Why Do Loss Making Companies Like Meesho, PayTM, Zomato Launch Their IPO?
It is almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors).
– Warren Buffett
This statement by one of greatest investors in the globe sums up the intention of the situation we are trying to highlight pretty evidently.
Understanding startup funding
The money needed to launch and maintain a firm is referred to as funding. It is a monetary investment in a business for inventory, office space, sales & marketing, manufacturing, product development, and expansion.
An initial public offering (IPO) is the procedure of releasing fresh shares of stock to the public for the first time in a private firm. A corporation can raise equity funding from the general public through an IPO.
INR 3.5 trillion Wiped off by IPOs of 5 companies
A report released in November 2022 displayed statistics mentioned below which show the reality of Startup companies and condition of IPOs.
Investors were in a state of shock as a result of the top 5 biggest Initial Public Offerings (IPOs) of 2022, which collectively destroyed an astounding INR 3.5 trillion in market value. These much-awaited IPOs, which were supposed to change the game, ended up being huge letdowns that cost public investors a lot of money.
Zomato, a well-known food delivery service that has been struggling with losses for years, was one of the primary culprits in this destruction of wealth. Zomato attracted investors’ attention when its market valuation peaked at INR 1.4 trillion. But when reality soon sank in, its market cap dropped to just INR 592.6 billion, wiping off more than INR 800 billion in wealth.
In the similar manner, Paytm, which was frequently hailed as the leader of India’s fintech revolution, fell short of expectations. Paytm, which tried to do everything at once and had a complicated business plan, peaked at INR 1.2 trillion. Its market capitalization is at INR 396 billion, which represents an alarming loss of wealth of INR 800 billion.
Even the biggest and most anticipated IPO in the country, LIC (Life Insurance Corporation of India), was unable to avoid the curse of underwhelming performance. LIC, hailed as the bulwark of stability and expansion, peaked with a market value of INR 5.5 trillion. With its current market valuation of INR 4.1 trillion, it has disappointed, causing an extra INR 1.4 trillion in wealth loss.
The parent firm of Policybazaar, PB Fintech, too saw a similar declining trend. At its height, Policybazaar’s market valuation reached over INR 650 billion thanks to the IPO’s strong investor interest. Despite this, the company’s market cap remains stuck at INR 174 billion, causing an awful loss of wealth of INR 476 billion.
Another highly anticipated firm, CarTrade Tech, saw its market valuation plummet from over INR 72 billion at its height to just INR 23 billion, wiping off an extra INR 50 billion.
While these five initial public offerings (IPOs) dominated the wealth destruction spectacle, other businesses, such as Delhivery and Nykaa, have also experienced significant drops since their IPOs, adding to the overall market value erosion.
The large losses suffered by investors have prompted questions about the market’s IPO frenzy in 2022. Many investors put a lot of money into these IPOs, propelled by FOMO (fear of missing out) and seduced by the promise of quick riches, only to be confronted with the harsh reality of market dynamics as well as company performance.
It becomes clear from expert analysis of the factors contributing to these IPOs’ poor performance that thorough due diligence and comprehension of a company’s fundamentals are essential for making wise investment selections. The excitement around IPOs frequently conceals the inherent risks, which can cause significant losses for inexperienced investors.
The Freebie and Discount Philosophy
Marketing with freebies is nothing new. It has lasted for a very long time. Everyone is aware that the best way to entice clients, generate traffic, and boost sales is to give freebies and discounts. You must have observed a few businesses routinely offering free products in the previous several years in an effort to win over clients to their brand.
The explanation is straightforward: people enjoy receiving freebies. People adore the power of freebies, whether it be grocery store samples, giveaways at trade shows, or a prize they win in a contest. Therefore, when you provide your customers something of value, you promote your brand and persuade them to purchase into it.
However, startups today use it in a different way.
Here are the steps-
- Start a company.
- Get users. Advertise, offer unusual discounts and freebies.
- By displaying users, seek out investors.
- Once angel funding is received, founders pay themselves well. Then they hire more staff to rapidly expand.
- When the first significant investor steps forward, the founders sell some shares to that person. Earning money for themselves.
- Next investor comes in, founders and previous investor sells some of their shares to the new investor. Generate income for themselves.
- Keep on repeating Step 6, as many times as you can.
- Sell the company or Shut it down.
Regardless of the company’s outcome, the founders and some investors would have made a ton of money by this point. Of course, this is a huge over-simplification of the fraud which actually takes place, but it provides you a general idea. It starts to resemble a pyramid marketing operation with multiple levels.
Why do investors invest in loss making startups? How do they make money?
Investors put money into startups that are losing money since they know they will profit while the public may lose money. It may do so in the following ways:
Overvaluation and Pre-IPO Scams: Scams involving pre-IPOs may occasionally be carried out by deceitful individuals or businesses. In order to make a firm or its assets appear more desirable to potential investors, they could artificially inflate their value. Early-stage investors are drawn in by the perception of strong growth potential as well as scope for profitability produced by this overvaluation.
The benefit of initial investors: Initial investors, often known as venture capitalists or angel investors, take part in the initial investment rounds of startups. They stand to win handsomely when the firm goes public at the inflated IPO price if they were able to invest at a significantly lower valuation prior to the artificial inflation. Early investors may earn significantly from this disparity in valuation.
Pump-and-Dump Schemes: In some cases, dishonest players may artificially inflate the stock price by a variety of strategies, such as disseminating rumors or fake positive information to “pump” up the stock’s value. These people or companies “dump” their shares after the stock price reaches a specific point by selling them at the inflated price, generating substantial gains while leaving regular investors with overpriced and possibly worthless securities.
IPO to Cover Losses: Early investors in a startup that is having trouble or is not making money may seek to exit through an IPO. Even though there are concerns about the company’s long-term financial prospects, the IPO enables them to sell their ownership and recover part of their investment. They are able to make a profit and offset their losses by selling their shares to the general public at the inflated price.
False Information: In some situations, businesses may publish false financial data or predictions in an effort to persuade investors that their business will be profitable in the future. These exaggerated forecasts may increase the stock price, which will be advantageous to early investors who can later resell their shares for a profit.
Losses to the Public: Due to a false feeling of strong growth potential and profitability, the general public, especially retail investors, who participate in the IPO or buy the stock after it goes public, may end up purchasing shares at an inflated price. The stock price may fall, costing these investors money, when the company’s true worth is discovered or when the bubble bursts.
Failure of Indian Startups like Meesho, Zomato, PayTM
The founders of Indian startups these days claim to have devised a formula for brilliance that entails selling goods for absurdly low costs while squeezing their investors dry. But let’s face it, this strategy lacks true business acumen and raises fundamental doubts about the viability of these endeavors.
A true testimonial to intelligence and vision in the business world is the ability to make anything profitable. It reveals a founder’s capacity to recognize market demands, create an alluring company plan, and provide value to clients while assuring a good return on investment for stakeholders. On the other hand, there are the “loss-making virtuosos” who believe that selling goods at exorbitantly low prices is the key to success.
Even though it might initially draw a lot of clients, this excitement is frequently fleeting and ends when the money runs out. Relying on this strategy not only hurts investors, but it also raises fundamental concerns about the startup’s long-term viability.
Understanding that lowering prices to an unsustainable level without a clear route to profitability is crucial. When the inevitable crash arrives, it is a slippery slope that ends in a dead end, leaving workers without jobs, investors dissatisfied, and clients looking for alternatives. The majority of start-ups in India have experienced this, which is why they issue initial public offerings (IPOs), attempt to recoup investors’ costs, and ultimately shut down.
Indeed, why work so hard to create a successful company when you can enjoy the benefits of negative cash flow? Showing potential investors that their hard-earned money is in the capable hands of true prodigies who understand how to bleed funds like there is no tomorrow is the most effective way to impressing them, according to these startup wizards.
Meanwhile, those dull, traditional businessmen concentrate on the laborious work of making profits in a parallel realm where logic still rules. How incredibly ordinary! They might build long-lasting companies that pay off investors and offer customers value, but who needs that when you can simply ride the hype and hollow promises?
SEBI and the road ahead
The Securities and Exchange Board of India (SEBI) must take the necessary actions to maintain openness and safeguard the interests of the investing public in light of the worries expressed over IPO scams, overvalued shares, and loss-making startups. In order to maintain investor confidence and regulate the securities industry, SEBI is essential. Following are some actions SEBI can take to solve these problems:
Thorough Due Diligence: SEBI ought to impose stronger rules that call for extensive due diligence before a company goes public. This should involve a thorough analysis of their financial situation, business strategies, sources of income, and market potential. Startups that want to go public should be closely inspected to make sure they have a realistic chance of becoming profitable.
Independent Audits: Requiring independent audits of businesses preparing to go public can aid in spotting any inconsistencies or false financial data. To ensure accuracy and transparency, these audits should be carried out by respected and objective auditing companies.
Disclosure Standards: SEBI should implement detailed disclosure requirements that force businesses to give prospective investors accurate and timely information. This includes disclosing risks, financial results, business plans, and probable difficulties. Investors can make wise selections if they have access to transparent information.
Cap on Valuations: SEBI may impose restrictions on the company values made during the IPO process. It can avoid overvaluation and save investors from speculative bubbles by ensuring that valuations are based on reasonable and defensible parameters.
Promoter Lock-in Period: Implementing a required promoter lock-in period after an initial public offering (IPO) can match founders’ interests with long-term business performance. This motivates promoters to concentrate on sustainable growth and discourages short-term profiteering.
Enhanced Examination of Loss-Making Startups: SEBI should examine startups more closely if they have a history of losses or no product distinction. For these businesses to become lucrative in the future, they must present a detailed and workable plan.
Strengthening Investor Education: SEBI should fund comprehensive investor education initiatives to increase financial literacy and awareness among the populace. Investors with more knowledge are better able to spot unsafe or dishonest investment possibilities.
Market Surveillance: In order to identify and prevent market manipulation, pump-and-dump schemes, and other fraudulent practices that could raise share prices artificially, SEBI must improve its market surveillance procedures.
Whistleblower Protections: In order to encourage people to come forward with knowledge regarding potential scams or fraudulent practices without fear of retaliation, SEBI should implement robust whistleblower protection mechanisms.
Strict Penalties: Companies and people found guilty of deceiving investors, giving incorrect information, or indulging in fraudulent operations shall face strict penalties and legal repercussions from SEBI.
SEBI may foster a more reliable and sustainable capital market environment by implementing these steps, which will increase transparency in the IPO process, safeguard investors from losses brought on by inflated shares and loss-making businesses, and protect investors from overvalued share losses.
The ultimate objective is to promote investor trust and confidence in the Indian securities market while fostering genuine entrepreneurship and ethical business practices.
The startup ecosystem in India confronts considerable obstacles, and educated founders frequently struggle to build profitable businesses. Lack of distinctiveness and a strong selling proposition among startups is one of the key problems. Numerous businesses fall short of providing distinctive solutions or addressing particular market demands, which results in fierce competition and the inability to draw in and keep clients. As a result, some firms turn to dubious methods and con games to make money, further undermining ecosystem trust.
These immoral methods damage the credibility of the entire startup ecosystem in addition to eventually resulting in shutdowns. A strong business IQ, an awareness of the nuances of their target market, industry trends, and the significance of a sustainable company model are essential for founders to flourish in this environment.
In India’s startup environment, a strong emphasis on genuine innovation, moral behavior, and offering genuine value to customers will be essential for building successful firms. Additionally, creating a welcoming atmosphere where entrepreneurs have access to resources like finance, mentorship, and fundraising can help them create strong businesses and have a beneficial impact on the expansion and development of the startup scene in India.
