Articles

The Impactful Investing: Your gateway to exclusive financing opportunities via social entrepreneurship

by Sandeep Kumar

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In recent years, investors’ demand is growing and so is the need for sustainability. Modern investors now look out for investment options that not only increase their returns, but are also contributing positively to social and environmental issues. In order to make sure both the needs are fulfilled, the answer can be found in the field of sustainable finance. By funding social enterprises, investors can ensure that their money is utilised for the benefit of the society and also provides returns.

Sustainable finance for Social Entrepreneurship

For any enterprise it is important to ensure financial sustainability to carry out its operations. Social enterprises essentially try to maximise their profits in order to carry out programs that will help overcome social and environmental issues. Thus, social impact and positive financial outcome, both are equally important for such a firm. In order to achieve these objectives, sustainable financing is very important.

There are several ways in which social enterprises can raise funds- donations, grants, crowdfunding, loans. However, these methods come with some drawbacks or the other. They take time to raise funds, involve costs, or some kind of competition. Sustainable finance through impact investors are valuable to bridge the gap between social development and funding. Before we look into the benefits of impact investments in particular, let us understand what the different approaches are available in sustainable finance.

Different approaches – SRI, ESG, and Impact Investing

Different approaches in sustainable investment consists of following:

  • Socially Responsible Investing (SRI)

It includes a value based investment system, in which the investor avoids taking up options that are against his/her believes or value system. Example, a person who hates smoking would avoid investing in a firm that produces tobacco products.

  • Environmental, Social and Corporate Governance (ESG) Investing

ESG looks at the environmental, social and governance practices of the firm that would significantly impact the performance of firms’ finances, and thus the return on investments. The main objective of this approach is to focus on the financial performance of the investment.

  • Impact Investing

This approach weighs financial performance and positive social impact equally. Such funds are often used to support causes that are not directly addressed by public financial markets. 

How is impact investment different?

While the above three terms may appear similar, they are different. It is important to note that SRI and ESG investing involve publicly traded assets, whereas impact investing considers private funds. Impact investing is more transparent in terms of assessing how the investor’s funds are used. SRI and ESG are more of a screening process for social and sustainable investment; while impact investing focusses on actually generating a positive impact.

The Global Impact Investment Network (GIIN), defines impact investing as “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return”. Impact investment is not just philanthropic, rather it combines it with rigorous analytics of traditional investing. This is achieved by expanding accessibility of goods and services to the deprived section of the society, or through the use of environment-friendly and inclusive production processes. Such investments also target a wide range of areas including agriculture, clean energy, health, education, infrastructure, etc. While public funds and philanthropic measures help in providing for the poor, the role of impact investing is to give them a push as they climb the income ladder.  

Positive Outlook of Impact Investing

The Global Impact Investing Network (GIIN), the impact investing market is estimated to be as big as $715 Bn in the year 2020. The survey also finds that investors report that their portfolios have been performing at par and even exceeding their expectations in terms of both environmental and social impact, as well as financial impact.

 Source: GIIN, 2020 Annual Impact Survey

A report by Impact Investors Council of India estimates that Indian impact investing has shown growth at 26% CAGR in the last decade (2010-2019). $10.8 Bn funds have been mobilized by 586 impact serving about 490 Million beneficiaries, most of which belong to low income communities who are underserved by traditional investors. Impact investments have seen a gradual growth over the decade, especially since 2018 with average deal size tripling from $5 Mn in 2010 to $17 Mn in 2019.

With such high growth rates and the effects of Covid-19 pandemic, investors are now making a conscious decision to move towards sustainable investing. Moreover, the growing number of fintechs and use of advanced technologies, make investing a hassle-free process for all. The adoption of modern and innovative techniques will further accelerate the future growth of impact investing.

Source: Impact Investors Council of India

Since the share of impact investment in financial services has grown over the years, it has helped in fulfilling SDGs of reducing poverty, creating jobs and economic growth, gender equality, industry, innovation and infrastructure. Every dollar invested through impact funding has been able to crowd in at least twice the commercial capital. Impact investing has played a significant role in funding Seed and Series-A capital, and also provided for about 70% of the later-stage financing. Indian impact investing is largely focused on financial services. This will help achieve the goal of economic growth, which will eventually serve in accomplishment of other SDGs including poverty alleviation, gender equality, zero hunger, etc.

Sector-wise Impact (Source: Impact Investors Council of India) 

Your ticket to a positive impact

As the Covid-19 pandemic has derailed the economy, there is greater need to focus on SDGs to get back on the track of development. A broader focus on social entrepreneurship and sustainable finance options is needed to bring the economy back on track.  Social entrepreneurship is always supported by the government, since it helps them to get to the path of development by bringing a change about a change in the social and environmental issues.

Impact investing is the modern way of obtaining the twin goals of greater social impact and financial return. It is gaining popularity as more people strive for sustainability. In the Indian scenario, majority of the impact based funding is focussed on the financial institutions that help achieve global goals of greater economic efficiency and poverty alleviation. Other areas that are served through impact investing include gender equality, clean and affordable energy, better well-being through education, health, sanitation, etc. So if you want your funds to grow by bringing a positive change in solving social problems, impact investing is the way.

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This article has been co-authored by Tamanna Kapur, who is in the Research and Insights team of Torre Capital.

BYJU’s: The next big tech unicorn to curb the appetite for IPOs in the Indian Markets

by Sandeep Kumar

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BYJU’S is India’s biggest training organization and the maker of India’s most famous K-12 learning application, which offers profoundly versatile, drawing-in, and powerful learning programs for understudies. Revaluating how understudies learn in the time of cell phones, the BYJU’S approach consolidates top-notch instructors, demonstrated educational strategies, creative innovation, and information science to convey customized learning across grades. Byju’s likewise offers to instruct administrations for cutthroat tests, for example, JEE, NEET, CAT, IAS, and worldwide tests like GRE and GMAT.

Since India authorized a lockdown in the nation over in late March, closing schools and other public spots, Bangalore-settled start-up Byju’s has arisen as one of the quintessential stages for school-going understudies on the planet’s second-biggest web market. It took the start-up around four and a half years to gather 40 million understudies. Since the lockdown, its client base has expanded to 65 million.

Snapshots 

  • Notable Investors: Blackstone, Blackrock, Ant Group, Tiger Global, T. Rowe Price, Silverlake
  • Last Funding Round: Series F (Nov 2019)
  • Amount: $ 1.5 Bn
  • Valuation: $15 Bn
  • Employees: 21,000+
  • Founder: Byju Raveendran and Divya Gokulnath

The market for fast-growing IT stocks

The education market in India as a whole is worth around $135 Bn with approximately 360 Mn learners. The Edtech segment of India is divided into 6 parts:

· Pre K-12

· K-12

· Test Preparation

· Higher education

· Continued learning

· B2B Edtech areas

The opportunity in the Edtech market is huge and Edtech startups are contending for a larger share of the pie. The Indian Edtech market investments in 2020 were led by big names like Byju’s, Unacademy, Toppr, etc. The market managed to garner $2.22 Bn funding in 2020 up from $553 Mn in 2019. Byju’s and Unacadmey have been the MVPs raisng over $1.64 Bn and $347.5 Mn. 

As there is a shift in methods of teaching there is an increase in focus on self paced learning and the idea of continued learning after college through professional courses this has been the driving force behind the innovations of the content is made and how it is delivered to the consumer. There are quite a few factors at play that led to the growth of investments in Edtech market. A major one being the increase in government spending allocation to the education sector from $ 11.3 Bn in 2018–19 to $ 13.2 Bn in 2020–21 and the launch of the National Education Policy this year. Another driver of growth is the increasing internet penetration in India especially in tier 3 and 4 cities

 

The pandemic fever

In just a matter of days, the pandemic forced people indoors that changed the way they worked and lived. Lockdown, though confining for the public at large was a gate opener for the Edtech market that was looking for a breakout in investor’s attention. An abundance of startups was able to benefit from the favorable conditions created in the market. Also, many new startups popped up across sub-segments to ride the Edtech wave this year. Large and small Edtech companies offering solutions for remote learning witnessed off-the-charts levels of activity — up by as much as 600%.

Global scenario and opportunities

Education has been one of the most traditional industries, however, that is changing in recent years we have seen applications of advanced technology in education and learning. Education is no longer only associated with the traditional classroom. The learning process now tends to leverage Edtech solutions like online classes, learning management systems, and others to make education more effective and accessible. The pandemic lead to further growth in demand for Edtech solutions sets the pace in the Edtech industry for many years to come.

 

 Source: Holon IQ

China, with the largest education market in the world, has led education VC investment growth over the past five years. China now makes up over 60% of all Global VC investment in education, the USA 15%, India, 14%, and Europe 5% in 2020. While not as large, VC investment in Indian Edtech is worthy of note, growing almost 4x since 2018.

Is it undervalued or overvalued?

A plethora of investors and VCs back Byju’s, some of the most prominent names are The BlackStone Group, Blackrock, T. Rowe Price, etc. Byju’s raised approximately $1.55 Bn in its latest funding round Series F (Jun 2021) which increased its market valuation to $15.05 Bn

 

 

Byju’s most prominent competitors namely Vedantu, Unacademy and Toppr have an average Enterprise Value to Revenue Multiple close to 136x which is way higher than Byju’s 15x.

Peer comparison

Strategic partnerships

Over the years Byju’s have had numerous mergers and acquisitions, to name a few Vidyartha, Osmo, Labin App, WhiteHat Jr. and the most recent one Aakash Educational Services Ltd(AESL). With these acquisitions, all in edtech startups having their own niche offering, Byju’s is becoming on giant umbrella encompassing everything. The acquisition of WhiteHat Jr. aims to expand its product offerings, and widen its base in India, as well as the US where WhiteHatJr already has a presence. The latest acquisition of AESL, a leader in test prep services, brings together the best in offline and online learning. They aim to create India’s largest digitally enabled, omnichannel test preparation company.

The road ahead

Going forward Byju’s is planning to launch Byju’s Future School, the startup’s international business, which will be led by Karan Bajaj, founder of WhitHat Jr., which Byju’s acquired last year. The company plans to expand internationally in U.S., U.K., Brazil, Indonesia, and Mexico next month and explore other geographies later this year. At launch, BYJU’S Future School will offer coding and math lessons. New subjects like Music, English and Fine Arts will be part of future plans. The company aims to reach 350mn users worldwide by FY 2022. The company is also piloting a model in India where schools are working with BYJU’S in imparting coding education within the school curriculum.

Conclusion

With the plans to expand its operation across cities and internationally, the company has the necessary funds for the expansion and investing in R&D of new methods of augmented learning through Artificial Intelligence, Machine Learning, and analytics. Banking on the massive subscriber base with the aim to expand it further, Byju’s will sure have data to feed its models and be able to provide truly customizable learning for each individual subscriber.

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This article has been co-authored by Ayush Dugar and Khubaib Abdullah, who is in the Research and Insights team of Torre Capital.

Pension funds trying to change the world — is it justified?

by Sandeep Kumar

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Simply put, a pension fund or a pension pot is basically a pot of money that provides retirement income. So, when you and I retire, we’re going to need to live off the money. We might have saved up but right now when we are working, we can invest money into our retirement and that is where a pension fund comes in. It is a large sum of money that is being invested in order to pay you and me when we retire.

Pension funds often pool huge sums of money to be invested in capital markets like the stock and bond markets, in order to produce profit (returns). It represents an institutional investor that invests substantial sums of money in both private and public corporations. The primary purpose of a pension fund is to ensure that there will be enough money to cover employees’ pensions after they retire in the future.

The rise of pension funds

The “unseen revolution” altering corporate ownership in the United States is now evident to all, fifteen years after it was first documented. Around one-tenth of the equity capital of America’s publicly owned corporations is held by the 20 largest pension plans (13 of which are pensions of state, municipal, or nonprofit employees). In total, institutional investors — most notably pension funds — own over 40% of the common stock of the country’s large (and many medium) corporations. Public employee pension funds, which are the largest and fastest expanding, are no longer willing to be passive investors. They are increasingly demanding a say in the companies in which they invest, such as veto power over board appointments, executive salaries, and key corporate charter elements. Pension funds also control over 40% of the medium- and long-term debt of the country’s larger corporations, which is still widely disregarded. As a result, these institutions have become both the largest lenders and owners of corporate America. For years, finance texts have highlighted that the lender’s power is equal to, if not greater than, that of the owner.

One of the most dramatic power swings in economic history is the rise of pension funds as dominant owners and lenders. General Motors developed the first modern pension fund in 1950. Pension funds now have $2.5 trillion in assets, split about evenly between common stocks and fixed-income instruments, after four decades. These assets will continue to increase aggressively for at least another ten years, according to demographics. In the 1990s, unless there is a prolonged depression, pension funds will have to invest $100 billion to $200 billion in new resources per year.

Source: Financial Stability Board

 

 

 

Types of pension funds and its difference

There are two key types of pension funds. The first type is Defined contribution and the second type is Defined benefit.

Regardless of how well the fund performs, a defined benefit fund distributes a fixed income to the recipient. The employee contributes a set amount to the fund. These donations are invested prudently by the fund managers. They must outperform inflation while not losing the principal. The fund management must make a sufficient return on investment to cover the benefits. Any gap must be covered by the employer. It’s similar to an insurance company’s annuity. In this instance, the employer acts as the insurance company, bearing all of the risks if the market falls. Because of this risk, several firms have discontinued offering these policies.

In a defined contribution plan, the employee’s rewards are determined by the performance of the fund. 401(k)s are the most common of them. If the fund’s value falls, the employer is not required to pay out defined benefits. The employee assumes all of the risks.

The most significant distinction between a defined benefit and a defined contribution plan is the risk shift. The defined benefit is being rolled out because it is old school. Defined contribution on the other hand is around for the most part today. Most employers, companies, and individuals are likely to be on defined contribution pension schemes.

Country-wise comparison of pension funds

Globally, the quality of pension systems accessible to workers varies substantially. According to the Mercer CFA Institute Global Pension Index 2020, the Netherlands has the best system, whereas the United States is nowhere near the top.

· Netherlands: Its retirement income system is based on a flat-rate public pension and a semi-mandatory occupational pension tied to wages and collective bargaining agreements. The majority of employees in the Netherlands are members of these occupational plans, which are defined-benefit plans that are industry-wide. Earnings are based on an average over a lifetime.

· Denmark: Denmark features a public basic pension system, an income-related supplementary pension benefit, a fully funded defined-contribution plan, and required occupational pension plans.

· Israel: The retirement income system in Israel is made up of a universal state pension as well as private pensions with the mandatory employee and employer payments. Annuities are typically paid via the private pension system.

How pension fund diversifies its investments

By shifting their concentration to other assets, pension funds can protect themselves from a stock market meltdown. Most pension funds have typically sought growth by investing in shares, but with global stock market valuations so high, the short-term outlook appears dismal. Alternative assets, such as private credit, private equity, and real assets, may outperform a standard growth portfolio on a risk-adjusted basis.

Investors are shifting their focus to alternative credit investments in search of yield due to low bond rates and scheme demographics. As contributions fall, a growing number of schemes become cash flow negative, putting an emphasis on income-generating assets while requiring forced sales of growth assets.

Because interest rates on traditional assets like gilts and investment-grade bonds are so low, trustees are looking into alternative credit markets like high yield, private lending, royalties, and long-term leasing.

 

Performance of pension funds during the financial crisis

  • The funds’ investment performance all suffered in the early aftermath of the pandemic’s outbreak. Their returns, on the other hand, have fared “significantly better” than they did during the global financial crisis when they fell far short of their standards.
  • The funds’ ability to withstand shock was aided by the swift and unprecedented monetary and fiscal support provided in response to the rapid spread of Covid-19. However, improvements in the asset class mix and risk management capabilities of the funds also contributed to the funds’ ability to withstand shock.
  • Since the financial crisis, pension funds have extended their exposure to alternative asset classes such as private equity, infrastructure, and real estate, which has helped to mitigate the risk of their public assets.
  • In addition, the robust liquidity positions of pension funds have helped to protect them from market volatility.
  • During the market upheaval in the first half of 2020, these funds had minor liquidity stress, in contrast to the previous financial crisis. We feel that since then, advances in risk management governance mechanisms have been effective in protecting funds from market volatility.

Source: OECD website

 

How pension fund tackles inflation?

Inflation protection refers to assets that tend to appreciate in value when inflation rises. Inflation-adjusted bonds (such as TIPS), commodities, currencies, and interest-rate derivatives are examples of these. Although the use of inflation-adjusted bonds is frequently justifiable, some have expressed worry about the greater allocation of pension fund assets in commodities, currencies, or derivatives due to the additional idiosyncratic risk they represent.

Liability matching, sometimes known as “immunisation,” is an investing technique that compares the timing of predicted future expenses to the timing of future asset sales and revenue streams. The method has gained traction among pension fund managers, who use it to reduce the risk of a portfolio’s liquidation by matching asset sales, interest, and dividend payments to planned pension payments. This is in contrast to simpler techniques that aim to maximise return regardless of when withdrawals are made.

To supplement social security payments, pensioners living off the income from their portfolios, for example, rely on secure and consistent payments. A matching strategy would entail buying stocks strategically in order to receive dividends and interest at regular periods. A matching strategy should ideally be in place well before the retirement years begin. To ensure that its benefit commitments are met, a pension fund would use a similar technique.

Pension fund driving sustainable investing

Pension funds might be a powerful force in persuading businesses to embrace ESG goals such as tackling climate change and increasing employment justice. However, they must balance these objectives with their fiduciary responsibility to protect their members’ retirement savings. They must also overcome obstacles in the United States, such as gaps in ESG adoption measurements and misunderstanding about government restrictions on such investments. According to the paper, total assets managed by U.S. institutional investors using ESG principles have increased significantly over the last 15 years, reaching $6.2 trillion in 2020, with public pension funds accounting for more than half of that (54%). Climate change and war risks in terrorist or repressive regimes have recently risen to the top of investors’ concerns, followed by tobacco usage, corporate governance, and sustainable natural resource and agriculture practices. Investors’ appetites for ESG principles, on the other hand, oscillate between extremes.

According to the Wall Street Journal, ESG fund investors are moving their focus from growth to value companies, while other institutional investors are “lining up trillions of dollars to support a shift away from fossil fuels.”

Conservative risk measures

Pension funds make guarantees to their members, ensuring that they will be able to retire with a particular level of income in the future. This means they must be risk-averse while simultaneously generating sufficient returns to cover the guarantees. As a result, together with blue-chip stocks, fixed-income instruments make up a large portion of pension portfolios. Pension funds are increasingly looking for additional returns in real estate and alternative asset classes, albeit these assets still make up a modest portion of their overall portfolios.

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This article has been co-authored by Sayan Maitra and Yogesh Lakhotiawho are in the Research and Insights team of Torre Capital.

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The Impactful Investing: Your gateway to exclusive financing opportunities via social entrepreneurship

by Sandeep Kumar

Keep up to date with the latest research

In recent years, investors’ demand is growing and so is the need for sustainability. Modern investors now look out for investment options that not only increase their returns, but are also contributing positively to social and environmental issues. In order to make sure both the needs are fulfilled, the answer can be found in the field of sustainable finance. By funding social enterprises, investors can ensure that their money is utilised for the benefit of the society and also provides returns.

Sustainable finance for Social Entrepreneurship

For any enterprise it is important to ensure financial sustainability to carry out its operations. Social enterprises essentially try to maximise their profits in order to carry out programs that will help overcome social and environmental issues. Thus, social impact and positive financial outcome, both are equally important for such a firm. In order to achieve these objectives, sustainable financing is very important.

There are several ways in which social enterprises can raise funds- donations, grants, crowdfunding, loans. However, these methods come with some drawbacks or the other. They take time to raise funds, involve costs, or some kind of competition. Sustainable finance through impact investors are valuable to bridge the gap between social development and funding. Before we look into the benefits of impact investments in particular, let us understand what the different approaches are available in sustainable finance.

Different approaches – SRI, ESG, and Impact Investing

Different approaches in sustainable investment consists of following:

  • Socially Responsible Investing (SRI)

It includes a value based investment system, in which the investor avoids taking up options that are against his/her believes or value system. Example, a person who hates smoking would avoid investing in a firm that produces tobacco products.

  • Environmental, Social and Corporate Governance (ESG) Investing

ESG looks at the environmental, social and governance practices of the firm that would significantly impact the performance of firms’ finances, and thus the return on investments. The main objective of this approach is to focus on the financial performance of the investment.

  • Impact Investing

This approach weighs financial performance and positive social impact equally. Such funds are often used to support causes that are not directly addressed by public financial markets. 

How is impact investment different?

While the above three terms may appear similar, they are different. It is important to note that SRI and ESG investing involve publicly traded assets, whereas impact investing considers private funds. Impact investing is more transparent in terms of assessing how the investor’s funds are used. SRI and ESG are more of a screening process for social and sustainable investment; while impact investing focusses on actually generating a positive impact.

The Global Impact Investment Network (GIIN), defines impact investing as “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return”. Impact investment is not just philanthropic, rather it combines it with rigorous analytics of traditional investing. This is achieved by expanding accessibility of goods and services to the deprived section of the society, or through the use of environment-friendly and inclusive production processes. Such investments also target a wide range of areas including agriculture, clean energy, health, education, infrastructure, etc. While public funds and philanthropic measures help in providing for the poor, the role of impact investing is to give them a push as they climb the income ladder.  

Positive Outlook of Impact Investing

The Global Impact Investing Network (GIIN), the impact investing market is estimated to be as big as $715 Bn in the year 2020. The survey also finds that investors report that their portfolios have been performing at par and even exceeding their expectations in terms of both environmental and social impact, as well as financial impact.

 Source: GIIN, 2020 Annual Impact Survey

A report by Impact Investors Council of India estimates that Indian impact investing has shown growth at 26% CAGR in the last decade (2010-2019). $10.8 Bn funds have been mobilized by 586 impact serving about 490 Million beneficiaries, most of which belong to low income communities who are underserved by traditional investors. Impact investments have seen a gradual growth over the decade, especially since 2018 with average deal size tripling from $5 Mn in 2010 to $17 Mn in 2019.

With such high growth rates and the effects of Covid-19 pandemic, investors are now making a conscious decision to move towards sustainable investing. Moreover, the growing number of fintechs and use of advanced technologies, make investing a hassle-free process for all. The adoption of modern and innovative techniques will further accelerate the future growth of impact investing.

Source: Impact Investors Council of India

Since the share of impact investment in financial services has grown over the years, it has helped in fulfilling SDGs of reducing poverty, creating jobs and economic growth, gender equality, industry, innovation and infrastructure. Every dollar invested through impact funding has been able to crowd in at least twice the commercial capital. Impact investing has played a significant role in funding Seed and Series-A capital, and also provided for about 70% of the later-stage financing. Indian impact investing is largely focused on financial services. This will help achieve the goal of economic growth, which will eventually serve in accomplishment of other SDGs including poverty alleviation, gender equality, zero hunger, etc.

Sector-wise Impact (Source: Impact Investors Council of India) 

Your ticket to a positive impact

As the Covid-19 pandemic has derailed the economy, there is greater need to focus on SDGs to get back on the track of development. A broader focus on social entrepreneurship and sustainable finance options is needed to bring the economy back on track.  Social entrepreneurship is always supported by the government, since it helps them to get to the path of development by bringing a change about a change in the social and environmental issues.

Impact investing is the modern way of obtaining the twin goals of greater social impact and financial return. It is gaining popularity as more people strive for sustainability. In the Indian scenario, majority of the impact based funding is focussed on the financial institutions that help achieve global goals of greater economic efficiency and poverty alleviation. Other areas that are served through impact investing include gender equality, clean and affordable energy, better well-being through education, health, sanitation, etc. So if you want your funds to grow by bringing a positive change in solving social problems, impact investing is the way.

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This article has been co-authored by Tamanna Kapur, who is in the Research and Insights team of Torre Capital.

“All that glitters is not gold” — Growing valuation bubble of Indian start-ups

by Sandeep Kumar

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 The valuation game

The Venture Capital valuation is a simple game, but never an easy one. While there is little to learn, to play it perfectly takes years, if not decades of experience under the belt.

So how do the VCs arrive at that valuation figure? Market Opportunity? Product Market Fit? Strong Founder Team? Disruptive Product Offering? Extensive Network Economics?

Nah.

Capital invested divided by the stake diluted. That’s it!

The VC chooses the amount of capital he is ready to deploy and the stake he wants to have in the company. Of course, the wish is to part with the least capital for the most stake. Now coming up with these two numbers, the capital chunk to invest and the amount of stake to buy, this is where experience comes in.

The winning bet in your portfolio

Most VCs have personal favorite ranges which they are comfortable with. Some VCs may like to hold only a few concentrated bets while others may want to deploy small amounts into numerous startups. The premise is the same. Each VC wishes to hold at least one winner in its portfolio, the winning bet that ‘returns the fund’.

This gets us to staging. The valuations do nothing to the VC portfolio, except increase the unrealized returns section, which, as the name suggests, are ‘unrealized’ and don’t mean anything unless the company makes an exit from that valuation.

But what if the company is not yet ready for an IPO or a buyout?

The VCs of course know this. Hence when they get together to finance a startup at some stage, let’s say series A, they are offering just enough money to take the startup to the next funding stage. This continues until the IPO or buyout.

Nowhere do the VCs use the DCF or any other model to find a fair value of the shares of the startup. Startup valuation is not a valuation game, it’s a pricing game. It is not about finding a startup trading at a lower than its fair value price and hoping the market corrects itself, the game is about finding another buyer who will be ready to pay higher. All this has nothing to do with cash flows generated from the assets held by the startup, adjusted for the underlying risks of all sorts (DCF basically). All these valuations are nothing more than exhaust fumes as suggested by Fred Wilson, an NYC based VC:

“Early-stage valuations aren’t valuations. They are the exhaust fumes of negotiation about two things — the amount raised and the amount of dilution.”

The information asymmetry

Now let’s take a look at what we have: You are a VC that is trying to get a stake in some startup. What do you do to get an idea of how much you should pay? You don’t have DCF or any other model to help. So, you look at what similar companies have been valued at. With new business models operating in diverse geographies, you realize that it is hard to say how you can define a similar company. Let’s say you came up with food delivery as one category. Despite the difference in the business models, one can hardly cobble together a list of 4–5 startups in the Indian space.

So, the VC game is plagued with opaque, inconsistent deal information. While the figures the VC arrives at are most probably wrong and have nothing to do with reality, they have nothing to worry about as long as they are able to find someone who’s ready to buy at a higher price from them.

The Indian startups in numbers

The past few years have been a gala time for the Indian startups who have managed to secure funding unabated despite the pandemic and its blues.

Startups in India managed to raise $7.8 Bn until April itself. This is a significant number almost 70% of the total $12.1 Bn raised in 2020 and more than 50% of $14.2 billion raised in 2019.

The average funding size has increased to $25.21 Mn, up from $14.94 Mn in 2020. There have been 402 funding rounds until April itself, against 1,114 deals in 2020 and 1,036 in 2019.

Overvaluation and the global landscape

The push towards absurd overvaluations has been a result of the negative interest rate environment. Post the GFC, there was heavy lending and even more borrowing. So much so that people had to pay up money just so that they could lend money. Of course, this led people to look for alternative avenues to park their money and generate juicy returns. The baseless optimism and hollow belief in spotting the next Bezos, Zuck, or Musk have led to an audacious amount of money flowing in, creating completely senseless valuations, having no roots in reality.

Tesla, more than $13 Bn in debt at the end of last year, recently had a market capitalization of $160 Bn, greater than General Motors and Ford combined. At the IPO price, Square was valued at close to $3 Bn, which is 50% below the $6 Bn valuations for which it had raised money from private investors a year before. Uber which in accounting terms stands at around 5x times its revenues, is also grossly overvalued as it is nowhere close to being the leader in the driverless car’s space. WeWork tried to go for a $47 Bn listing but ended up getting corrected to $8 Bn.

The WeWork fiasco was dubbed as a wake-up call in a Morgan Stanley report stating that the days of ‘’ were over.

Unicorns were considered rare. Today, however, the United States has a herd of more than 100 of them, with 100 more outside the US. Each worth a billion dollars or more.

Will history repeat itself?

Let’s talk about the Indian scenario and the startups which we believe are overvalued and most likely to come back to their intrinsic value as and when the markets correct themselves.

1. Byju’s: World’s most valuable Ed-Tech Company

Byju’s operates an online learning platform. It also creates a mobile app for pupils that offers a variety of learning activities. Exam preparation classes are also available. Original material, watch-and-learn movies, rich animations, and interactive simulations are all available to users on the site. The firm is having an EV/Revenue multiple of 17x.

It is the only major player in the Ed-Tech space in India, which has led the company to raise multiple rounds of funding and leading to an enormous increase in valuation. Knowledge in today’s world is free, however, Byju’s creates unique content with animation and the product often seems to be overpriced. In recent times there were a number of instances on various social media platforms where people questioned the pressure on the sales team and how Byju’s is so concerned about their sales when they try to push their offering in the market.

In the long run, the expected return from Byju’s is questionable. Below is the chart of the revenue and valuation of Byju’s over the last five years.

2. Cred — The borrower’s messiah

Losses in billions of dollars are nothing new for hyper-funded companies, especially when they’re chasing size and consumers at any cost. CRED’s metrics tell a tale in and of itself. CRED has made a profit of $71,000 in its second year of operation. CRED hasn’t been able to monetize its user base in FY20, despite acquiring a large customer base with a high propensity to spend and consume.

While the two-year-old company’s sales remained low, its total expenditure increased by more than 5.9 times to $52 Mn in FY20, compared to $9 Mn in FY19. The greatest cost center for the financial firm was advertisement and marketing, which accounted for 47.6% of total expenditure. From $3 Mn in FY19, such costs increased by 9.3 times to$25 Mn. During the fiscal year that ended in March 2020, CRED spent Rs 726.7 to earn a single rupee of operating revenue. CRED’s yearly loss in FY20 was INR 360.3 Crore, up 5.9 times from the $8 Mn it lost in FY19. The current cash burn is difficult to sustain, with an appalling EBITDA margin of -1979.5% in FY20, and the company will have to focus on its collections.

Despite registering astronomical losses it has attained a unicorn status by raising its valuation to $2.2 Bn in 2021. It is worth noting that the company is founded and led by Kunal Shah who is a known name in the start-up world for founding and leading numerous companies which may be an explanation behind the astronomical valuation of Cred. The graph below shows the valuation and losses of Cred over the years.

3. CarDekho — India’s leading car search venture

CarDekho helps users buy cars along with expert reviews, detailed specs, and prices, comparisons as well as videos and pictures of all car brands and models available in India. It has recently acquired an auto marketplace, Carmudi (Philippines) in late 2019 to expand business in Southeast Asia. GirnarSoft, the parent company of Jaipur-based automobile-related services behemoth CarDekho, has seen its losses increase by 155% to $45 Mn in FY2020. This comes after the company’s losses had already increased by 39% in the previous year.

Despite that CarDekho has managed to raise its valuation. Last year, Cars24, a CarDekho competitor, increased its consolidated revenue to $418 Mn and achieved unicorn valuation, and has a much lower EV/Revenue multiple. Let us now see the EV/Revenue Multiple of the peers in this game through the table below.

As per the last reported revenue and valuation figures.

We can infer from the table that CarDekho has a huge EV/Revenue multiple which signifies that the valuation of the firm is increasing at a much faster rate with respect to the revenue that the company generates, leading to overvaluation of the company. The graph below shows the valuation and revenue of CarDekho.

4. Unacademy

Unacademy is a Bangalore-based educational technology startup in India. Unacademy lessons are available in the form of Live Classes, which are both free and available on a subscription basis. Unacademy earned $12 Mn in revenue but spent $53 Mn, resulting in a loss of INR 300 crore. Employee benefits accounted for 23.7% of the edtech start-up’s costs, while other expenses accounted for 75%.

While 2020 brought plenty of development, the corporation would need to significantly increase its expenditures to reverse the losses it had in the fiscal year 2020, which ends on March 31, 2020. Unacademy’s revenue in FY21 is estimated to be over $55 Mn. It’s worth $3 Bn or approximately 35 times the expected income. The graph shows the valuation and loss of BharatPe.

5. BharatPe

When we talk about e-commerce giants, PayTm, Amazon, and Flipkart all wanted payments to take place within their own closed networks. BharatPe’s goal was to achieve what all the large brands were afraid to do: simplify things for retailers by adopting a standardized interoperable QR code. It allowed shops, street food vendors, and tea vendors to accept payments using any UPI app (PhonePe, Google Pay, PayTM, and so on) without having to download the apps. It was a simple and cost-effective approach with an added layer of security. The payment system’s complexity was reduced by a factor of ten by combining multiple UPI apps into a single sticker.

BharatPe was able to achieve early success by keeping things simple. BharatPe’s product strategy is based on making things simple for merchants, and the company uses P2M transactions as a springboard for future services. Because BharatPe does not charge merchants a setup or transaction fee, its fundamental feature money collection using QR codes is essentially a loss-maker for the company. It must spend a large amount of money to manage the servers that process millions of transactions every day. However, this provides BharatPe access to merchants who are passionate about their products and eagerly accept their offers. Despite having no visible revenue stream and without even earning a penny, the valuation of the company is increasing, and currently, it stands at $900 Mn, very close to the unicorn status. The graph shows the valuation and revenue of BharatPe.

The apprehensive loop of growing valuations

The indications are all too familiar. With large markets, illustrious founders, rapid growth, and top early-stage VCs on your side, you have a good chance of raising the next big round, even if you don’t yet have unicorn status (the desired billion-dollar value). And when major acquisitions are made for unproven companies, and valuations double or triple in a matter of months, it begs the question: are we in a bubble? This is always a challenge because most people only realize they were in an economic bubble after it has burst in the past.

Rich valuation multiples have also spread from the typical suspects — consumer internet companies — to enterprise software providers. This is a first. SoftBank, for example, invested in Mindtickle last year, valuing it at $500 Mn based on estimated revenue of $20 Mn — $25 Mn. Even SaaS companies in the United States, including Slack, Zoom, Snowflake, and Cloudflare, have gone public in recent years with great success. Sentiment in India often comes straight from the United States, particularly in related industries and from funds that invest in both nations, including several of India’s leading venture capital firms. Startup valuations are also affected by how publicly traded firms trade if retail investors are ready to pay high prices for loss-making companies, whether banks financing a share issue can find enough at a given price, and so on. There isn’t a single bubble across the board. Because of the vast quantity of money available in the market, investors are willing to pay a premium for good business. But that should be done judiciously.

Investors beware

For the first time in years, it’s possible to claim that private markets are more logical than public markets. If stock markets are the yardstick, select pricey companies may not be overvalued. A closer examination of what constitutes a bubble, as well as what Indian entrepreneurs are doing, reveals a more complete picture. Growth investing has been positive in industries that have recovered quickly from the epidemic, and there has been a lot of interest in a few market leaders. At such levels, one would expect some amount of rationalization. Investors must evaluate the prospects and the future road map of a company before investing. As more investments flow into a company without a proper business model or less revenue, it results in overvaluation creating a bubble. Investors can lose a colossal sum by not choosing the right company.

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This article has been co-authored by Sayan Mitra and  , who is in the Research and Insights team of Torre Capital.

Startup investing 101: The HNI’s guide to investments beyond the conventional asset class

by Sandeep Kumar

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Why invest in startups?

Investing in a startup is a high-risk, high reward game

Deciding the right opportunity and best practices for investing in a startup

Ways to invest in startups

Delaying the IPO comes with certain advantages for Startups

How startup investing really works

When can you expect a return or are you locked in forever?

Source: Pitchbook and CBInsights

Exits are what investors care about, but many founders dream of becoming a unicorn and avoid using the word “exit” until it’s too late. Despite this, M&As accounted for 97% of departures in 2020. And the majority of them occurred prior to Series B.

Exit or no exit: A fatal call

Investing in alternative assets and why you should care about them?

by Sandeep Kumar

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What is the meaning of a secondary market?

The private secondary market is the one in which stakeholders of private, venture-backed companies (employees, ex-employees and early investors) wish to transfer their shares to an investor in exchange for liquidity. The investor on the other side exchanges cash in return of shares of that private company. The sales proceeds go to the selling shareholder, not to the company.

A primary issue of shares is the source of equity for a given company. Primary issue happens when a company issues a new class of shares and grants those to employees (in the form of stock options) or sells them to investors in an event of fund raise. The employees and investors who own primary shares may choose to sell them in the secondary market, through Torre Capital’s marketplace.

How can you diversify your portfolio and expect higher returns by investing in the secondaries market?

  • Given the expense of going public (which can be significant in terms of time and resources) and the public markets’ short-termism (which can cause public companies to focus on quarterly earnings and not on long term growth).
  • Tech-Based companies have fewer reasons to go public than they did a decade ago, because of which the venture-backed technology companies are increasingly reaching $1B and even $10B valuations before they go public, which leaves less potential for public market investors. In the year 1999, US technology companies went public typically after 4 years but today, the average technology company IPO comes after a minimum of 10 years.
  • As the companies are taking longer to go public, their early investors and employees have to wait substantially longer for liquidity than they would have in the past.

There are many reasons why early shareholders of now valuable private companies might want to tap into liquidity through Torre Capital. For example, an early stage venture capital investor might want to return capital to limited partners ahead of the launching of a new fund. An early employee of a now late-stage company might want to sell shares to finance transactions like buying a house.

Torre Capital acts as an intermediary between the shareholders who need liquidity, and the investors who want investment exposure to proven technology companies before they ultimately go public or get acquired. If the company goes public, investors receive shares post the lock-in period (which restricts private company shareholders from selling their publicly traded shares, ranging between 6 months to a year). If the company is bought for cash, the investors are compensated for the same as well.

More than $50 Billion in value is estimated to be locked up in private, pre-IPO companies, and the secondary market is unlocking that value for investors who were previously unable to participate due to high minimums and restricted entry.

Who influences the pricing of the secondary market?

The investors who participate in the fund raise have an influence on primary market prices; secondary transactions are usually priced in relation to the most recent funding. The price is generally influenced by factors of supply and demand. If a private company has a high demand, its shares might trade at a premium in the secondary markets (in other words, the shares would be priced higher than the share price from the most recent funding). If the sellers of a particular security are more than its buyers, the shares might trade at a discount (lower than the share price from the most recent funding).

Apart from the influences of demand and supply, following are the other factors that can affect the price per share of private market securities:

a. Share Class: Two of the primary types of shares are preferred stock and common stock.

  • Preferred stock is a type of equity security that has certain rights over common stockholders. These rights may include, but are not limited to, liquidation preferences dividends, anti-dilution clauses, and managerial voting power.
  • Common stock is a type of equity security that is most frequently issued to founders, management, and employees. In the event of liquidation, preferred shares are generally given priority over common shares.

b. Discount for Lack of Marketability: A valuation discount exists between stock that is liquid and traded publicly, and stock that is illiquid and not publicly traded. Because Torre Capital’s offerings are relatively illiquid, it’s common for them to be priced at a discount to the most recent round of funding.

Why invest with Torre?

Torre Capital is a VC funded Singapore based Financial Technology company and a Registered Fund Manager in Singapore. We are creating a fully digital Wealthtech to connect family offices and HNI investors with global opportunities, including alternative assets like Private Equity, Venture Capital, Real Estate Funds, and Hedge Funds. Our investment vehicles offer exposure to high quality global growth startups, private debt opportunities, and other thematic funds in the pre-IPO space. They are available to registered investors around the globe.

Our current customer set includes 500+ family offices and High net worth investors (CXOs, first and second-generation entrepreneurs). With the team composed of ex-Mckinsey consultants, Asset management veterans, and Digital experts.

Exclusive features offered by Torre:

  • Pre-vetted/ Curated funds
  • Low-minimums
  • Low and transparent cost
  • End-to-end digital

Who are the shareholders?

Shareholders include all angel investors, employees of the company, founders, or anyone who currently has equity in an eligible private company in the form of common shares, preference shares, stock options or restricted stock units. The following services are provided by Torre Capital to private company shareholders:

  • Opportunity to sell shares in the Torre Marketplace
  • Avail equity funding for your private company ESOPs

How does the Shareholder’s journey work?

a. For selling shareholders:

  • Register on the platform by providing a few basic details about your equity stake.
  • Explore the Torre Capital marketplace to submit your request. Our private market specialist connects with you to perform due diligence checks.
  • We offer the shares to our investor community and gather investment commitments. We also work with the company directly for a completely secure transaction.
  • Transfer documents executed and you receive the sale proceeds. Torre Capital charges a nominal transaction fee.

b. For shareholders who seek to avail equity funding:

  • Register your interest and submit your financing request. Find out how much funding you can avail.
  • Our credit experts get in touch with you to perform due diligence checks, understand your tax liability and underwrite the funding.
  • Depending on your company’s terms and agreement, the forward equity contract is signed and you receive your funds.
  • Share a portion of profits with us post liquidation event. In case of no liquidation event, you don’t have to pay us back.

Advantages of selling at Torre’s Marketplace:

  • Immediate Partial Liquidity.
  • Maximum benefit to shareholder: You only pay us in case of a liquidity event.
  • Get to keep your upside: If your company never meets a liquidation event, you still have received funding for part of your shareholding.
  • Minimized Risk: Upfront part funding and safety of investment till liquidation. 
  • Multiple asset class: If you own multiple classes of preferred stock, common stock, ESOPs, RSUs, you can sell them easily on the Torre Capital marketplace.

Who are the investors?

Currently only accredited investors as defined here are able to make investments through our platform (Investments are not open to US Citizens). With Torre’s platform, the opportunities are endless. You can choose to allocate capital across four different asset classes – equity, ESOPs, structured products, and funds.

How does the investor journey work?

  • Register your interest on our platform. We leverage our network to provide company specific offerings to all employees.
  • Reserve your interest. All IPAs issued post approval.
  • Shareholders agree to terms, sign a Forward share ownership contract.
  • Funds transferred to shareholders’ account. Company leadership informed of agreement with Torre Capital. Receive frequent updates.
  • Upon liquidation, receive principal and profits redemption requests raised to shareholders.

Advantages of investing at Torre’s Marketplace:

  • Exclusive access to high-growth startups: 20% – 30% discounted equity ownership in series D and above global pre-IPO unicorn/soonicorn shares leading to lower investments than secondaries.
  • No upfront cost: Zero transaction cost versus 10% charged by secondaries.
  • Attractive Returns: 3x – 5x better returns than direct secondary transactions.
  • Vigilant and protective measures: 3x collateral protection for initial investment till 80% downfall in stock value.
  • Faster cash-inflows: 3x – 4x faster return of capital than top VCs.

Torre’s Pre-IPO Fund

If you believe in the power of the Torre Capital platform for sourcing strong deal flow and you believe in the pre-IPO asset class, but you are not comfortable or otherwise do not want to select single names for investment, you should consider a managed fund investment. The Fund Series investment committee will select all investments, which are a curated subset of what comes across the Torre Capital platform.

If you would like your investment to give you diversified exposure to the pre-IPO asset class, but can’t commit to multiple $100,000 investments, a managed fund is a good option. You will get investment exposure to multiple pre-IPO companies that are carefully selected by the fund series investment committee.

In a low-yield world, is Pre-IPO investing the hidden secret to higher yields?

by Sandeep Kumar

  • Pre-IPO secondary transactions are growing, and over the past few years have consistently generated higher returns over other traditional asset classes
  • Startups are remaining private longer. The average age of technology companies going public has gone from 4 years in 1999 to 11+ years now. As a result, several broker networks and pre-IPO marketplaces have emerged to provide liquidity to early-stage investors and employees
  • Our analysis shows that secondary investments in mature startups 2–3 years prior to a liquidation event have yielded between 40%-70% annualized returns with fairly high success rates. That’s not a typo!
  • Case in point — Slack went public with IPO priced at $38.5 per share, earning around 200% above the last private funding round 10 months prior to the IPO
  • However, investing in Pre-IPO is no silver bullet. Just like all other forms of investing, you can go wrong and will go wrong. Imagine investing in Airbnb in 2017, or in Bytedance in Dec 2019. Airbnb’s valuation has halved since, while Bytedance has taken a nosedive.

It’s been busy year for public markets. The pandemic shock and resulting global economic turmoil has seen world exchanges experience a never before roller-coaster ride in the last few months. What with the V-shaped recovery in the stock markets and emergence of Robinhood traders across the world, equity is the name of the game right now. A slew of technology startups is slated to come up with IPOs in the next 12 months, and people are actively debating investing in these IPOs for listing gains.

There is a set of investors, however, who already own shares in most of these Pre-IPO companies, and are waiting for listing gains. They purchased these shares either directly from angel investors, early-stage VCs, and employees holding vested ESOPs or from one of the secondary marketplaces mostly available in the US.

To give you some perspective, our team went back 5 years and looked at the secondary market valuation histories of all IPOs that happened during this period.

(All numbers are taken from actual secondary transactions. Data for a few years in not available.)

Returns realized from investing in Pre-IPO companies 1/2/3/4 years prior to IPO event startups

If you don’t like dense tables, let us call out a few things:

  • If you had invested $ 10,000 in Beyond Meat on 02 Oct 2015, it would be worth $ 102,000 as on 02 May 2019, the date of listing.
  • If you participated in a secondary transaction as on 21 Sep 2018 in Lyft, you would make a cool 150% return in about 6 months. On the other hand, if you bought Lyft as a retail investor in the IPO, you would be sitting on an approx. 70% loss right now.
  • On a more modest note, an investment in DropBox or Uber in late 2015 would earn you only a 2–3% annualized return, highlighting that not all hits are a homerun.
  • Other notable names are Slack (42% annualized return), Roku (88% annualized return), and Coupa (104% annualized return)

Our outside-in neutral perspective can be summed up as:

  • If you make a good selection (right about 60–70% of the time) of investing in the right startups in the secondary markets, the returns far outweigh any other asset class with comparable risk.
  • The biggest benefit to the investor according to me is the shortened investment period. Shorter the time period, lesser chances of something going wrong. In the time that it takes to invest and wait in an early-stage VC, you could churn your money twice and maybe make higher, but more certain returns. Corollary being that shorter the investment time horizon, shorter can be the returns as well.
  • You get to invest in high-growth Unicorns at an earlier stage before the company goes public and leftover gains are distributed.
  • A mature startup is slightly more stable, has proven product-market fit, has hopefully learned how to scale, and has a proven team that works well together. All this adds up to slightly higher principal protection.
  • Don’t go for overhyped startups, irrespective of how mature a startup is, you have to make a call on if the valuation has some margin of safety built in.

What is a Pre-IPO marketplace and how does it work?

Pre-IPO marketplace is a private market where the private company shares exchange hands between private (almost always accredited) investors. Pre-IPO shares are generally held by founders, employees and early-stage angels/VCs. Sometimes the holding period becomes just too long to tolerate (ask any early investors of Palantir!). VCs need to show performance and return capital, angels and company employees need liquidity. Ergo, the need to sell shares in the secondary market to new investors. Please note one important distinction. In a secondary sale, the company does not receive any proceeds from the sale, it is shareholders exchanging monies and assets.

With private markets maturing and investors getting more sophisticated, this secondary market has expanded rapidly over the past 4–5 years. The development of broker networks and secondary marketplace have reduced some of the liquidity concerns of the investors and contributed to the rapid growth.

How real are the returns?

Historically, stock markets have given returns of ~10% annually. But investing in select Pre-IPO companies, such as high growth tech startups can provide substantially higher returns. With a larger number of companies choosing to stay private for a longer-term, many investors (majorly retail) miss out on the ultra-high growth stage of the company. This is the stage where the company’s valuations rise multifold and retail investors miss out on the substantial portion of the returns waiting for the IPO to happen. Also, IPO is not the only liquidation event, instead there are a lot more corporates and private equities acquiring mature startups.

Take the example of the Direct listing of Slack, a popular workplace collaboration tool that went public in 2019. The Company raised series A funding in 2009 and decided to take 10 years to go public. Slack’s stock was valued at $11.91 per share in the last VC funding round 2018. Within a year, Slack’s shares after IPO opened at $38.5 per share, implying an approximately $23 Bn fully-diluted valuation Company’s price closed at 225% above the last private funding round 10 months ago.

Few other success stories in the last few years:

Zoom is a global video communication platform that went live with an IPO in April 2019. Zoom went live at a valuation of $10 Billion with shares priced at $36, by the day close shares traded at $62. Zoom in the last VC round raised $115million putting the company’s pre-money valuation at $885.03 million (at $14.97 per share).

Beyond Meat is a plant-based meat producer that went public in May 2019. The company’s IPO was priced at $25 per share, valuing the company to $1.5billion. By the end of the day shares were trading at $65 per share. The company last raised $50 million in 2018 at a valuation of $1.3 billion, with shares priced at $16.15 per share.

ForeScout is a network security monitory firm that went public in 2017, 17 years after it started its operations in 2000. Till date company has raised around $300 Mn in funding. In the last funding round company was valued at $1 Bn, but when the company went public the valuation of the company dropped to ~$800 Mn. This is an example of a situation where things didn’t go as planned.

Allocating a small portion of your portfolio to Pre-IPO high-growth securities can provide opportunities of earning substantially higher returns than investing in public markets, with risks lower than that of the initial stage VC investors. But it is no silver bullet where all the bets are winners, you have to be selective and meticulous in the due diligence of private companies before investing to earn substantial returns in Pre-IPO secondary market. Buyers beware!

Where will the Secondary pre-IPO Market go from here?

Private markets have grown and matured over the past two decades. Since 2002, Global Private Equity asset value has grown more than twice the rate of public market capitalization. At the same time, the private equity secondary market has also seen tremendous growth in volume. We believe that a similar progression of events may happen in the startup secondary market as well. Once very insignificant, the pre-IPO secondary market has evolved to become a very useful mechanism for founders, ESOP owners, CXOs to liquidate their private securities, either partially or fully. Companies now tend to remain private for longer period of time and thus increasing the relevance of the secondary market. Secondary pre-IPO market has seen a continuous growth in transaction volume and has become a reliable source to get differential exposure and skip the J curve. The chart below indicates the rising secondaries transaction volume.

What’s driving the growth of the Secondary pre-IPO market?

1. Longer gestation period to a liquidity event

To date, there are 400 unicorn startups (private companies that are valued above $1 Bn) globally. With large corporates and funds willing to back these companies, they don’t have a huge incentive to go public to raise funds. Going public also exponentially increases the compliance and reporting needs. According to McKinsey & Company, the average age of U.S. technology companies that went public in 1999 was four years. By 2014, that average rose to 11 years and the trend is on the rise. There could be many reasons factoring in a company’s decision to delay raising capital from public:

  • Additional cost involved
  • Incurring new and ongoing operational requirements (filing financial statements)
  • Losing autonomy
  • Risk of takeovers
  • The dreaded IPO flops
  • The delayed IPO exits have led investors to look for other options to exit and diminish liquidity concerns.

2. Founders need liquidity, VCs need to show successful exits

I was speaking to a founder who has been running a very successful tech startup in the valley for the past 10 years and may take another 4–5 years to successfully do an IPO or sell out. The problem is, he needs liquidity today to fund his kids’ education, mortgage, and other obligations.

VCs with a fund life of 10–11 years at times are unable to liquidate all their investments within this period. Given the need to return capital to investors, it can also become imperative to sell a portion of the portfolio in the secondary market. Whatever be the reason, the fact remains that there is increasing high-quality supply available in the secondary market.

3. Increased secondary market efficacy

With the advent of multiple offline brokers and online platforms (such as Torre Capital), it has become easy for founders to connect with buyers looking to acquire stake in unicorn startups. Increasing tokenization of asset classes using technology has also helped reduce investment minimums, documentation, and timelines.

How does the Pre-IPO market actually work?

Investing in Pre IPO shares generally can be done in a few ways.

  • One way to invest in unicorn startups is via Brokers or advisory firms that specialize in Pre-IPO secondary transactions. Using offline brokers or investment banks requires a large transaction size (a couple of million at least) and may come with high transaction charges (sometimes up to 10%), and longer lead times.
  • Another upcoming way is to list your shares on a secondary platform which then collates a set of shares and offers it to its existing investor network. The drawback here is that unless you are offering shares of very well-recognized startups, there may not be enough demand.

Taking an example of company XYZ. The Company was founded in 2010 and the founder owns 100% of the shares (complete ownership). Company raises 1M at the post-money valuation of 10Mn. Thus, the early-stage investor owns 10% of the shares and the founder owns the remaining 90%. Over the next few years, multiple investors invest in a company and the valuation of the company also rises. Founders and early investors have a large portion of their wealth locked in the company stock. Traditionally, the only way for them to liquidate their share was for the company to go public or engage in an M&A transaction. But now, they can opt to sell a portion of their shares on a secondary platform and enjoy the benefits of their labor while continuing to grow their company.

We at Torre Capital provide our investors access to best-in-class startups, and shareholders easy liquidity in two ways:

  • You can opt to list and sell your shares outright on our platform. Our investors are always looking for high quality opportunities to invest in.
  • If you don’t wish to sell your shares, or can’t because of restrictions, you can also secure a loan from Torre Capital against your shares.

With our broad network across the globe and many collaborations, we bring to our investors the best of opportunities while allowing startup shareholders fast access to liquidity.

Pre-IPO market comes with its own set of risks investors should be aware of

Private markets are growing and maturing at a fast pace but investing in the Pre-IPO private equity market and securities in the secondary market carries extra layers of risk over investing in public securities such as bonds and public equity. Some of the risks that a secondary market investor bear is:

  • Risk of IPO not going live or getting delayed

There is a small risk even with high growth unicorns that the IPO may not go through, or the company may further delay going public. This risk is generally mitigated by the discount at which the Pre-IPO securities are available. But the probability of not going live and the inability to find other exit options is always present.

  • Sudden reduction in liquidity or valuation because of black swan events

Take the example of Bytedance. Till December last year, you could not get hold of shares of Bytedance even at inflated premiums. Due to the happenings over the past six months, investors who came in the past 12 years might find it quite difficult to exit their investment. WeWork is another example that has been much talked about. Such situations can’t be ruled out completely. The secondary private market has an inherent liquidity risk as the number of buyers and sellers in the market is limited. Also, there is no one centralized platform or stock exchange with market makers.

  • Information Asymmetry

Private securities in the secondary market are not held to same reporting standards as those on the public side. This makes it much harder for an investor to evaluate a private company. Founders and managers holding the security have more information available than the buyer and have no big incentive to share the information in the market. This information gap adds the risk and impacts investor confidence in the secondary market.

In conclusion

We firmly believe that Pre-IPO markets for mature/unicorn startups is going to expand exponentially over the next 5–10 years, and investors should carefully examine the opportunities available. If suitable for their risk profile and portfolio size, this can be a great asset class to allocate 5–10% of your portfolio to in order to improve overall returns and reduce dependence on traditional investments.

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This article has been co-authored by Daksh Arya and Sargam Palod who are in the Research and Insights team of Torre Capital.

ESOP Financing: Access the capital you need to exercise your stock options

by Sandeep Kumar

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Why ESOPs are given?

Employees are granted stock options for a variety of reasons. Stock options are more frequent in start-up companies that can’t afford to pay their employees significant wages but are willing to share in the company’s future success. In such cases, stock options are given to employees as part of their remuneration package. In some cases, the employee is also given stock options, which he can exercise at a later date/s, in order to ensure his long-term commitment. Employee stock ownership plans (ESOPs) assist to build a sense of belonging and connection among employees in addition to giving monetary benefits.

When a stock option is provided to an employee under an ESOP program, it is free. The ESOP scheme spells out the terms and conditions under which an employee can use his rights. After a specific lock-in time, which is usually more than a year, the employee’s option can be exercised.

How do they work – vesting portion

The right to exercise the option may vest in the employee at a later time. The “vesting date” is the date on which an employee becomes eligible to exercise his or her right to purchase shares. The rights may vest fully or partially over the vesting period.

For example, on 31 March 2018, an employee is granted 1000 options, which can be exercised in three phases: 20% at completion of the first year, 30% with completion of the second year, and 50% on completion of the third year from the date of the grant. So, in this situation, the vesting dates for 200 options are 1 April 1 2018, for 300 shares, 31 March 2020, and for the remaining 500 shares, 31 March 2021.

For such vesting, the plan may specify the same or a different grant price or exercise price. The grant price, or the price at which an employee can purchase a share from the company, is usually set and is significantly lower than the current market price of the shares.

It is not mandatory for the employee to exercise the option because it is only presented as an option with no obligation linked to it. In the event that the current price of the shares is lower than the exercise price, the employee can choose to execute the option or let it lapse. The employee is granted a certain amount of time to execute his option, after which his vested rights may lapse. The ‘exercise date’ is the day on which an employee exercises his option to purchase shares.

When options are granted, as well as when they are vested in the employee, there are no financial outflows or tax ramifications.

Exercising options: why, how much, and when?

If your current cash curve isn’t doing as well as you’d like, exercising stock options may be able to help.

Exercising, on the other hand, is an investment in terms of money. Is it therefore worthwhile to pay the price?

When executing options, you pay money to increase your cash curve. The more options you utilize, the more money you spend; nevertheless, the curve improves as you utilize more options.

The numbers will change depending on your situation. You boost your chances of making more money in the future by paying today. However, if your company fails, you will lose that money.

An employee’s option does not have to be exercised after it has vested in him. The employee has a certain amount of time to exercise his or her privilege. When an employee should exercise his or her options is a crucial subject from a financial and taxation standpoint.

The employee must pay the preset price for the shares when he exercises the option, resulting in a financial outflow. Because the shares cannot be sold unless they are listed on a stock exchange, the money is locked up until the shares are listed or the promoters offer you a way out. Furthermore, extending your exercise date has tax implications because the capital gain holding period begins on the exercise date. As a result, the decision must be taken carefully after considering the cash flow and tax implications.

You exercise your options and officially have shares

When it comes to exercising, you have complete control. As long as you work for the company, you can buy shares whenever you want, and you don’t have to buy them all at once. When you leave a company, you usually have 90 days to decide what you want to do next (a few companies extend this to 5, 7, or 10 years).

You can exercise closer to the exit and then pay for it with the money you earn, so there are no out-of-pocket expenses. However, there are a number of disadvantages to this method.

It’s a big decision to decide which tactic to use.

Your company exits – finally!

When a business closes, one of two things happens:

  1. It is acquired, which means that another firm buys it. Microsoft purchased GitHub, Amazon purchased Twitch, and Facebook purchased WhatsApp. It goes public, which means it sells its stock in an initial public offering on the open market (IPO). Slack, Uber, and Lyft have all done just that.

Employees usually have a 90- or 180-day ‘lock-up’ period after the IPO during which they are unable to sell their shares.

You can sell your shares for a profit if the company’s exit value is high enough.

Your alternatives would be pointless if you didn’t have a way out.

Determination of your shares’ exit value

Your cash curve determines how much money you’ll make if your firm goes bankrupt.

Your ISOs and NSOs are in place to make you money in the future. “Exit” was the moniker given to that particular day. This occurs when your firm goes public via an initial public offering (IPO) or is acquired by another company. The amount of money you receive if and when your company closes is dependent on how successful it has grown. Your company’s exit value is determined by its level of success.

Regrettably, the exit value is unpredictably variable. You’ll never know how much money you’ll make as a result of your efforts. The only certainty is that when the exit value rises, you will make more money.

When should you sell the shares?

Selling an ESOP stock is equivalent to selling any other type of investment. You must evaluate the capital gains implications as well as the need for liquidity when making a decision. The selection will also be based on the Company’s future prospects.

It’s also possible that the shares you purchased through an ESOP aren’t listed, in which case you won’t be able to sell them until they are, or until the promoters offer you an exit, which may or may not be under very favourable terms. It would be advisable to wait until the shares are listed on a stock exchange in this scenario.

Tax implications when exercising the option

The taxes of ESOPs have a common structure. It is subjected to two levels of taxation.

The employee’s option to purchase shares at the exercise price is exercised in the first stage. The shares are eventually sold in the second stage.

First stage, 

When an employee’s ESOP options are exercised, the difference between the exercise price and the security’s value is treated as a prerequisite in the employee’s hands. The employer must deduct tax from the employee who exercises the option at source, recognizing it as a prerequisite. If the shares are listed on any stock exchange in India, the value of the shares given to the employee will be the average of the market price (average of highest and lowest price) on the date the option is exercised. In that instance, the fair market value will be determined by the merchant banker’s valuation certificate. The certificate of share valuation must be no more than 180 days old from the date of option exercise. Even if the shares are listed outside of India, the Company must get a certificate from a Merchant Banker because such shares are considered unlisted for ESOP purposes.

Second stage,

When the employee sells his/her stock. Capital gains tax will be imposed if a sale occurs. Depending on how long the employee has owned the shares, the gains can be either long or short term. The holding time requirements for both listed and unlisted shares are different.

Starting from F.Y. 2016- 17, If the holding period is more than 12 months, the listed shares will become long-term. However, if the holding period is more than 24 months, unlisted shares will be considered long-term.

The period of holding begins from the start of exercise date and ends at the date of sale.

At present the long-term capital gains on listed equity shares (on a recognized stock exchange) is tax free, however, short-term capital gains are taxed at 15%. Let us explain!

When shares are traded through a broker the long-term capital gains are fully exempt under Section 10(38) of the Income Tax Act.  However, as per the newly inserted section 112A via Finance Act 2018, if the amount of long-term capital gain exceeds Rs 100,000 than the amount in excess of Rs 100,000 shall be chargeable to tax at 10% without indexation (plus heath and education cess and surcharge). However, the application of sec 112A is subjected to certain conditions, one of it being the transfer should have taken place on or after 1st April 2018. Moreover, such short-term capital gains shall be taxed at flat rate of 15% under Section 111A.

If the shares are not sold through the stock exchange’s platform, long-term capital gains are calculated by indexing the original purchase price. Indexed gains will be taxed at a 20% flat rate, plus any applicable surcharges and cess. Short-term capital gains are treated like any other form of income, and they are combined with other kinds of income and taxed at the appropriate slab rate.

For the purposes of computing capital gains, the cost of acquisition is treated as FMV (fair market value) on the date of exercise, which is taken into account for the purposes of perquisites of the options, rather than the amount actually paid by the employee.

Taxation of Foreign ESOPs

If a foreign company grants an ESOP to an Indian resident, the ESOP will be taxable in India. Furthermore, the tax regulations of the company’s home country, as well as the double taxation avoidance agreement, must be investigated in order to determine the actual tax implications. Furthermore, because these shares would not be offered on Indian stock exchanges and are unlikely to be listed in India, the long-term capital gains exemption under Section 10(38) or the concessional rate of 15% tax on short-term capital gains in respect of such shares would not be available. ‍ 

When you have incurred a loss

In case you have incurred a loss you are allowed to carry forward short term capital losses in your tax return and you are eligible to set them off against short term capital gains in the coming years. Long term loss on equity shares is a dead loss and has no treatment, simply because gains are not taxable as well.

Torre’s Offering: Non-recourse financing and how it benefits startup employees‍

Employees in private enterprises (like you) can execute stock options using non-recourse financing. Because the loan is non-recourse, your other personal assets are never in danger.

For example, if the loan is non-recourse, the lender accepts the risk and you are not required to put up personal assets as collateral, such as your automobile.

Before we get into the technicalities, let’s take a look at why financing is useful in the first place.

It’s usually better to execute your stock options as soon as possible rather than later. If your company grows, exercising sooner means paying less tax both during the exercise and after the IPO— which means more profit for you.

However, exercising options can be financially out of reach for many employees of high-growth businesses on the verge of an IPO or exit. Consider this: exercising options costs nearly twice as much as a household’s annual income.

Furthermore, as the value of start-ups rises, exercising options becomes more expensive and prohibitive. That’s because the higher your options’ 409a valuation, the more tax you could owe.

Non-recourse finance can aid in this situation. It works like a cash advance, allowing you to exercise your start-up stock options without having to pay for them out of pocket.

How it works?

The lender delivers you the funds you need to execute your stock options and pay your taxes. You wait for your company to go out of business. There are no monthly interest payments, unlike a traditional loan.

If your firm has a successful exit (such as an IPO), you repay the money you borrowed plus any fees. You owe nothing if your company does not exit or falls out of business entirely. The lender is responsible for the loss. Your other personal assets are never at risk because it’s non-recourse finance.

If you already own stock in your company, non-recourse financing might enable you to access cash for other financial goals, such as buying a house or diversifying your stock portfolio, without having to sell your stock.

Is non-recourse financing too good to be true?‍

So what’s the catch?

To summarise, non-recourse financing does not put your personal assets at risk, and the financing source bears all of the adverse risk. So, what’s in it for the financial service provider?

Case 1: The supplier benefits from your success: the more effective the exit, the better for everyone. In the end, the amount you owe is determined by the value of your equity.

For example, you have $100,000 worth of ESOPs and on a successful exit you gain $50,000 then a commission of 30% would be charged which is $15,000 plus the principal amount. Similarly, if your gain is higher let’s say $80,000 then you owe a charge of 30% of $80,000 that is $24,000 plus the principal amount, hence the amount you owe will be determined by your equity value at the exit event.

Case 2: The financing provider receives a share of your pay-out plus a return of the initial advance if you successfully depart (plus any interest).

Continuing the previous example along with the commission on profit x% of interest will be levied on the principal amount. Suppose you borrowed $80,000 for exercising the ESOP, x% of that amount will be charged as interest in addition to a $15,000 commission.

Case 3: The funding provider bears the brunt of the loss if the exit fails. There is no payoff for the lender to take a portion of, and you are not required to repay the original advance.

Carrying forward the previous example of $100,000 worth of ESOPs. Suppose, the exit the value of your position is $90,000 and you are in loss of $10,000. Hence, there will be no payoff to take commission and we will bear the loss without bothering the borrower. Plus, the borrower will not be required to repay the principal amount, nor his personal assets be liable.

We are ready to take such a risk because we are very selective about the companies we engage with —thus, the people we finance. As finance providers, we also diversify the risk by investing in multiple start-ups.

How Torre can help‍?

We’re on a mission to assist start-up employees and shareholders understand, maximize, and unlock their stock’s value. We offer non-recourse stock option exercise financing to help you reap the benefits of exercising your options early. We also offer financing alternatives that allow you to access the cash of your hard-earned equity prior to departure without selling your stock.

Zomato IPO: Analysing the future of the Indian Foodtech giant

by Sandeep Kumar

Keep up to date with the latest research

The future of Indian Foodtech is here

The food delivery and restaurant service tech giant, Zomato plans to go for an IPO this June or July. The IPO catches headlines, not just because of the amount being raised or the time when the IPO comes (both of which we discuss later), but also because Zomato could as well be the very first Indian Unicorn to go public. This shall be a momentous moment for not just the tech startup, but also for the entire startup community in India. The IPO could open doors to a new form of exit for the Indian founders and VC firms and cement India’s position as a startup friendly nation.

Zomato plans to raise over a billion dollars(!). This will be the biggest IPO since March 2020 after SBI Cards IPO at close to $1.3 Bn.

Business Model

Zomato was founded in 2008 as a simple restaurant reviews website. In 2015, Zomato entered a very crowded Indian food delivery space. Since then the landscape has changed completely. Out of the numerous startups (FoodPanda, TinyOwl, Scootsy, OlaCafe, UberEats) that were offering to deliver your food, chances are today you order food from one of these three: Zomato, Swiggy or Amazon (Amazon currently offers food delivery services in and around Bangalore). What happened to the rest? Well, most shut down, while the rest were acquired and then shut down. Barely a handful which were acquired by Zomato or Swiggy operate within, not independently.

Zomato acts as a restaurant discovery platform aggregating menus, dishes, user reviews and more. Zomato has nearly 3.5 lakh restaurants listings on its platform with more restaurants expected to join in as the pandemic and the induced lockdowns play a havoc on their dine in revenue streams. These restaurants pay Zomato a fee for greater exposure on the platform. The hope is, once a customer tried the food, chances are they will pay a visit to the restaurant. Now the pains and the faults in this premise make for a story for some other day. 

Zomato’s next line of revenue is the exclusive paid membership program very creatively titled “Zomato Pro”(earlier known as Zomato Gold), offering special discounts and/or free deliveries to is subscribed members. This membership model works how a gym does, take the membership fee and then hope the service is not utilised. Zomato has one advantage though, it can decide what discount to offer and/or what price to charge (dynamic pricing), based on traffic conditions, meal hours, order quantity etc. Zomato currently has 1.4 Million pro members and over 25k restaurants listed on Zomato Pro program.

Not all restaurants choose to be a part of the Zomato Pro program as these restaurants are also expected to offer discounts and offers on dine in options as well and maybe not all restaurants find themselves in such a position (again a story for some other day).

Zomato’s next stream of revenue comes from Hyperpure which supplies raw material to restaurants. This is a genius move in my opinion, at least theoretically. Zomato’s food delivery business allows it to forecast the raw material demands of a restaurant. Efficient buying practices and careful hedging (Zomato is in no position to carry out hedges against sharp commodity price movements, simply because it does not do enough volumes to justify this sort of a thing) can allow Zomato to up sell these raw materials, earning a constant cut.

If the hedging works, the restaurants are also set to benefit as they will receive a fixed price for their raw materials, allowing prior ordering. Zomato currently has 6000 restaurants on its Hyperpure platform in just two years.

And finally comes the last source of revenue (no need to be amazed, all this revenue does not trickle down to the bottom line), the delivery partners delivering your food. Here Zomato earns commission from the restaurants as well as the delivery charges from the customer (yes, all those extra delivery charges you paid and still these guys aren’t profitable…).

  Source: Zomato’s DRHP

Now Zomato does not give a breakup of how much revenue it makes from each segment, but nevertheless, most of the revenue comes from food delivery business, the ones you are the most aware of.

The not so straightforward Market Landscape

Food and restaurant Services is a competitive market in India comprising food delivery players like Zomato and Swiggy, cloud kitchens like Rebel Foods and branded Food Services players such as Dominos, McDonalds and Pizza Hut which. Food delivery players also compete with multiple other participants in the Food Services industry including restaurants which own and operate their own delivery fleets and both online and offline modes where restaurants place their advertisements to attract customers.

The food and restaurant industry in India is composed of three segments: delivery, take-away and dine in. Out of the three, the food delivery business is expected to grow most rapidly. While this was true even before the pandemic, the post pandemic has further cemented this.

 

Source: Zomato’s DRHP

During first half of 2020, the food delivery business contracted as India braced itself for the COVID lockdowns. However, once the lockdowns and the initial hysteria was over, a boost of business came to the food delivery business, not to the dine in or the drive way streams. This clearly is good for Zomato.

But things are not as straightforward for Zomato. This is because of how the food delivery business inherently is structured. Food delivery is more of ‘now pamper me’ kind of business and not ‘I don’t care what it is as long as it gets my thing done’ kind of business. Services such as Netflix or Zomato come in the former while services like Uber or Paytm which offer more of a commodity sort of service, come in the later.

One doesn’t really care who gets you from one place to the other or what app you used to pay someone, but one strongly cares what shows or movies a certain platform offers or which restaurant offers its dishes on which platform.

Source: Zomato’s DRHP

Zomato’s Financials

Let’s pore over the unit economics first. The number of orders placed on Zomato is largely driven by its customer base, restaurant partners and delivery partners. The number of orders is also subject to seasonal fluctuations and tend to be generally higher when customers may be less likely to dine-out as a result of unfavourable weather or during certain festival seasons and holidays when customers are more likely to order food for delivery.

Source: Zomato’s DRHP

The Average Order Value for Zomato has gone up over the last 7 quarters and stands at INR 407. The AOVs are higher for orders from premium restaurants. The orders have grown from 30.6 Million for 2018 to 403.1 Million for 2020. That’s a colossal 1200% jump in merely 2 years of time.

Source: Zomato’s DRHP

The change of heart and mind with increasing Unit Economics

Moving on to the unit economics of Zomato and we are welcomed by greener pastures: while last year Zomato lost INR 30.5 on every order made, this year Zomato managed to make a profit of INR 22.9 on each order. This has been achieved mostly on the back of.

  • increasing restaurant commission charges (remember the story for some other time 😉)
  • increasing delivery charges from the customer (sadly)
  • and cutting costs on deliveries and discounts (I swear I felt the last one pinch).

All this tight cost cutting and pressurising the restaurants for more commissions has led to this rather phenomenal turnaround.

And like most things in life, if it looks too good to be true, it probably is; many think such commission structure is rather unsustainable and Zomato won’t be able to sustain this for long. Whether or not Zomato manages to sustain this or not, the IPO, pre-IPO funding and special stake sale from Naukri.com is bound to flush Zomato with tons and tons and tons of sweet cash.

Source: Zomato’s DRHP

All this positive unit economics (whether or not sustainable) is yet to impact its bottom line (which continues to dive deep in red), Zomato seems to be right at the verge of hitting profitability. While the market is in no way saturated, as more and more people start making digital payments, internet becomes cheaper and smart phones penetrate the society even more, online food ordering is bound to keep increasing.

The increasing Turnaround of Customer Cohort

As the number of customers to acquire rises, it would prove to be a challenge to monetise each customer so well that each order’s unit economics turns in the green. Acquiring customers takes cash, and that too loads of it. What matters is whether or not Zomato manages to make money from its customers, which gets us to our next metric: Customer Cohorts.

Source: Zomato’s DRHP

Acquiring customers comes with a cost and that cost needs to be redeemed from each customer. This directly implies that the customer must spend on the platform, more than what the platform spent on acquiring him. The above chart shows that once the customer is acquired, he continues to stick to the platform. The bunch (cohort) of customers acquired in 2017 now spend 3X of what they did in 2017. This is pretty impressive given a lot of customers must also have churned.

So, with the unit economics turning positive, the question that still lingers is, why does Zomato still operate in loss?

For that we switch over to the financial statements.

Source: Zomato’s DRHP

Well, there are two ways to explain the huge losses. Firstly, the huge amounts of cash spent to acquire customers and the time lag between CAC and LTV of each customer. Customers take some time to monetise once acquired. The costs have already been paid, even before the customer start generating any revenue. All those acquisition costs get added up as we see in Other Expenses line item.

 

These Other Expenses are not really “Other”, they are the marketing spends and all the discounts that Zomato offers on its platform. This line item accounts for most of the customer acquisition spends.

The other major source of expense is the Employee Expenses. Well, maybe because Zomato pays its peeps well, who knows…

All of this requires cash, which Zomato happens to have truckloads of. The latest pre-IPO round got Zomato over $680 Mn. If the IPO goes as planned, Zomato may end up with $1.00 – 1.14 Bn more. A war chest of $1.7 Bn!

The shares of the company are going to be listed on National Stock Exchange of India. We expect that the shares will be listed at prices upwards of INR 60 per share. Previously the shares of the company were converted at a price of INR 58 per share.

Zomato plans to use most of its IPO crop in organic as well as inorganic expansion, offering discounts (yayy!), sales promotions, cementing its delivery network and thus acquiring more and more of both customer and restaurants.

That’s what $2 Bn is capable of. I would not want my competitors to have a $2 Bn advantage over me.

Which gets me to Zomato’s rivals…

Peer Group Analysis

The pre-IPO funding round in February 2021 valued the company at $5.40 Bn. Within the expected price range the IPO would value the company at $6.50 – $7.00 Bn. Taking EV/Revenue multiple into account and weighted average calculation of the comparable companies, we arrive at an NTM multiple of 8.76x which gives us an intrinsic valuation of 2.07Bn.

The Indian Food Delivery space is Duopoly: Zomato and Swiggy. Under the shiny apps, things twist and turn very differently.

For starters, the business approach of Swiggy is vastly different from Zomato. While Zomato wishes to service the entire restaurant supply chain, right from raw materials, to getting it delivered to your home, Swiggy assumes a different role.

Swiggy sees itself purely as a delivery aggregator. A delivery aggregator, that will deliver groceries, books, meat, alcohol, medicine, pretty much anything that fits into that Swiggy rider’s bag. Food fits, so it delivers.

This is important. Viewing from this angle, Swiggy becomes a delivery player, mimicking Delhivery in its business approach than Zomato! 

Food just happens to be what shot Swiggy to fame. Swiggy runs not a restaurant service business, but “I’ll find someone to deliver your stuff” business – a low cost, low capex, low overhead last mile delivery business, something which most players struggle to deal with.

Be reminded though, most of Swiggy’s revenue still stems from food. The IPO for Zomato is a big deal for Zomato, but an even bigger deal for Swiggy, which will force it to act. Acted Swiggy already has, raising a new funding round, but that’s no match for the $1 billion Zomato IPO. The IPO sets the scene for not just Zomato but Swiggy as well. A bombed IPO may as well hurt Swiggy’s IPO prospects.

There’s also a new kid in town, Amazon Food. Amazon Food, is like that rich kid whose mere presence threatens Swiggy and Zomato’s dominance. Things seem quite for now. Amazon only operates in Bengaluru, offers very low delivery fees and no packaging fees; and if you happen to be a prime member, you don’t pay that even.

And I get it. Maybe Amazon is not so much of a threat that I call it to be, but my fears are based on two reasons: firstly, Amazon. Yes. That’s it. Second, just as the dust from the numerous players undercutting each other settled, a new player enters the scene. Now it isn’t as if Indian market can’t accommodate these new entrants. The market’s expanding. But what all previous tech businesses have taught is, whoever lands first gets the bucks. Amazon with its existing, robust delivery network can very easily undercut its peers offering cheaper delivery and deeper discounts, as it seemingly has already started.

Will the IPO deliver in the same way Zomato does?

Zomato’s IPO is one the most awaited IPOs. The listing has come at a time when the Indian economy is going through crisis. However, being true to its foodtech giant status, the company has used tech extensively in operations, sales, marketing and automation, which has excellent operational leverage in the longer term, and tech company values tend to get a fillip.

– – – – –

This article has been co-authored by Khubaib Abdullah and Ayush Dugar, who are in the Research and Insights team of Torre Capital.

 

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