Frothy Valuations Catch Up With Startups As Prices Crash

Frothy Valuations Catch Up With Startups As Prices Crash

by Business Briefs - Friday, May 20, 2022 11:24 AM IST
Frothy Valuations Catch Up With Startups As Prices CrashFrothy valuations hurting startups.
  • Even as it copes with a funding crunch, the Indian startup ecosystem has been hit with accusations of monetary mismanagement, tax fraud, account manipulation, siphoning off of funds.

With capital becoming costlier as central banks try to rein in inflation, loss-making startups face a completely different environment today, than they did a year back. Prices of startups that are listed on the stock markets over the last two years have collapsed by 50-70 per cent over the last few months.

The decline in the valuation of previously private startups that are listed on public markets is indicative of the frothy valuations in the private space. For instance, several technology companies that listed were on the Indian bourses last year have lost more than half their value since listing.

The drastic decline in prices has caught up with Softbank’s Vision Fund as well, which reported a $27 billion loss for the year ended March 2022 as the value of its holdings declines. Similarly, Tiger Global, which was heavily invested in growth-oriented technology stocks saw its losses touch $17 billion.

Similarly, Cathie Woods’ ARKK Innovation ETF has lost 73 per cent of its value since it peaked in February 2021. Some analysts suggest that if the private holdings of these funds are valued in the same manner as their public peers, they would lose a large part of their frothy valuations. Technology companies such as Netflix, Facebook, Peloton, Block and several others crashed up to 70 per cent.

Many special purpose acquisition companies (SPACs), which had been touted as a way for retail investors to invest in technology companies, turned out to be a costly lesson for retail investors. With high valuations, opaque structures, and low-quality companies being taken public through SPACs, retail investors lost money while creators and investment bankers had large sums of money.

If a Fortune report is to be believed, SPACs have lost 43 per cent of their value on average. In addition, out of the 199 companies that went public through SPACs in 2021, 88 per cent are trading below their offering prices. The drop in value comes as central banks continue tightening monetary policy to tackle inflation, and money rotates out from technology stocks into commodities, infrastructure and other old-economy sectors.

As capital grows scarce, companies are focusing on becoming self-sustaining and profitable to survive. Many of these companies had grown through freebies and discounts since they were flush with investor money. Sacrificing profitability for growth might not remain a viable strategy in a high-interest rate environment.

It is telling that Uber, which had listed on the stock markets in 2019, is focusing on cutting costs and turning free cash flow positive now as investors start looking at metrics like cash flows that indicate profitability and survivability. Investors who had been betting on high growth continuing well into the future might be disappointed as profitability becomes a concern.

In India, startups that include some popular unicorns are currently cutting down costs by firing employees, and raising funds before the funding stream dies out. The reasons offered by these companies usually point towards an effort to increase the runway they have. These companies had been on mass hiring sprees only a few months back — the reversal indicates that the hiring was likely unsustainable. An Indian payment company recently bought back an investor stake in its e-commerce arm at a discount of almost 99 per cent compared to its previous unicorn valuation.

Even as it copes with a funding crunch, the Indian startup ecosystem has been hit with accusations of monetary mismanagement, tax fraud, account manipulation, siphoning off of funds etc. Some industry observers have said that the corporate governance issues at startups have been attributed to incessant funding by investors without much oversight. A prominent venture capital fund is reported to have postponed the closing date of its latest fund as it faces trouble with corporate governance at its portfolio companies.

Some analysts suggest that the real pain is yet to come as the tightening cycle is expected to continue as inflation that was expected to be transitory has stayed around far longer than expected. Others suggest that the real rotation from “growth to value” is yet to happen and that these stocks are in for more pain in the next few quarters. Narratives that had been built to justify the high valuations of these companies have been falsified by the decline in technology stocks.

This article was first published here.

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