Rethinking IPOs for Startups with Small Profit Pools

Amidst the lexicon of startups, a new word has gained prominence – profitability. During the pandemic, with capital readily available, startups explored various avenues to utilize the cash. However, as the bubble burst and even highly celebrated startups faced challenges, founders are now prioritizing ‘profitable’ growth. While many startups are proclaiming profitability, the pool of profit remains relatively small. Profitability has shifted from being a trend to a necessity as numerous startups eye public markets.

In August 2023, Meesho became the first horizontal e-commerce company to achieve profitability, followed by Zepto, which also aimed to reduce cash burn ahead of its public listing. The question arises: Can a modest profit allure investors to these contemporary cash-intensive businesses?

Experts suggest that public markets have become more discerning, evident in the performance of recently listed companies like Nykaa, Zomato, PB Fintech, and Paytm. Post their IPOs, turning a small profit might not suffice to garner sky-high valuations. Mukul Gulati, president and CIO of Zephyr Management, emphasizes the expectations of the Indian IPO market for a certain size, suggesting that sustained small profit pools might pose challenges for such companies.

Many founders draw parallels with Amazon, which sustained a small profit pool during its investment phase. Meesho’s announcement of profitability underscores the changing landscape. Investors eyeing India’s ecommerce sector must recognize that valuations will remain premium even for startups with small profits. According to Dhiresh Bansal of Meesho, new-age companies have longer investment phases but generate significant cash pools over time.

For startups lacking a clear path to profits, SME exchanges offer an alternative for listing. Abhimanyu Bisht, General Partner at CapFort Ventures, highlights the SME Exchange as an option for steadily profitable startups. Such exchanges provide a platform for startups to raise capital from public market investors, offering VCs an exit opportunity from well-run businesses.

While startups with small profits may be viewed as long-term plays, evaluating their potential involves considering disruptive capabilities, market traction, and sustainable growth strategies. Srikanth V J Tanikella, managing partner at Pavestone Capital, emphasizes the importance of scalability and market resilience for sustained success.

While Amazon stands as an exception, most companies with similar narratives might be living in a fantasy land, warns Gulati. Perpetually small profit pools could hinder companies from going public or result in underperforming stock prices.

As startups with modest profits increasingly tap primary markets, retail investors face risks, particularly concerning their lack of experience in navigating volatile markets. Sunil Shekhawat, CEO of Sanchiconnect, cautions against the trend, stressing the need for startups to establish clear profitability strategies before going public.

Investors have faced setbacks with such startups in the past, underscoring the importance for startups to prioritize a clear path to profitability before considering public offerings. This approach safeguards investor interests and sustains the integrity of the startup ecosystem.