Being an old-timer, I remember the surge of dot-com companies during the late 1990s. Such was the craze to jump onto the dot-com bandwagon that even garment trading firms from Mumbai’s bustling Kalbadevi rebranded themselves dot-coms. 

Many penny stocks zoomed and many IPOs were launched to cash-in on the craze and dupe retail investors. The dot-com bubble burst very soon but another similar trend was witnessed again – the hype around entertainment and media companies. 

Starting in the year 2000 almost all production houses and many film studios listed their IPOs at a very high premium. When you look at their prices today, you'll see how merchant bankers, chartered accountants, lead bankers, brokers, and a network of investors played a role in creating the buzz. Naturally many made huge profits. But at the cost of many more. 

Nothing could justify the offer value of these IPOs barring a few exceptions. Most vanished without a trace. More or less, every five years there is a trending buzzword on the investor circuit. 

How Valuation Of A Startup Is Done?

The Great Valuation Game

With the recent Startup boom, this is the latest segment that has caught the fancy of this circuit. On one side are genuine, aspirational startups that channelise the energy of India’s youth and innovation. 

On the other side is the valuation game. Technically speaking there are several ways to determine the value of a startup, including the Berkus approach, cost-to-duplicate approach, future valuation method, market multiple approach, risk factor summation approach, and discounted cash flow (DCF) method.

Even as sound business ideas scout for funds, clever operators seek to create hype and buzz around others and try to create a FOMO (Fear of Missing Out Factor) situation. 

Consequently, business ideas that are more based on valuation than on a sound business premise sprout. Start-ups focus on attracting more and more investors to the first and second rounds of funding in their ‘so-called’ five-year cycle. 

In simple terms, the value of a currency increases as many times as it changes hands (velocity of money). Likewise, valuation of a business (velocity of investment), in this case start-ups, is also affected by each and every round of funding. However, this process also triggers doubts as to whether this velocity can be rigged to fabricate greater valuations. 

Are IPOs Overpriced? 

As a natural corollary, Startups are new businesses and their results have to be evaluated over a period of time. 

Many Indian start-ups are undoubtedly great success stories. However, there are others who make news not just for their innovations about their innovations but also the losses they incur. 

Brands like Zomato, Paytm, Nykaa, etc have become household names. However, another aspect related to them is that they have all made news due to the losses they have incurred. 

The question arises whether their IPOs were ‘overpriced’ or based on sound business foundations. 

Powerful networks including – Lead Bankers, Chartered Accountants, Brokers, Merchant Bankers, institutional investors can come together and create hype and buzz. However, the ones on the receiving end could be Indian retail investors.

Separating the Hype from the Substance

A lot has been flagged on social media by well-meaning people. However, BSE or even SEBI often do not do any fact-checking or prudent thinking before allowing IPOs. 

How can a company that has been in business for almost a decade, having received billions of dollars in various funding and still making huge losses, start generating profits with an IPO? 

Or is it just another route for the initial investors to make up for their lost money through the IPO route? I am of the opinion that agencies should investigate big investors in these IPOs and their exits. Also one must look at the valuation at which these Startups diluted their stake in various rounds of funding and the valuation after the IPO.

Look at the top 10 Indian loss-making unicorns (Source: Media reports)

• BYJUs: Rs 4,588 crore
• OYO: Rs 3,944 crore
• Udaan: Rs 2,482 crore
• Flipkart: Rs 2,446 crore
• Eruditus: Rs 1,934 crore
• PhonePe: Rs 1,728 crore
• Paytm: Rs 1,710 crore
• Swiggy: Rs 1,617 crore
• Unacademy: Rs 1,537 crore
• Freshworks: Rs 1,499 crore 

So, if these were loss-making entities, how have they achieved these valuations on paper? Is it more fart and less fact? 

According to Pitch Madison Advertising Report 2022, Startups spent over Rs 8,500 crore on advertising in India. And the figure for 2023 could be more than Rs 10,000 crore (estimated). So, what is the purpose of such massive spending on publicity? 

Despite making losses for years Byju’s got into a jersey sponsorship deal with BCCI last year and then extended it till November 2023 for a reported $ 35-50 million. A total of 35 Startups participated in Tata IPL 2022, as sponsors for an undisclosed amount. 

Definitely, many of them are loss-making Startups having received various rounds of funding and working hard on brand building and value creation for further funding.

The latest in the talk is Nykaa whose value discovery was made by professionals at 1000 times its profit. Mamaearth is reportedly seeking a value discovery of $3 billion through its IPO. 

Taking a dig at such an insane valuation Sana Zabeen a brand specialist in her LinkedIn post said “If Mamaearth can ask for a 24000 crore valuation, you can ask for a 200% salary hike. The problem is that Mamaearth probably get it. You probably won’t.”

On the popular television show Shark Tank India, a profit-making cosmetics Startup Recode's founders were denied funding, causing people to raise questions. 

Making the Valuation Process Objective

Is it a case of the select few who control the process, decide the valuation? To some, the entire valuation process seems suspect. How to ensure that the process is objective and no commercial interests are involved?

Vinay Agarwal, CEO of Innovative Services Private Limited raised this issue in his LinkedIn post. "If you are the founder of a business which is directly competing against any of shark's business and planning to take your business to Shark Tank India for fund raise then dont waste your time coz all sharks have formed cartel (in guise of friendship) that they will not allow competition."

The comment is not an isolated one. The social media is filled with such posts, some rational, some angry, some factual. 

A genuinely profitable Startup may be denied funding and laughed at because it comes from a Tier 3 city. There are the disadvantaged Startup entrepreneurs with limited business vocabulary.

As the Startup movement gains further traction, an underbelly is also emerging. The vital aspect is that no one can be allowed to derail the noble objectives of this fabulous idea