Startups are initially funded by promoters after which they seek funds from venture capitalists via seed funding. After a few years of growth when the company has grown to a reasonable size and decent valuation, the promoters decide to monetise a part of their stake by listing it on stock exchanges. Some of the promoters and angel investors offload a part of their stake through the initial public offering (IPO) and this is lapped up by eager retail as well as institutional investors who see potential and future growth prospects in the company.
There are numerous examples like Zomato, Paytm, Flipkart which have grown in size tremendously in the last few years.
has already come out with its IPO and completed its Rs 9,300 crore public issue in July while Paytm is waiting to get listed with its Rs 16,600 crore issue soon. Ola, Flipkart, Byju’s and Oyo are also expected to come out with their IPOs in the coming year.
The pandemic-induced lockdown saw a massive surge in the adoption of digital technology and turned out to be a windfall for online startups. In the year 2021, India has already created 20 unicorns taking the total count of startups with over $1 billion valuations to over 60 now.
Digital firms differ from traditional brick and mortar/asset heavy/manufacturing companies in a few important ways. The latter set of companies have long gestation period and path to profit and they apply traditional valuation methods for growth and net profits assessments. In stark contrast to this, digital players are asset light, quick to enter markets, disrupt and garner market share and they also tend to grow rapidly. But during initial years digital firms rarely show actual profits. Sometimes even a path to profitability is also not clearly visible, therefore, traditional valuation measures like return on assets (ROA), return on capital employed (ROCE), and free cash flow based models cannot be used for these firms.
Traditional valuation methods fall short when applied to new-age digital companies. Earlier, companies could approach the public market only after they had built up reasonably strong financials (revenue, profits, ROCE, etc.) in order to have a successful listing. Today that is no longer the case. Zomato, which went public recently is still a loss-making company and it had a very successful listing. Markets are betting on smart promoters, digital-driven disruptive business models and are willing to look far into the future for actual and substantial gains. Today’s investors do not want to miss the bus like Warren Buffet did when he did not invest in Google or Amazon early enough.
Since the IPO process can take a lot of time, some companies are adopting the SPAC route to list their companies on NASDAQ. A Special Purpose Acquisition Company (SPAC) is basically a shell company with no commercial operations that is created to raise funds through an IPO to complete the acquisition of target companies in future. They are traded just like any other stock on the exchange. Unlike an IPO where you know the company you are investing in when you invest in a SPAC, you are not aware of what the eventual acquisition target will be. When the acquisition is completed, investors have the option to swap their shares for the shares of the merged entity or liquidate the same. In case no acquisition is completed within two years, the money is returned to investors with interest. Consider the example of ReNew Power, India’s biggest renewable energy company that got listed on the NASDAQ through the SPAC route and achieved a market capitalisation of $4.5 billion. This could be a mode to explore by digital companies in the times to come.
In today’s fast-paced and disruptive world, startups raise funds from venture capitalists. As the company grows, there are progressive rounds of funding that pushes up the valuation of the company. By the time the company reaches the IPO stage, it is fully valued or close to it, leaving very little money on the table for retail investors. There is a mad scramble for allotment as is evident by the number of times the issue is oversubscribed. Since the shares marked for retail investors are quite low, they rush to buy from the secondary market on the date of listing pushing the price up rapidly. Sadly, this is the point where most of the large investors who enter at the pre-IPO stage exit after making a quick buck.
In recent times, the pre-IPO market has become very attractive for retail investors as they seek a piece of the real action before the listing. For high net worth individuals, pre-IPO funds have become the hot favourite as they can buy shares six quarters before the IPO and make a killing on listing day. The IIFL group had come out with India’s first dedicated pre-IPO fund.
Today’s investors have learnt from the examples of Google, Amazon and Alibaba. They don’t want to lose the opportunity by delaying the entry point, if they see potential in a business they want to jump on the bandwagon at the very first opportunity. If you can afford it, you can secure a piece of the action by buying SPAC shares or going through the pre-IPO route. With disruption becoming the name of the game, this sector is going to stay hot and attractive for quite some time.
(The author is Founder, ExchangeConnect. Views are his own)