Startups to be valued on profit multiples over revenue multiples, says investors

The shift in demand has forced investors to reevaluate how they value startups.

Investors are now looking at more realistic metrics, such as profit multiples, to evaluate businesses after the initial euphoria of the pandemic years has largely died down. This is due to the recent corrections in valuation and a slowdown in startup funding.

Over the past few weeks, large startups like Byju's, Meesho, Swiggy, and several others have seen their valuations slashed by investors, largely in tandem with their publicly listed peers, by anywhere between 10 and 70 percent. This comes at a time when funding into Indian startups fell to $46.7 billion in 2022, down 40 percent on a year-on-year (YoY) basis. Investors are now asking founders to turn in profits, rather than pursuing growth at all costs.

The shift in demand has forced investors to reevaluate how they value startups. “Earlier (during the pandemic years), when we stress tested businesses in steady state for the next 8-10 years, EBITDA looked like 2 percent at best, but everybody said this is a new time and there's so much innovation happening, entrepreneurs will figure it out and do magic later, so let’s assume 10 percent. We were flexible earlier but are more circumspect now,” Prashanth Prakash, founding partner, Accel said at an industry event in Bengaluru.

“That was largely because our entrepreneurs have not figured out how to make money because India is among the toughest environments to create profits. Customers in the B2C space are the most value-seeking ones, they expect great service but do not want to pay for it. The new generation of entrepreneurs, who have not seen the value of building frugally, because of a combination of the three factors are now struggling,” Prakash added.

While startups in India operate on thin margins, Salil Pitale, joint MD and co-CEO, Axis Capital said they have an economies of scale advantage.

“Indian businesses have thin margins but they enjoy great volumes which eventually helps in the long-term,” Pitale said.

This is particularly important because most VCs now invest in startups based on profit multiples rather than a multiple on the top line.

Nilesh Kothari, co-founder and managing partner of Trifecta Capital, a venture debt firm, said the shift in focus was largely because of how new-age tech companies were "beaten down" when they went for a public listing around 2021. Defending startups, Kothari added that founders were in the right because they only chased what they were rewarded for. Investors were earlier investing based on revenue growth, so that was the company's focus. However, they are now infusing capital based on profits, and this mindset is here to stay.

“Public markets have historically demanded profits while startups decided to list on the stock exchanges. Early-stage startups need not be profitable upfront, but the path to profitability needs to be articulated upfront,” Pitale at Axis Capital said.

To navigate their way out of a tight capital market, an increasing number of startups will move away from venture capital money and instead tap alternate funding options like supply-chain financing, invoice-based financing, venture debt and acquisition financing, especially used for mergers and acquisitions (M&As), the panellists said.

Source : Moneycontrol