Start-up valuation: down, but not out

After the recent cut in Flipkart’s valuation by Morgan Stanley and Rowe Price by 27 per cent and 15 per cent, respectively, down revisions seem to be the new normal. Two more funds – Valic and Fidelity Rutland Square Trust – have marked down the company’s stock price by nearly 30 per cent and 40 per cent, respectively. HSBC slashed Zomato’s valuation by 50 per cent — from $1 billion to $500 million.

Such big hair cuts could mean that subsequent fund raising may happen at lower valuations than earlier round – also known as ‘down rounds’. Data on US start-up valuation trends from CB Insights show that the pace of down rounds and down exits is increasing. For instance, there were only seven down deals in VC-based start-up in the third quarter of 2015; it doubled to 14 in the first quarter of 2016. The addition of unicorns (companies with $1 billion valuation) has correspondingly slowed from 25 per quarter to five in the same period.

Not new

Down rounds and exits are not new for Indian start-ups. Venture Intelligence data show that many companies had raised funding at reduced share price in the 2013-15 period as well. For example, Fashion and You, backed by VC firms such as Norwest Venture Partners, Intel Capital and Sequoia Capital India, saw a deep discount to its November 2011 valuation, during its June 2014 funding round.

The acquisition of Commonfloor by Quikr is said to be at a discount to the $160-million valuation that Google Capital funded it at. Likewise, Baby Oye’s acquisition by the Mahindra group is another exit that is said to have led to losses and write-offs for investors such as Accel Partners and Tiger Global.

Limited risk

While fire sales for weak businesses may continue, market observers feel that the risk of down rounds may be limited. For instance, down rounds may not be a concern for early-stage companies, says Karthik Reddy, Managing Director, Blume Ventures. It is likely that sliding valuations may only pinch B2C e-commerce start-ups, as they saw the steepest rise. “B2B plays were never a part of this wave per se. Their valuations may continue to be suppressed but they are unlikely to bear any brunt of down rounds,” he says.

Even among B2C businesses, those that have multi-channel distribution may not suffer that much as internet-only players, says Sharath Naru, Managing Partner, Ventureast. He feels that among the stakeholders, investors typically have protections and may not be impacted. “Many of the deals may be structured and could have unrealistic targets, hiding lower valuations,” he says. So, there may not be any immediate pain and only when the shares convert down the road, the reduced valuation will hit promoters and employees with ESOPs.

Shailesh Ghorpade, Managing Partner and CIO, Exfinity Venture, feels that many of the big players have collected a war chest and may defer equity capital raise. “There is growth happening, so founders will look at debt options such as loan against receivables when they need funds,” he says. So there may not be an immediate hit to valuations and it may seem that all is well.

Many benefits

Rationalisation of valuations may not be all that bad and certainly not bad for everyone. For one, the ‘queered pitch’ created by money pumped in by hedge funds that ratcheted up valuations has given way to more caution and diligence, says Ghorpade. “It will be back to basics such as unit economics; multiples will not be just based on market leadership or GMV growth alone,” he says.

Also, the race to be first by throwing money around, driven by the belief that the winner takes all, may be over, say VCs. “Companies will try to find their niche and chalk their path to profit by focusing on new sectors instead of everyone wooing the same set of customers with discounts,” says Naru.

There may also be some winners in the current environment. Companies that offer solutions to reduce costs will likely benefit as start-ups focus on improving efficiencies. For instance, analytics could become important as start-ups want to do marketing with a focus by knowing who to offer discounts to.

Venture and strategic investors, who were waiting for an opportunity to invest, may find good opportunities in the near-term. There are many local funds and foreign funds focussed on India as well as corporate houses that are waiting to invest where they see value.

And promoters with a long-term view should not worry about raising funds at a lower valuation, advises Naru.

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