Opinion | Why profitability and sustainability matter most on the IPO route3 min read . Updated: 11 Sep 2019, 11:10 PM IST
Small startups that can be run profitably are the best candidates to raise money through an IPO
The initial public offering (IPO) of Alphalogic Techsys has sparked excitement in the startup community about the possibility of raising money through public markets becoming a reality.
It’s time to take a fresh look at the background to really understand what problem raising money from the public markets was expected to solve for startups in the first place, and then evaluate what implications an IPO could have on the startup funding scenario.
One of the greatest innovations in the financial world, after banking, is without doubt the idea of a public limited company, or PLC. A PLC allowed the risk to be spread in such a manner that any investor was exposed only to the extent of his or her investment in the company. PLCs allowed part ownership of a company by the public, and the company itself became a legal entity. Projects that required huge capital outlays could suddenly be undertaken. This structure helped de-risk a promoter in the event of the company going bankrupt, and, in the process, took entrepreneurship and risk-taking to an altogether different level.
While this construct allowed entrepreneurs and promoters to dream big and undertake mega projects without the risk of being taken to the cleaners if things went wrong, these companies were subject to far more stringent levels of governance, transparency, and disclosure than privately owned companies, for the simple reason that investors in public companies were ordinary folks like you and me.
On the other end of the spectrum were startups with no clarity on whether their idea would succeed. Quite naturally, only risk capital was available to startups.
Now, you can’t obviously have the best of both worlds. But behind the recent clamour for a separate platform for startups to list was the underlying belief that venture capital firms don’t allow them a free hand. This is not necessarily completely true. There were investors, mostly with an entrepreneurial stint in their prior lives, who were more supportive of entrepreneurs and there were investors who tended to micromanage.
Part of this frustration among entrepreneurs was misplaced, in my opinion. You can’t take huge sums of money from an investor and expect the investor to just be a bystander. If you want to retain control, then build a profitable business and don’t cede control. If you want to burn money through discounts and incentives with the hope of changing consumer behaviour, and expect someone to bankroll your idea without wanting that someone to have a say in running your company, you must be living in a fool’s paradise.
Anyone who believes venture capitalists (VCs) don’t give operational freedom need to see how tightly public markets control a company’s direction. A public company that is not managed well also runs the risk of being taken over by someone who believes they could run it better. So the belief that a startup will have total operational independence when it raises money from the public is a convenient illusion.
Startups that are burning money to acquire customers with no clarity on whether the business will ever be profitable or sustainable cannot be allowed to take money from the public. These startups are huge capital guzzlers. The limited option of listing on the small and medium-sized enterprise platform will not quench their appetite for capital. In the case of Alphalogic, it’s a profitable firm with characteristics similar to any other company that had raised money in the public markets in the past, in terms of both sustained profitability and pricing. I can’t imagine investors being interested if a similar startup with no visibility to profitability had tried to raise money through this route.
Small startups that can be run profitably are the best candidates to raise money through an IPO. They can retain control, and provide steady returns to their investors. VC and private equity investors are generally not interested in companies that don’t aim to disrupt and grow.
The via media provided by Sebi and the stock exchanges to help startups raise money through this route is helpful for a certain category of them. I don’t think there is a need to be too excited because most startups don’t fall into this category—steady, profitable, sustainable—and hence are unlikely to derive any benefit.
T.N. Hari is head of human resources at Bigbasket.com and adviser to several venture capital firms and startups. He is the co-author of Saying No To Jugaad: The Making Of Bigbasket.