New-age company IPOs have been a disappointment. Are VCs to blame?

The new-age companies that went public in India had the venture capitalist take away virtually all of their excess returns while they remained private, and when they went public Illustration: Chaitanya Dinesh Surpur
 

India has always been a market which has been driven by public markets and public market investors. Where public markets are involved, the rules of public market investing are applied across companies of all shapes, sizes and hues.

The metrics are straightforward: Public market investors will ask questions about a company’s return on equity, return on capital, cash flow generation, capital expenditure programme, governance practice which includes accounting, and then all these factors are going to be coalesced into a view on the company’s valuation using standard methods like PE (price-to-earnings), price/book value (P/BV).

Whether in a primary market offering or in the secondary market, just look at all the above factors, and then place your bets.

Well, this was the story till the new-age tech companies decided to muddy our peaceful clean waters of India wherein we were sticking to the traditional methods of valuing companies. And suddenly, instead of PE, P/BV, we had to start using something called price/sales.

Price/sales? Why should we use this ratio, which is absurd in every way? We were told then by these new-age companies and their merchant bankers that we were all dated, obsolete, old and, in polite terms, totally clueless about how these companies should be valued.

Truth be told, we indeed were clueless. But the stories were so seductive, and the managements were so slick, that all these offerings were swallowed by dewy-eyed Indian investors.

What happened thereafter is history. Almost all these companies sank. Their stock prices tanked. Their financials stank. But their venture capital (VC) investors, who had sold their stock in the IPOs, were dancing the skank. And while the collective media called these VCs, new-age companies’ managements, and their merchant bankers, skunks.

We know that we, lowly natives, were not equipped to handle such esoteric valuation terms like price/sales, let alone figure out “take rate”, “GMVs” (gross merchandise value) and stuff like that. But was that the real reason why most of these companies have disappointed in post listing stock price performance?

Well, the answer to this question is a question that I pose to you: Tell me, the best companies in the last 30 years that you can think of across the world. Let us start: Microsoft, Apple, Tesla, Amazon, Infosys and HDFC Bank. Pretty good list, isn’t it?

Why do we consider them in the Hall of Fame of the great companies of the world? Answers: Great management, vision, execution, amazing products, innovation, etc.

Only one metric is the reason why we consider these companies to be great: And that is long-term stock market returns that have handily beaten the respective benchmarks over a long period of time.

Therefore, now we have a simplified perspective of what is a great company. Simply put, all these companies and their founders and their managements are put on the pedestal simply because they have made us a lot of money. We do not want to admit it because it makes us look too commercial and, therefore, we invent excuses like “these companies have great products” or “they have great governance”.

But the real question is: What is common to all these companies? Without exception, all these companies went public within the first few years of their birth. HDFC Bank IPOed in 1996, when it was still a startup in every sense of the word. Amazon IPOed in 1996, again when it was just a startup bookseller. Tesla IPOed in 2010, at which point it did not even have a car that could be called a car. Infosys in 1993, when it was small in every sense. Same with Microsoft, which IPOed in 1986.

Also read: Investor appetite fading for IPOs of new-age tech companies

The thing that binds all these companies is that they had virtually no venture capital or VC supplying capital for the initial several years. They went public quickly and that is the crucial difference between these great companies and the mediocre, these great stock price returns and the mediocre returns. if you can even call them that from the Indian new-age technology IPOs.

Every company has a finite period of excess returns relative to market. If a VC comes in at an early stage and keeps supplying the capital required for this company to achieve a certain size and scale, then that VC has taken away all that or most of the returns that this company would make for its investors—be it venture capitalists or listed market investors.

All the companies that I mentioned went public really early and, therefore, the returns that were embedded in their long-term future were enjoyed by the public market investors.

The new-age companies that went public in India had the venture capitalist take away virtually all of their excess returns while they remained private, and when they went public, they were already a fully baked cake which could not inflate much more and, on the contrary, would deflate as the air went out once pricked. And that is the answer to the mystery as to why the new-age companies that went public in India in the last two years have largely been a disappointment.

Great companies become great because they deliver great returns to investors over a great period of time. And in order to be able to do that, great companies go public quickly and early in their life cycles. I always encourage good companies—which are early-stage companies—that they should go public sooner rather than later because the halo effect of great stock price returns that small retail investors make remains durable for years and decades. While the great returns that venture capitalists make are shared just amongst a handful of cosy club VC members.

There is no punya (virtue) that a company earns in that. The real punya is making millions of small investors rich. And, therefore, the founders of new-age tech companies planning to go public in the future should read this article several times to get it into their heads that real greatness lies in making great money for a great number of people and not for just a handful of fat cat VCs. And, for that, they have to hit the IPO market as soon as it is legally possible.

Make the retail investor restore your venture capitalist. In a vast and deep and liquid retail investor market like India, there are millions of small guys wanting to be your venture capitalist. Give them a shot.