Stratospheric Startup valuations benefit select few, but wreck many minds
Any startup valued upwards of $1 billion are called Unicorns. Stratospheric valuations have been witnessed with creation of international Unicorns viz Uber, Xiaomi, Palantir, AirBnB, SnapChat and closer home in the likes of FlipKart, SnapDeal, Ola or PayTM.
The key driver for valuations reaching dizzying heights is that each new Private Equity (PE) Fund (say X) which invests in a Startup, is protected by few clauses in its Share Purchase Agreement (SPA). One clause protects the valuation at which it is investing by forbidding future infusions (from PE players entering down the line – say Y) at a valuation lower than at which X entered. In case Y enters at a lower valuation than X’s, extra shares are issued to X and its shareholding remains the same. Another clause makes it even easier for X – It says in case of any kind of exit opportunity available to investors of the company, priority would be given to X to liquidate its shareholding, against previous investors to X.
These clauses have resulted in PE Funds lapping on to exponentially growing companies, unbothered by the stratospheric valuations being accorded and thus creating an explosion of Unicorns on the Startup landscape. Startups like Uber and AirBnB have valuations in multiple billions, thereby surpassing traditional companies in spaces as varied as Oil, Pharma and FMCG. This seems to be an anomaly and hence surprises many.
Such hype around stratospheric valuations of Startups has shifted the focus of traditional entrepreneurs from their businesses to becoming billionaires overnight. Traditional businesses make a standard 10-30% markup on their sales, with a standard business growth of 10-20%. Comparing their linear returns with exponentially surging Startup or Real Estate valuations, was always an exercise in futility.
The same happened when Real Estate prices went through the roof, shopkeepers started comparing their profits with the probable rentals they can make, given high market value of their shops, and many chose to shut shop, rent out their property and became property dealers. Subsequent Real Estate crash burnt most of them. These conservative, traditional businessmen could never understand the reasons of hyperinflation in Startup valuations, Real Estate and stock prices.
Another aspect of the crazy valuations is that by taking money from investors outside of the Stock Exchange route, these Startups manage to avoid many of the disclosure requirements and are hence, able to keep their business secrets private.
With global phenomenon now affecting all Global indices, listed companies are prone to see their market capitalization fall, but most unlisted Startups keep growing in value. Recent events of FlipKart’s valuation getting marked down by its Investors are more an exception since they are Balance sheet actions, driven by mark-to-market accounting practices.
Over the long term, it is seen that valuations of Private, Unlisted companies grow faster compared to their listed peers.
Some of my articles explained these issues in greater detail, see below:
More in next Part, next week