Paytm was a sparkling success story from the Indian startup ecosystem, with a valuation of more than $1 billion placing the payment app among the country’s highest valued fintech firms. But when the company decided to go public and raise money from shareholders, the unicorn wasn’t able to keep up with the bulls, as its euphoric stock market debut turned out to be a dud. Among other reasons cited for this failure, overvaluation of the company stood out as a factor that had also led to similar listing debacles for other tech startups such as WeWork.
Investors in India are now complaining about inflated startup valuations based on accounting that lacks transparency, and the Securities & Exchange Board of India has decided to act. The regulatory authority has asked investment funds to share details about their valuation practices, to understand how venture capitalists and private equity houses value the startups that they are backing. According to a report by The Economic Times, SEBI is taking a closer look at the hiring process and qualifications of a valuer, along with the valuer’s link to the fund as an associate or sponsor.
What is the regulator looking for?
Along with the credibility of the valuation process and the methodology employed, the market regulator can also observe practices adopted by different funds since there are no regulatory guidelines for valuation of startups. The SEBI directive is also seeking details including the date of the latest valuation, cost of total investments and valuation of the investment portfolio. It also wants to know if valuation is based on audited or unaudited data of an investee, along with details about additional valuations and deviations from the methodology adopted for valuing a startup.
Picking the most suitable factors?
Now unicorn, seed funding, incubator financing, angel investor and venture capital among others have created the image of a thriving startup ecosystem with exciting business ideas. But investors have largely been drawn towards startups based on the allure of their ideas, instead of the value attached. The result is that valuations are decided on how attractive a concept is, how reasonable a business plan is, the background of founders and their expertise.
Opaque formulas with aspects such as gross merchandising value, and number of users on their app for multiple rounds of funding. The reason for this is that Earnings Before Tax Depreciation and Amortisation (EBITDA) or cashflow have to be ruled out, since the startups aren’t posting profits initially. There’s lack of transparency since it isn’t specified if revenue comes from commissions or money that apps charge on product listings, or from actual sales.
Knocked out in the trading
The valuation keeps multiplying in each round of funding, based on insights from foreign investors who have a higher appetite for risk. But shareholders in India prioritise conventional factors such as earnings and profitability, which is why IPOs such as Paytm crash due to the weight of their own overpriced stocks.
Another flawed approach is that while making long-term predictions, businesses are a bit too optimistic about the demand for services in the Indian economy. In case of Paytm, the investor interest fizzled out when the company wasn’t able to secure a license to launch a lending business.
So now India’s startup ecosystem has more than a 100 unicorns, but with firms such as Paytm turning out to be overvalued, a different picture may emerge if SEBI introduces norms for consistency in the valuation process.