Tech and Start-ups: Unreal Valuations and the Public Markets Test

It’s not just the debate on whether there’s steam left in the funding engine for Indian start-ups which is worrying the entrepreneurship ecosystem these days. The disastrous showing by some of India’s most storied start-ups and tech companies is causing several of them to go back to the drawing board. A leading tech company entrepreneur I spoke to, whose company was planning an IPO which would have been very keenly watched, recently told me clearly that the market situation led to his board deciding to push back the public offer until things stabilized. But while it would seem that the reason is the choppiness in the markets in general, the problem is also exacerbated for tech companies and start-ups in India for other specific reasons.

Yes, there is a huge selloff being witnessed by the largest global tech companies, from PayPal to Netflix, Nvidia to Meta, have all seen hefty declines on the public markets as global liquidity becomes tighter, inflation threatens the biggest markets and central banks resort to withdrawal of their accommodative stance. But in India, tech firms and start-ups, long pampered by huge valuations which often fail to justify the businesses, are facing a grim reality on the public markets post listing. 

Nothing speaks better than data, so let’s consider some numbers. Data compiled by my colleague Rahul Oberoi of the BT Research Bureau shows that investors have lost anywhere between 9 per cent to 71 per cent of their wealth thanks to some of the celebrated tech and start-ups which have hit the markets over the past several months. Topping this list, of course, is Paytm, which hit the markets on November 8, 2021 at an issue price of ₹2,150. As of June 9, 2022, the Paytm stock was languishing way below the issue price, at ₹623.35, down 71 per cent from the issue price. PB Fintech, or Policbazaar, hit the market on November 1, 2021 at an issue price of ₹980, and was trading at ₹588 on June 9, a decline of 40 percent. The Zomato stock did better, but is still down nearly 10 per cent from its issue price on June 9. CarTrade, on the other hand, has taken a big hit, and was down nearly 57 per cent from its issue price. Investors in the Paytm stock lost a staggering ₹99,000 crore compared to its issue price, while PB Fintech investors shed over ₹17,600 crore compared to its issue price. 

In contrast, there are some successes like Delhivery, which has seen a 7 per cent increase in its stock price compared to its issue price since it hit the markets on, May 11, 2022, and FSN E-Commerce (Nykaa), which saw investor wealth growing 28 per cent till June 9 leading to investors gaining nearly ₹15,000 crore from its issue price after it hit the markets on October 28, 2021.

As the public markets continue to give a taste of the bitter medicine to some of India’s most storied tech firms and start-ups, it is clear that a key reason has been the overvaluation seen by them in the private markets in the past. Sudhir Dash, founder and CEO of boutique investment advisory firm Unaprime, who has seen both public markets and the private markets over the years, having worn several hats at UTI and Axis Bank earlier, puts it simply: “It’s a case of real businesses, but unreal valuations.” Dash points out that some of the biggest global VC and PE firms, flush with liquidity earlier, had invested in all kinds of start-ups, driving up their valuations to dizzying levels. Bolstered by this rush of big money, Indian entrepreneurs too began asking for huge valuations at every successive round of funding, with little relation to the actual scale-up possibility of many of these businesses. Valuations were driven by revenue multiples rather than Ebitda multiples, distorting the funding framework in many cases. Those were the heady days of easy liquidity.

Spoilt for choice, and driven by the ambitions of both the VCs and the entrepreneurs, these firms came to the public market too with high valuations which in many cases were not justified by the nature of the business or the path to profitability. They were carried away by the hype even in the public markets, as benchmark indices reached dizzying heights and investors lined up to access the bourses. With liquidity driving the public markets too, it was only natural for the big boys of the start-up world to look at IPOs at high valuations. 

That was then. Today, the public market, the great leveller which has been a Waterloo for many in the past, has shown the mirror to many of these Indian start-ups, with stocks either getting pilloried on the bourses, or IPOs having to be pushed back as fear grips the start-up world and the liquidity starts seriously drying up. VCs and PEs have now started looking at Ebidta roadmaps and cash flows as the path to profitability for the start-ups becomes the driving factor for these private market investors. Alongside, some of these overvalued companies, for instance those in the edtech space which garnered massive funding owing to the pandemic giving the edtech sector a huge boost, are now facing the prospect of successive funding rounds driving down valuations sharply. Investment banking sources tell me privately that in the heady days, it wasn’t unusual to see successive funding rounds lead to dizzying increases in valuations of edtech companies, with valuations moving up sharply from less than $600 million to $1 billion in a span of months in some cases. Today, edtech is among the worst hit in the private markets as the pandemic recedes, and big names in the sector are thinking long and hard before taking a call on whether to go the IPO route.

The important point to note here is that most of these businesses are real. There are genuine cases where businesses have the potential of scaling up and be profitable over a period of time. VCs, PEs and the entrepreneurs they fund will, hopefully, take the lesson the public markets have taught them, and understand that unreal valuations cannot work in the long term. Reality will bite. And the fall will hurt.

The author is Editor, Business Today.