The process begins with assessing the legal background of promoters to ensure there are no serious regulatory violations or criminal cases. This is followed by financial scrutiny, focusing on balance sheet transparency, related-party transactions, and the quality of earnings. Information asymmetry and governance risks tend to be higher than in larger listed companies.

On-ground inspections are equally critical. Engaging with founders, employees, vendors, and customers helps assess real-world operations — an approach often referred to as “scuttlebutt investing.” Finally, technological due diligence evaluates intellectual property, patents, licences, and order pipelines. Looking ahead, analysts believe the SME sector will play a pivotal role in India’s economic growth. SMEs contribute roughly 30 per cent to GDP, account for about 36 per cent of manufacturing output, and generate nearly 44 per cent of exports.

With more than 50,000 sizeable SMEs yet to be listed, the opportunity remains vast. Over the next two decades, SME investing could emerge as one of India’s most significant wealth-creation avenues.