Pre-IPO Power: How Alternative Investment Funds (AIFs) Are Quietly Powering SME Growth Before Public Listings?

MSMEs contribute nearly 30% to India's GDP, making their growth central to the country's economic momentum. Over the last decade, the MSME ecosystem has also seen a structural shift in how it finances expansion.

Alternative Investment Funds (AIFs) have been a continuously expanding source of patient, structured capital alongside traditional bank lending and promoter money, especially as investor interest in alternative asset classes expands beyond traditional equities.

HNIs are paying significant attention to SME-Exchange oriented AIFs within this trend, particularly after SEBI launched SME listing frameworks and specialized SME exchange platforms in 2012. Over time, the ecosystem has become more mature in terms of governance and discipline execution, yet investing directly into SMEs can be challenging, especially for individual investors due to limited research resources.

This is where Category II Alternative Investment Funds (AIFs) are emerging as a powerful pre-IPO bridge, helping SMEs professionalize, expand, and prepare for public markets with discipline.

Why Pre-IPO funding is necessary?

Pre-IPO activities for growth-stage SMEs include the introduction of new products, technological advancements, hiring specialized personnel for various departments, geographical development, and, frequently, debt reduction to strengthen the balance sheet.

Pre-IPO capital acts as a bridge that enables companies to pursue these priorities without compromising operational stability. Pre-IPO funding allows a company to enlarge its boundaries without compromising its operational stability.

"Pre-IPO funding allows private companies to address liquidity issues and prepare for the transition to a public entity. Before shares are traded on a stock exchange, it is generally the last round of private funding," said Kresha Gupta, Director & Fund Manager, Steptrade Capital.

How Category II AIFs support SME expansion?

"Private equity, growth equity, and specific credit strategies are examples of Category II AIFs that are intended for structured investing without fund-level leverage and with an emphasis on long-term capital deployment. For SMEs, this matters since the investment strategy can be adjusted to focus on enterprise development rather than short-term appearances," as per Kresha Gupta.

By incorporating discipline, governance, and IPO readiness into a SME's growth process, a well-managed Category II AIF adds value. Capital is deployed with clear objectives of capacity expansion, working capital optimization, geographic rollout, or acquisitions.

Along with funding, the organization is under pressure to institutionalize fundamental procedures such as consistent MIS, more robust internal controls and audits, better documentation, board procedures, and related-party compliance. Lastly, the presence of an institutional investor on the board increases market trust and lends legitimacy.

How SMEs can be IPO ready with AIF infused Pre-IPO capital?

India's growth-stage funding requirement is estimated at nearly $600 billion, yet only about 10% of this capital has been deployed so far, marking a significant opportunity to accelerate enterprise growth.

If deployed effectively, this capital can play a transformative role in scaling Indian businesses, with domestic manufacturing alone projected to reach $1.3 trillion by FY30, growing at a CAGR of 18%. Investor confidence in late-stage and growth capital remained robust even in FY25, when operating cash flows slowed down from FY24. Funding in this sector increased 14% year over year to almost $4 billion. This demonstrates a definite preference for disciplined, scale-supporting structured financing.

"AIF-infused pre-IPO funding offers just this structure for SMEs. By establishing a new manufacturing facility and investing in systems and leadership at the same time, a SME may grow capacity to meet an expanding order book with planned capital support. Employing experts in marketing, sales, finance, and compliance helps improve internal procedures and bring the company into conformity with listing criteria," commented Kresha Gupta.

Additionally, this stage offers a chance to boost cash flows and margins through operational excellence programs that strengthen cycle resilience. Beyond money, expert advice from fund managers can improve discipline execution, capital allocation, and strategic decision-making.

Additionally, AIF ecosystems and networks can open doors to new customer segments, partnerships, and market opportunities, helping SMEs expand beyond their existing circles.

What does an AIF see in an SME before investing?

Before investing, AIFs typically evaluate whether the business has the stability and quality needed to scale responsibly and eventually tap public markets.

Key factors include consistency of revenues and unit economics; quality of promoters and capital allocation plan' discipline in managing cash conversion cycles, and a clean compliance and documentation track record.

"It is crucial to see whether the business has a realistic expansion plan, a qualified team, and an achievable timeframe. These expectations also explain why many investors hesitate to invest directly in SMEs," commented Kresha Gupta.

All about India's first SME-Exchange focused AIF:

Limited reliable information, lack of consistent resources for research, governance concerns, scaling risks, and valuation traps often create a gap between investor appetite and investor confidence.

"To address this gap, Steptrade Capital launched India's First SME-Exchange focused CAT-II AIF, Chanakya Opportunities Fund I in 2022. The fund is being managed by CA Kresha Gupta and Ankush Jain, CFA, and completed its final close in December 2024, partially fulfilling its green shoe capacity," stated Kresha Gupta.

The company's due diligence, which includes examining financial records, promoter background, business vintage, and evaluating the company's likelihood to list within about 18 months of the investment, supports the investment method.