Many of us are flummoxed by startup valuation, as we speculate on why certain IPOs succeeded or failed.
The offer price of recent IPOs in the market appear to be an important deciding factor in its success. Timing and market perception matter too.
Zomato walks away with a good deal despite being a loss-making company. It comes in early and encashes on liquidity floating in the market.
PayTM and Star Health Insurance come in later, when funds are drying up.
WHERE WILL YOUR MONEY GO AFTER THE IPO?
The funds collected in an initial public offer are commonly used as follows:
- To cover the cost of the IPO launch – largest component is underwriting fee, legal fees, marketing cost and fees paid to other consultants.
2. Early investors offload their stake and move out. The initial transactions on the bourses are generally between old and new investors, not new investors and the company.
3. Repaying debts
4. Expansion and new initiatives
Offloading of stake by early investors and repayment of debts is not a positive sign. It shows a lack of faith by early investors in the company’s future. The market did go against PayTM and Star Health for this reason. PayTM is seen as a cash-guzzling company, though it did show merchant acquisition in its expansion plan.
Nykaa shows all three plans – expansion, repayment of debts and broad-basing merchant networks. It wins the game.
Star Health fails to provide clarity on proposed utilisation of funds, and loses.
PROMOTERS’ SKIN IN THE GAME
Nykaa is a clear winner with the promoter family holding 52% of stake in the company.
One can argue that Zomato with a promoter’s stake of 4.71% , and Policy Bazaar with 3.84% had oversubscribed IPOs too. All said and done, a promoter’s skin in the game matters to an investor. If a promoter has a lot to lose by letting the business go down, it remains alert.
Why valuation is important?
It determines the optimum offer price for an IPO.
A high offer price seems to have had a negative impact on PayTM and Star Health IPOs. The merchant bankers designing the Initial Public Offer of a company, decide the offer price, based on the valuation they do.
A low offer price attracts investors, but also leads to the company losing out on market potential. Then comes a long wait for share prices to move up. Retail investors come in to sell the share at a higher price on listing, and are not in it for the long run.
A high offer price dissuades investors from entering, as they fear a fall in share prices and consequent losses.
Hence, the offer price needs to be structured carefully after following certain valuation methods.
What kept mutual funds away from the Star Health Insurance IPO? They couldn’t digest valuation done on basis of revenue, instead of profit.
What repelled investors from PayTM was the high valuation despite huge losses, and perceived competition from UPI-like apps.
COMMON STARTUP VALUATION METHODS
- Absolute valuation
This method evaluates the wealth of a company in terms of time value of money.
2. Relative valuation
Here, the analysts compare the wealth of a company with that of its competitors.
3. Discounted cash flow method
This is a complex methodology using techniques to assess future cash flow, investment, revenue flows etc. calculations form the basis for absolute valuation too.
4. Economic valuation
These parameters taken into consideration by this method are businesses residual income, debts, value of assets owned and liabilities and risk-bearing potential.
5. Price to Earning Economic Valuation
This compares the total market capitalisation with the profits made by the company.
Find details on other methods of evaluating a startup here.
FACTORS AFFECTING STARTUP VALUATION IN IPOs
- Total number of shares
- Growth Potential
- Financial performance
- Business model
- Anticipated demand from investors
- Current market price of companies listed in the same sector.
- Overall trends in capital markets