IPO Exit: A Real Exit Possibility for Startups

The Bombay Stock Exchange (BSE). Photo Credit: Reuters

FY21: The Boom and the Glut

Seventeen companies raised money on the Indian bourses in the last quarter, averaging over an IPO every week — highest in over a decade! The well documented “liquidity surge” in the market has created an insatiable appetite for paper among institutions, the well-heeled and retail investors alike. No surprise then, that India was the best performing public market for the 12 months ended March 31st, 2021, with nearly 78% returns for the benchmark Nifty Index, ahead of the US and Japan at around 60% leaving behind market laggards China, UK and HK in the twenties.

Quarterly IPO Issuances, past 8 quarters
Global Indices Performance FY21
Source: Equirus ECM deal Tracker, Mar 21

Amidst all this market euphoria, one more phenomenon emerged — the listing of PE/VC funded companies in numbers far higher than defined periods prior to now. Indeed, 10 of the 17 companies listed this quarter were “startups” funded by private institutional investors. While a few of these are traditional businesses having raised the customary “Pre-IPO” rounds, the other include unusual names like Easy Trip Planners, an app-based travel booking platform and Nazara, India’s first listed gaming company.

Many of these names have been known IPO candidates for years but the bullish market momentum, a changed perspective on profitability (more on that later) and a new-found confidence on market acceptability has accelerated the process for the companies that successfully rang the haloed “bell”.

Growth at all costs Vs Profitability Focus
Rewind twelve months — The Indian startup ecosystem was in the throes of an unprecedented crisis — of sudden loss of business, cash-sufficiency calculations having gone awry, of funding and survival, of anxious uncertainty and the need to do something, well, different. Investor groups and founding teams sprang into action, determined to not perish in the pandemic mayhem, conjuring up pivots of the cleverest thinking, changing business models, customer acquisition and retention strategies, and tough employee decisions.

One of the themes that has struck a note with the whole ecosystem is to try to take control of their destiny through profitability — it is no longer about growth at all costs and throwing fiscal prudence to the winds in the hope of that “next round of funding”, but about making sure that startups are more in control of how they grow, how much they “burn” and how to raise money from a position of strength.

The private funding market has revived sooner than almost anyone expected, just like the public markets; a flurry of investment activity has started since the second half of 2020. But something has changed — Companies are raising money while still having plenty in the bank, the propensity to burn capital to maintain break-neck growth rates has been subdued and many more companies are talking about the holy grail — the path to profitability. It is a healthy change, and one that will endear the startup ecosystem to the Indian public market.

Perhaps the below chart wears a different look for the just concluded FY21?

Unverified financials of select Indian startups
Source: Twitter; @hvgoenka

What does it take to go IPO?

“Profit for a company is like oxygen for a person. If you don’t have enough of it, you’re out of the game. But if you think your life is about breathing, you’re really missing something”

- Peter Drucker

Like most ECM bankers would advise, a company needs defensible business and revenue model, kosher corporate governance, management with strong track-record and ability to plan and predict business outlook to make the cut with fund managers both at IPO and on an ongoing basis — There’s one more thing, a track record of profit. Traditionally, Indian bankers would advise having a minimum track-record for three years of profits as that makes it palatable to the relatively risk-averse Indian investors who have shown preference for profitable companies to those promising future profits.

In the last decade and a half over which tech-entrepreneurship has matured in India, entrepreneurs have chased various lofty metrics to establish a benchmark for their achievement or success — 1 billion USD in GMV/GTV (Gross Merchandise/ Transaction Value, a typically quirky and hazy metric that defines how much business passes through the system) OR 10 million app downloads OR 1 million active customers OR 1 billion USD in private valuation — How about a simple metric like INR 100 Cr (~$13.5M) in profits? We have market validation that past this benchmark, the company will be likely acceptable as an IPO candidate for Indian markets and create favorable outcomes for both founders and investors.

Source: Screener

Above chart lays out precedents of multiple companies going public in the recent times with under INR 100 Cr in PAT and having had strong reception to their respective issues. Now, neither is the 100 Cr of profits a trivial milestone for most companies, nor is the need for companies to pursue interim operating and traction milestones, nor is the ever important “need for speed”. The point is, aligning management and investors to a profitability benchmark can link an outcome for many more companies to an Indian listing than is the case today, and that can change with a cataclysmic catalyst like the pandemic.

Another interesting trend to note is that Indian investors and institutions have gradually come around to the notion that IPOs are not only about raising growth capital from the public markets, but also an equally legitimate vehicle for listing creation, monetization and divestment of stakes by promoters and investors alike. Pure “offer for sale” is no longer the stigma it used to be, which is great news for investors and founders who are planning for IPO to be an exit mode.

The overseas Listing Angle
Many Indian startups are pursuing an overseas listing outcome for a variety of reasons. Typically, the most important one is that valuations on some exchanges like NASDAQ may be more premium than what Indian exchanges may offer. These could range from global SaaS companies to consumer internet startups. The other reason is that some of the overseas markets have higher tolerance for non-profit-making companies listing, provided they show extraordinary growth and have a path to profitability sometime in future (examples like Amazon from the past and Uber in the recent times, the latter valued at over a 100 billion USD at the time of writing this).

Perhaps the argument of pursuing profitability holds less urgent relevance to this set of companies than companies that are seeking a public listing outcome in India, although in the long term, no public listed company can hold on to its relevance (and listed valuation) if eventually the profits do not materialize.

IPO focus — Upstream changes
With the build-sensibly, grow-profitably and go-public line of thinking, there are changes that can and potentially go upstream. Founders starting to think about sustainable product-market-fit and business models earlier than currently, early investors using the “IPOability” filter right at the time of investment, future round investors looking at funding and growing companies more sustainably — all desirable changes that can happen in course of time.

With the knowledge that startups are, by the very definition, risky and often operating at the frontiers of technology and business model innovation, not all companies can or will follow this path. But the ones that are meant to survive and thrive for a multiplicity of factors, this is an approach to think about as eventual outcomes of portfolio investments is concerned. For the majority of technology VCs in India, where M&A and secondary sale to a growth investor used to be the only discussed and documented paths to exit, it is perhaps time to pro-actively add and act towards, an IPO outcome.

India has half the market cap to GDP ratio of US and far less than many of the top economies of the world, signifying that there is space and appetite for a lot more listed companies to be created. Following the lead of institutions, the Indian retail and HNI investor has shown willingness to participate into equities in general and IPOs in particular, diversifying from their traditional comfort asset classes — fixed deposits, real estate and gold. The startup ecosystem has the opportunity and ability to utilize this appetite and create more avenues of wealth creation for the equity market participants.

Source: Gurufocus; April 2021

Sistema Asia Fund Portfolio

Of our dozen company portfolio, we are hopeful that 25% or more companies have a good chance to go IPO. Not only does that make us confident of creating successful fund returns, but also it helps us in answering difficult questions about exit timing and liquidity which is a great asset in a traditionally exit-famished investment ecosystem like ours.

Current SAF Portfolio: Infra.Market, Uniphore, Licious, Rebel Foods, Lendingkart, Healthifyme, Seclore, Kishht, Subtra

Exited Portfolio: Qwikcilver, Netmeds, Wooplr

Venture Investor, Adventure Lover, Amateur Drummer, Travel Buff, F1 Fanatic

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