Things to look out for before investing in a tech-startup IPO
Looking back at 2021, tech startups in India have mopped up $20 billion this year by going public. It was also the year that saw several unicorns turn into public companies. Some notable names include Zomato and Paytm who floated IPOs worth $1.1 billion and $3 billion (the biggest we’ve seen) respectively. Most funds raised through IPOs this year were used to offer an exit to existing PT/VC funds or to existing promoters and shareholders.
December 2021 will also witness some much anticipated IPOs, including that of Rakesh Jhunjhunwala-backed Star Health that aims to raise ₹7,249. Anand Rathi Wealth opened its offer for ₹660 crore and RageGain Travel Technologies launched a ₹1,336 crore IPO. Following suit could be Delhivery, MobiKwik, CarTrade, Freshworks and Flipkart. And with so many companies going public it is essential to know what exactly to look out for before investing.
Firstly, it is very important to distinguish between an IPO and a ‘Startup’ IPO.
This is crucial because most companies that fall under the ‘Startup’ category are loss-making organisations — which is not necessarily a bad thing. Take for instance Zomato. In its Draft Red Herring Prospectus, Zomato clearly highlighted its history of losses and a possible increase in expenses that might further push expenses upwards. Infact, Zomato incurred a net loss of ₹682 crore for a nine-month period ended in December 2020 and a net loss of ₹2,385 crore for FY 2019-20. Zomato is just one among several B2C tech startups that are loss-making.
More mature markets like the United States have also seen such IPOs in 2020. Companies like Airbnb, DoorDash and Snowflake were all loss-making entities. Yet Airbnb had a $3.5 billion IPO and crossed the $100 billion market cap mark on listing.
What we must remember is that the growth journey of tech startups is very different from that of legacy companies.
Legacy companies go public to solidify their stature and rope in funds to expand their business after already achieving a great deal of stability. That’s why investors look for the organisation’s current performance and potential to multiply investments before investing. However, new-age companies go public to fund endeavours to increase their user base and stickiness and only when their offering becomes a must-have to their users do they monetise. That’s why it is essential to assess a start-up’s road map for profitability, potential future performance, and exponential customer growth before investing in IPOs of new-age companies.
Amazon is a frequently cited example among companies that went public during the loss-making phase. In fact, it took Amazon 10 years post listing to deliver profits and grow its stock valuation by 12,040%.
The success of the Amazon model does not translate into sure-shot success for any fast-growing company that takes this route for growth.
That’s why investors must exercise caution and look for key-indicators that suggest exponential growth even though the company as a whole might not be profitable. These indicators may include the company’s competitive advantage, vastness of the user base and how many users remain to be captured, important marketing metrics like cost of customer acquisition, feats in product development, and corporate governance.