Santosh N., senior advisor, Duff and Phelps.
Santosh N., senior advisor, Duff and Phelps.

‘Not all startups will see a sharp rise in valuation when raising more funds’

  • Santosh N. believes that while revenue growth will continue to score over profitability for startups
  • Santosh N. explains why foreign investors continue to believe in India and why they can expect significant returns on their investments

Santosh N., senior advisor, Duff and Phelps, one of the largest valuation service providers in the world, believes that while revenue growth will continue to score over profitability for startups, not all of them will see a sharp increase in valuations.

In an interview, he explains why foreign investors continue to believe in India and why they can expect significant returns on their investments over a period of five to seven years. Edited excerpts from the interview:

How are foreign investors perceiving India?

A crucial component of a healthy private equity/venture capital (PE/VC) ecosystem is an investor’s ability to exit the investment and make attractive returns. The general sentiment, driven by attractiveness of the Indian market from a growth perspective as well as recent successful exits, have given confidence to investors that it is possible for them to realize significant returns on their investments in five to seven years.

Startups in India have seen steep valuation jumps. Is it sustainable?

Valuations are high in India and it is true for growth-oriented markets where revenue growth still scores over profitability, at least in the short-to-medium term. Certain sectors like fintech and consumer internet have seen massive capital inflow due to the available opportunity and their ability to disrupt other industries, which is driven by lack of organized players and demographics. The sector might consolidate as well, and therefore the valuation jump could now not be across the board.

It will be either driven by the category leaders/successful first movers and/or differentiated players. Consolidation among PE/VC players in their portfolio companies could also drive valuations.

It is difficult to predict if new financial investors would come in, as most of the marquee names are investors in India already.

The game changer could be strategic investors via their in-house venture funds (Google, Unilever, Infosys, etc.).

They are constantly scouting for innovative startups and looking for partnerships, strategic alliances, outright purchases to keep up with tech innovation and compete with new age startups.

Will SoftBank raising its next fund impact its deal-making activity in India?

At this stage, although India is a large unexplored market, it will still take some time for the market to mature and absorb investments of the quantum that the fund is intending to invest.

The first fund had earmarked cost to $20 billion into India and had deployed approximately half of it before making a profitable exit in Flipkart. I see them continuing to invest in India via the first fund. The biggest impact of the vision fund could be exits to VC investors on some of the consumer internet companies. This would have a positive impact on the PE/VC space and could spur deal activity.

In addition, Softbank might start making early-stage investments in India through their Asia-dedicated fund.

As more and more new businesses are being built, are you looking at innovative ways of driving valuations, compared with the traditional world?

Often times, it is difficult to value these new age companies using the traditional income approach or comparable companies’ method. The companies may not have positive cash flows in the projected period and may not have reliable projections in the first place. Similarly, as most startups differentiate themselves as disruptive and unique, it is often difficult to find other companies that are comparable to them and have reliable data on their valuation multiples.

Similarly, it is difficult to find comparable transactions like the host company. The new age businesses need innovative perspectives to value them. For example, traditionally, one would look at multiples for revenue or profitability of comparable companies to value.

Sometimes, these metrics do not capture the uniqueness of the business. Multiples such as enterprise value or the number of users or the number of active bots created is then considered.

Alternative methods sometimes used to value these companies include a VC exit formula method, or a score card method (comparing a fund seeking startup to other funded startups adjusting the average valuation on factors including market and stage). Eventually, the use of professional judgement is a key component of estimating value.