iPO readiness & Startups

On today’s episode we have Rajinder Balaraman, Director at Matrix Partners india, as well as Vikram Vaidyanathan, Managing Director at Matrix Partners india. They cover they key markers that help determine a company’s iPO readiness, the right size for an iPO, the role played by the board of directors and the board can be leveraged for an iPO and much more. Tune – in.

Salonie:

Hi and welcome to Matrix Moments, this is Salonie and on today’s episode we discuss iPO readiness. Joining us for this discussion are Rajinder Balaraman, Director at Matrix Partners india, as well as Vikram Vaidyanathan, Managing Director at Matrix Partners india.

Through the course of this episode, we cover they key markers that help determine a companies iPO readiness, the right size for an iPO, the role played by the board of directors and the board can be leveraged for an iPO and much more. Tune – in.

Rajinder:

Hi. And welcome to Matrix Moments. i’m super excited to be doing today’s podcast on iPO readiness with Vikram Vaidyanathan my colleague. Vikram, congrats, today the ET Startup Awards that you got nominated for the Midas Touch. You have three companies today that are at iPO, basically maybe four. And so this episode is all yours.

Vikram:

i’ll tell you what i tell my mother which is don’t believe everything you read in the papers. But these iPOs are still coming for us and i think this episode is our learnings on how we’re thinking about iPO readiness and i think i’m sure we’re going to have more learnings once these companies actually go iPO.

Rajinder:

Awesome. Actually just on that topic, first, how does a founder even know whether their company is iPO ready and, you know, you’ve been in enough of these conversations where they’re asking these questions. What are the key markers for them to actually track to figure this answer out?

Vikram:

i think the first one is meaningful scale, i think there are two. One is meaningful scale and second is predictability of the business. So on meaningful scale i think the thumbrule that all of us are going by is about 100 million of revenue because that usually leads to a billion plus iPO and so that seems like a reasonable scale to go public. Now in the US companies are going public at $25 million, there are lots of companies they’re going public at 50-100 but in india i think this asset class is getting defined now and people are recognizing this asset class now.

So it’s better for you to be at the higher end of this range and answer meaningfully the question on meaningful scale. i think the two other ways of thinking about meaningful scale, the first is category Leadership and if you’re number one, number two in a category which is very large or you have 20-25 percent market share in a category which is very large that’s the other way to answer this question on meaningful scale. You might be a little bit lower on revenue but you can actually show you’re a category leader in a monster category.

And that comes to the second point on meaningful scale which is public market investors want to answer the question not just meaningful scale today, but they want to hold these companies or rather stock in these companies forever. So you want to answer the question, 4-5 years from today you will be 5-6x bigger and are you able to tell a story which actually gets you there. So that takes you to the second point.

First point was meaningful scale, the second point was predictability of the business and what about the business. The first is growth and the second is unit economics financials in some way.

i think the second thing that’s important for companies going public is the predictability of business. And when i say predictability of business it’s two parts which is growth and unit economics. And for public market investors they want to see an easy way that they understand of predicting the future. And as long as they can see that they will pay you a forward multiple of that business which is a one year forward. You often hear this term one year forward which is the one year forward in revenue or a one year forward on profit and so you get a one year forward on your PE multiple.

So if you can predict first their growth engine which is easily extendable and public market investors, pay a couple of year forward, what does that mean? That means you are valued at a multiple which is one year forward in your revenue or one year forward on your profit. So public market investors want to know how easily you can predict that, where will you be one year forward or two years forward. And so if you’re able to project that out in a very simple manner that i’m going like this and this is going to continue that’s what public markets want to see. Now i think in a high or rather a low cost of capital environment today growth is more valued and i do think for Startups that is going to be true that growth is the first determinant of going public and staying at the price that you want to go public at.

And i think the biggest thing you’ll have to demonstrate is is your growth engine at a reasonable cost going to continue for the next one year, two years, three years and so on. in a more risk centric higher cost of capital environment i do think the unit economics will matter and even today i think those matter and most companies are cognizant of the fact that unit economics matter and they’ve actually right sized the unit economics before they go public but i do think growth will trump off.

So i’ve said growth will trump off too many times i’m cognizant that’s coming off as a bull market investor and a perennial bull without enough cognition of how public markets are. So unit economics is hygiene, so if you don’t have that and your unit economics are gyrating a lot then it’s harder for you to go public.

But if your unit economics are in a zone that the public markets understand so call that as hygiene then growth comes all.

Rajinder:

Yeah, i completely agree. And i think we see in public markets there are some companies that get like a FY 23 multiple or an FY 24 multiple but for high growth companies like many of these internet companies that are going public i’ve actually seen analysts reports talk about FY 26, FY27, FY28 so they’re really projecting growth 5-6 years out to actually break in their DCF analysis, so fully understand that. i’m just wondering like again as a founder as you’re preparing to go public how should one think about growth versus profitability?

Vikram:

i don’t know if it is growth versus profitability it’s and but as a founder what i would care about is is my business cycle tested, one of the main things. Markets are going to go through ups and downs and you’re going to get rewarded for different things as we go through ups and downs. And can you ride out those cycles in a capital constrained environment and you’re able to take advantage of a capital flush enviorment. So if you have maximum control of your levers on growth where i know variable cost growth will come down and my business will automatically look healthier, that’s a great place to be.

And if you’re profitable and you know your profitability levers really well and you can dial up and dial down those profitable levers then that’s also a great place to be. Now i don’t think you’ll have all of them when you’re going public especially in categories that are still getting started which are most of the companies that i do think they’re in year 1 of these categories getting started and the companies are already going public. You might not have all the levers but if you have enough levers that helps you ride out short storms in the market then that’s good enough.

Rajinder:

Now it sounds like the founder has a real tall order. When it comes to going public how important is the role of the CFO versus the CEO and as a founder CEO what should one look for in a CFO if you’re looking to go public?

Vikram:

So i don’t think a founder’s role can be replaced in any big event and it can’t be in this. The CFO does play, can play an important role, and i was talking to a founder recently and i recalled a Warren Buffet quote that accounting is the language of business and i’ll paraphrase language of public market. So you have to learn it or someone in your company has to be well versed in it and that’s the CFO.

So what does that mean, the CFO in a company i think has three roles, the first is performance review analytics, the second is compliance and the third is investor relations. i would argue that in the early stages a CFO likely has more emphasis on performance review, cost controls and compliance more cost control than anything else. As you scale and especially as you go public i think the emphasis of the next two which is compliance and especially audit because every one of your process is going to be tested and especially your audit processes.

And so compliance, audit and so on plus investor relations will become more and more important for the CFO and you’re not going to find this magic superman CFO. And so it’s important to understand what your CFO’s strengths are and supplement it, the CFO might be really good at performance review and compliance, then you might need to hire an iR person.

Or might be really good and they might come from an investment banking world who are really good at iR and some of the other things but might not be as good at compliance so you might want a very strong financial controller whose good at it. But you will have to really build that finance function.

Rajinder:

Yeah. Just double checking on the performance management piece what about metrics and how should one think about what metrics one is really talking about as you prepare to iPO?

Vikram:

it’s a good question and often as early stage investors we’re looking at “surrogate metrics” because you don’t have real metrics so you might look at a GMV metric and you’ll know what the take rate is going to be which will lead you to net revenue. And often that becomes the language of the company and that’s how you’re measuring that company. As you get towards iPO you have to get to the real metrics, that which is move from gross revenue to net revenue, move from take rate to gross margin, move from CM to EBiTDA.

And so you will have to convert some of what you’re measuring at early stages as surrogates because GMV is the surrogate for revenue, CM is the surrogate for EBiTDA. But because you don’t have EBiTDA you’re trying to predict it using CM. You’d have to convert it all into some of those real metrics as you’re going iPO because that’s the language of the public market.

Rajinder:

And i guess some of these companies are so capital flush given the private equity markets that EPS metric actually doesn’t even get discussed and so as you’re raising a lot of capital you also want to be conscious of what the EPS measure looks like as you’re going public.

Vikram:

it’s a good point and i need to train myself on thinking about that.

Rajinder:

Yeah. You know, a lot of companies had this debate prior to the Zomato iPO on why should one be going public. Should it be in india, should it be the US. Now Zomato has gone in india, Freshworks has gone in the US. How should one think about this?

Vikram:

i think the clear answer today is that india markets have arrived and are ready for companies to go public. i don’t think we could make that statement even 12-18 months before or even maybe 6 months before conclusively. And here was a prevailing wisdom before on why all of us, us included, thought the US is a better market for our startup tech companies to go public. The first was that there were investors there who understood these companies better. And second was that there is a deeper pool of capital there.

So if there’s $100 million at play here there are billions of dollars at play. Both of that are no longer true, because now if you look at domestic markets we have access to the same set of investors. So you’ll see in the public companies or in the iPOs that have happened the likes of capital groups, the likes of FMR with Fidelity, everybody is participating. So these are the companies, these were the investors that you were like looking to target with your US listing, they’re here. The only difference is that they might be investing out of an emerging market pool so there’s a tick that’ll say, hey, this is our emerging markets allocation, that’s the only difference.

So even if you have a billion dollar iPO you can actually get funded with these same institutional investors. Now i think if you’re let’s say safe for going public at $100 million and it’s a $10 billion iPO then you might not have that large enough pool of capital. i think a lot of companies, of our companies are going to test it so we’ll find out. But today 1, 1.5 billion type iPO going public domestically i think it’s a great idea and all of the iPOs have already proven that you can go for a break with that kind of float.

Rajinder:

And what aboutthe indian retail investor because it seems like everyone’s been lining up in the last like six months to lap into this iPO frenzy in some way.

Vikram:

So the india retail market is deepening and Covid’s been an inflection even in that market. i would argue for a domestic household brand and a lot of our companies are household brands where people are using it everyday, talking about it everyday. it might even be better for you to go public or it might be far better for you to go public in india because they’re all known brands and because everybody around you is using it you can believe the story more, hey, this is going to grow. Everybody around me is using it and their usage is going to grow. So it’s easier for you to actually take a bet on that growth story.

Rajinder:

And i guess there are also sector specific differences, right, for regulated markets like financial services maybe there is a natural reason to go to india when you’re going public, for software companies where the customer is largely in the developed world there’s a reason to go to the US. Maybe there are some sector specific nuances as well?

Vikram:

Absolutely. And i think this is public that we’ve actually signed on a document and petition with the government allowing for dual listing. And so if our belief has changed that domestic iPOs are the right approach for all of us then why are we thinking about US listing for example. And example, Freshworks just went public, yesterday it’s a big event celebrated not just in india but across the world by every indian that this is the next big thing that’s going public on Nasdaq.

Now why is it important is because Freshworks is actually selling to Fortune 100 companies and some of them might take this as a great signal that, hey, this is public on Nasdaq and they might trust something that’s going public on Nasdaq with those standards a little bit more. And so if i’m going to trust a software company with my data and secrets and then to trust an india company it might be an additional signal that you’re public on a US exchange. And i think it should be an option that should be available not that there are domestic markets which are rewarding companies to go public in india.

Most companies are going to do that anyway and the india retail investor should be free to invest in those domestic companies as well as in international companies. Now there’s a lot to be figured out, there’s capital count convertibility, there’s how does SEBi deal with it, how does RBi deal with it, but by and large i think the establishment is trying to figure this out and very constructive on this issue.

Rajinder:

i know that there’s been a lot of work that a lot of investors have done in the last year, switching gears to a different topic what’s the right size for an iPO in your mind, like is it a $100 million, is it a billion. You werekind of referencing different numbers when you spoke at the Facebook iPO so?

Vikram:

Yeah, it’s the most hotly debated topic in boardroom investor conversations on what is the right size. And some people want $100 million, some people want $250 million, some people want a billion. So let’s start with regulatorily what is required. A ten percent flow which means 10 percent of your overall share holding be public and listed and freely tradeable is a requirement for any iPO.

That can be fulfilled by OFS or offer for sale as well as primary that you raise, so that’s the 10 percent threshold. Now you want to figure out with that 10 percent and now that 10 percent is going to equate to a number so if it’s a $500 million valuation of a company 10 percent is $50 million so the iPO size is $50 million. if it’s a billion the iPO size is $100 million. Now the question is what kind of investors do you want for the iPO, the easy answer is long term investors because people who will hold their stock and not -- the stock won’t gyrate once you go iPO and it doesn’t mess with your head as a founder and top management because it does if the stock is gyrating.

Now you want enough long-term institutional investors who understand your company and understand that a company is going to go through ups and downs and they’re going to stick with you. Now the question is how much of the iPO can be institutional and give or take probably about one third you can get to real institutional shareholding. Now let’s say it’s a $500 million valuation, $50 million iPO, one third, that’s too small to attract a really large investor who manages billions of dollars of capital to say, hey, why don’t you pay attention to a company which is $50 million where you can only invest $50 million.

if you have to make it a meaningful chunk for them to really invest in your company and that determines what is that sizing of the iPO. And i would say about $250 million and honestly we’re going to find out but 200-300 million is what we’re hearing from all bankers that you would need as the minimum to attract the right share of investors. And then the second thing is that as it grows bigger you obviously need large investors let’s say the billion-dollar iPO need large investors plus for them to believe in the story enough to risk large amounts of money both.

So obviously you’re setting yourself a high bar on raising that large amount of capital. Why do you want to raise a large amount of capital because you will need it for both, you will need it to ride out storms. it’s one way of making sure your business can last through a cycle, therefore some companies might choose to play the larger round even though it puts a higher bar on making the iPO successful.

Rajinder:

Yeah, i was then just doing a back calculation and since at 10 percent minimum $200-300 million but you may choose to raise a slightly larger amount. That means a billion and a half and above is kind of the valuation mark post which people begin to think about this.

Vikram:

i would think so. if you’re about a billion to 2 billion it’s where you should be thinking about going public because that’s when you know, your float is sizeable. There are other ways to do it, you could have a 15 percent float or a 25 percent float and over a period of time you do want to get to that so that if somebody is selling a 1 percent chunk and as early investors you will start exiting and you are selling 1 percent its not a big deal to add some float because at 10 percent adding 1 percent float is a big deal. And at 25 percent adding 1 percent float is less of a big deal.

Rajinder:

And that’s a good point, i didn’t think of that. You know,you started on this topic of boardroom discussions and the size of the iPO being a very contested discussion topic. Talk to us more about what is the role of the board in this, i think the role of a founder is very clear. What is the role of the board, what is the role of different board members in this entire process?

Vikram:

i’am going to find out for whether and how we can be helpful. We are part of a lot of these discussions and we’re trying to be as helpful as possible but bringing our network to bear and so that’s but this is all early days. ithink this topic is more talked about in terms of early market signaling, who should i have on the board who can signal to the market that hey this company has arrived and so on. And ithink it’s more talked about than it should be and maybe for the wrong reasons.

Because peopleare thinking of who likes this person in public markets and because the person is liked in public markets let me get them on the board. And i think that part of the conversation i’m not sure i fully agree with and maybe people who are more senior than me have a better view on why that is the case. i think having people on the board of repute is incredibly important, it’s a signal to the market that you’re serious about governance and you’re serious about getting people who have been through this journey that you will listen to along this journey.

And so you need to develop enough trust with those board members, don’t just get a figurehead for signaling but you have enough trust that you’re actually going to listen to them. And i think that’s the most important part of choosing these kind of board members. What is clear for me is that there’s a very strong role for independents so on the nomination remuneration committee, NRC, on the audit committee, on the iPO committee, on risk especially in Fintech i think independents have a very strong role to play because all of those committees and the processes that you follow are going to be scrutinized in the runup of the iPO especially so in Fintech and financial services companies where i spend a lot of time.

Rajinder:

Yeah, and all of us in business school have done this class of governance and boards and it’s just great to be reminded of it all. i was wondering there seems to be like a transition when you’re a private company and still a very shareholder driven company and it sounds like when you’re a public company it’s a very board driven company. And it seems like the key difference is really these governance committees for individual topics. is that the way to think about it?

Vikram:

i think you do become more board governed as you become more public because the board has access to information that others do not. And there are rules for example if you’re on the board when you can sell, if you’re on a board and you own stock as an investor what windows you can sell in and so on. And therefore as a board you’re privy to more information and you have to take that responsibility very, very seriously. Whereas in the earlier days lot of people had information about a company that is private so i guess it does change.

i think the responsibility on the committees does start in the run up to the iPO, you can’t suddenly wake up overnight and say i have all these committees, they’re functioning well, they’re chaired by people who know what they’re doing. So i think that you have to plan in advance.

Rajinder:

You know, we can’t close any discussion on iPOs without talking about the two big iPOs that just recently happened, Freshworks and Zomato. How have they in your mind impacted if at all the overall early stage in india. Global investors for example started looking at the startup ecosystem differently, has the narrative changed on india?

Vikram:

So first things first, you know, both the Freshworks iPO and Zomato iPO we had a very small stake, we ended up or rather two of our companies that we invested in got sold to these companies so we ended up with small public stock on which we did and will do really well so thank you and we also got a reason to cheer them on. But honestly we didn’t need a reason to cheer them on and we’re going to cheer on every iPO that’s coming out in the market because we’re all invested in each other’s success on these iPOs as a startup ecosystem.

Because the last piece of the puzzle on india startup ecosystem is falling into place with this liquidity because iPOs are a sustainable way of going public. So one of M&As, one of big strategic sales they’re not repeatable. Whereas iPO is a repeatable formula and therefore it is a big, big deal for all global investors, global LPs looking at india that the last piece of the startup ecosystem puzzle has fallen into place. So there’s a big, big deal what does that mean, it means more dollars will come into india because now you cannot guarantee but you can predict liquidity with much more certainty and sustainability and so on.

So that is one. Second is, i think the currency in the startup ecosystem is also going to change because for us for example we sold companies into or the company got sold into these public companies and then they’re liquid and they’re actually converting into cash. And so more and more founders are going to start thinking about the fact, hey, maybe i should be merging with this company that might go public and that startup currency is going to change where people are going to sell into some of these public companies or companies that are going to go public because they value that currency more.

And in the Valley you’ll see that there are lots of small Startups which end up being either a product in a platform or feature in a product they actually sell into a Facebook, into a Airbnb and into a Skype and then that’s the currency. So founders also have a way of getting that liquidity then moving on to the next startup. So i think i’m hoping firstly that you’re seeing this spur of M&As because founders also see that in their currency. And secondly, more founders Startups because you can now get liquid much faster by selling into a public company.

Rajinder:

i think it’s amazing. Any closing thoughts on just what this means for us?

Vikram:

i think it’s a big moment for the ecosystem and i’m wishing everyone the best including us who are also going to be learning along the way and i’m sure we’re going to make a bunch of mistakes. it’s important to remember for most of us this is not an outcome. For the founder its not an outcome, for us its not an outcome, in a lot of cases we’re not going to sell anything, in some cases we’re going to sell a little bit in the iPO. So it’s actually the beginning of the next phase of the journey to build institutions that last and outlive the founders, outlive the first set of employees, outlive the first set of investors and move on to creating long term lasting impact and create value for another set of shareholders.

it’s really the beginning of that journey. So, yes, we’re celebrating this milestone but it’s important to remember its not an outcome, it’s the beginning of the journey and so Godspeed to everyone that’s going public and good luck to all of us.

Rajinder:

Thanks.

Salonie:

Thanks for tuning in. For more Matrix Moments episodes, you can head to www.matrixpartners.in/blog. You can also follow us on Twitter, Linkedin, and YouTube for more updates.