The risk factor

New-age tech firms are inherently more risky

The initial public offering (IPO) of Paytm managed to sail through, but the listing has been a debacle. India’s largest-ever issue raised Rs 18,300 crore for the parent company, One97. But a disastrous price-drop on listing wiped out an estimated Rs 38,000 crore of market value and the sell-off has affected the worth of unlisted start-ups. The regulator is reportedly seeking an explanation from the company, and the merchant bankers concerned, as to the possible underlying causes. While the Securities and Exchange Board of India (Sebi) is well within its rights to enquire as to whether investors were misled by the offer document, or statements made during roadshows, it must never be forgotten that equity investment carries no guarantees. The old adage of “Caveat Emptor” or “Buyer Beware” always applies to equity investment in general, and to new-age technology companies (NATCs) in particular. Any business carries risks, which an equity investor must be prepared to bear; NATCs carry higher risks since their business models are by definition unproven.

NATCs often carry large losses into their IPOs. In many cases, such businesses also state upfront that further losses are likely. The focus is on growth and market share, with profits being very much a secondary consideration. Unlike in a conventional business, NATC investors don’t “buy” the balance sheet; they buy a narrative promising vast returns sometime in a potential future. This model has worked for success stories like Amazon, Uber, and Tesla, which have multiplied the wealth of shareholders. The flip side is an inevitably low “strike rate” with several NATCs going bankrupt for every single one that succeeds. There are often wild swings in NATC share prices, given unconventional business models which are hard to assess. For example, IPO investors in Facebook and Google suffered huge losses in the first few months of listing before the market trend reversed.

Sebi eased regulations to allow loss-making start-ups to access the primary market relatively recently. Indian investors are still in the early stages of the learning curve when it comes to understanding NATCs. In addition to allowing companies with losses to launch IPOs, the Sebi reduced the lock-in period for early-stage investors to one year, from the earlier two years. It also allowed start-ups going public to make discretionary allotments, subject to a lock-in period of 30 days. Allowing start-ups to raise domestic capital and list on Indian exchanges has worked in the sense that several NATCs have listed and many more are aiming to tap the primary market. Buoyant market conditions have obviously contributed.

Many of the 100-odd unicorns in India are seeking listing, and most are loss-makers. Zomato, which had a successful IPO, has gained in market value after listing and declaring further losses. The similarly successful Nykaa is barely profitable. Policybazaar is also loss-making and doing well on the stock markets. Paytm is also loss-making, of course. Among prominent NATCs reportedly preparing for IPOs, Ola is loss-making and so is MobiKwik. Recent proposals by Sebi seek more clarity about the allocation of IPO funds, including funding for unspecific acquisitions and general corporate purposes. They also place more constraints on pre-issue shareholders in terms of offer for sale and lock-in periods. While these measures may offer comfort to IPO investors, the bottom line remains: NATCs are highly risky businesses and any investor in these businesses must be prepared for a roller-coaster ride.