Indian startups are flush with money but are they staring at a valuation bubble?

However, all this was before the COVID-19 pandemic hit, giving uncertainty and slowdown a whole new meaning.

A rise in internet users during the pandemic, unprecedented growth, and a rapid bounce-back from lockdown has taken deal-making back to its heyday. The valuations are rich, the metrics are sometimes shaky, and growth is always the priority. Valuations are determined not necessarily by fundamentals such as forward revenue multiples or share price to earnings, they are determined by demand and supply, urgency to invest, fear of missing out, and excitement driven by growth.

Take fintech for instance. Cred, BharatPe and Khatabook and three companies, collectively valued at $1.7 billion, have exactly zero revenue.

Online learning firm Unacademy is expected to have a revenue of about Rs 400 crore in FY21, according to a person close to the firm. But, it is valued at $2 billion (Rs 14,000 crore), about 35 times forward revenue.

Even Byju’s, India’s most valued edtech startup is valued at $12 billion with about $700 million in expected revenue - an aggressive, but far lower multiple of 16-17 times.

The signs are typical. Large markets, pedigreed founders, high growth, top early stage Venture Capitalists (VCs) backing you, and the chances of that next outsized round, even at a unicorn status - the coveted billion dollar valuation - are high. But when the large deals happen for unproven companies, when the valuations double and triple in no time, it leads to one question - are we in a bubble?

The question is always a hard one because historically, it is only after economic bubbles have burst that most people realise they were in one.

“It is particularly hard to tell this time around, because we are going through a digital revolution. For the longest time, India’s internet market size was a huge question. With Jio, UPI, and now the pandemic, digital adoption has taken off in a way even bullish investors didn’t expect a year back. So, companies will be priced on future value. And if you are a smart entrepreneur, the price will be higher than many expect,” said a partner at a leading venture capital firm, requesting anonymity.

Rich valuation multiples have also spilled over from the usual suspects - consumer internet firms, to enterprise software companies. This is new. For instance, SoftBank last year invested in Mindtickle, valuing it at $500 million on about $20-25 million of expected revenue. Even software-as-a-service (SaaS) firms such as Slack, Zoom, Snowflake and Cloudflare in the US have gone public in the last few years with resounding success.

"SaaS valuations are very rich following on the lines of the frenzy in the public markets. And a demand supply dynamic where investors want to get into a few late stage quality SaaS deals. Both public and private markets are at a high and further building upon this,” said Karan Sharma, co-head of the digital technology arm at investment banking firm Avendus.

Sentiment in India often flows directly from the US - more so in similar spaces and from funds which invest in both countries - to many of India’s top VC firms. US-based startups raised a record $130 billion in 2020, rising 14 percent year-on-year despite the pandemic which shut economic activity for a few months, according to CB Insights, a data tracker.

Indian startups raised $10.6 billion, compared to $12.5 billion in 2019, as per Venture Intelligence, a startup data tracker.

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Public vs private

Startup valuations are also linked to how publicly listed companies are trading - whether retail investors are willing to pay high prices for loss-making companies, whether the banks underwriting a share issue can find enough at a certain price, etc. For example, in 2019 when Uber’s shares did not rise after going public, and WeWork saw its valuation slashed by more than two-thirds privately, it was seen as an indicator that private companies are perhaps overvalued, and that their “real” value will be determined only at listing.

Today, the opposite seems to be happening. American food delivery firm Doordash and hospitality firm Airbnb’s IPO opened spectacularly, jumping 92 percent on trading day. Indian equity markets have seen a similar wave albeit at a smaller scale. Recent IPOs of Burger King India, breadmaker Mrs. Bectors, IT firm Happiest Minds and others, have all been oversubscribed hundreds of times.

“For the first time in years, you could very seriously argue that private markets are actually more rational than public markets. So the select over-valued companies may not be overvalued if stock markets are the benchmark,” said a partner at a venture fund, requesting anonymity.

And a more critical look at what a bubble comprises, and what Indian startups are doing, provides a clearer picture.

The alternative investing industry, including private equity, venture capital and hedge funds, is expected to have $17 trillion in assets, as per a report from Preqin, a global alternate asset data tracker. Further, commitments in Asia Pacific are growing the fastest, at 25 percent compounded annually.

All things considered, while valuations are exuberant and the best startups have their pick of investors and price more than ever before, there seems to be more rationale behind it than previous years, investors say.

"There has been bullishness in growth investing behind sectors that have come out very strongly from this pandemic and high interest is driven towards select market leaders. In the growth stage, the unit economics and profitability profile has significantly improved over the last 18 months,” said Sharma.

“One would always assume some rationalisation at such levels, however, given the level of liquidity in the market, it might not be significant. There might be some volatility, but a large correction seems unlikely in the short term,” he added.