Roadmap of startup to IPO — Is IPO investing really a steel deal?

As the Indian Startup ecosystem is growing, startup funding has become a flamboyant word and IPO Launch the dream destination. Commonly, every entrepreneur asks themselves - how do I finance my startup? There’re multiple opportunities of funding available for startups. However, the origin and magnitude of funding depend on the stage of operation of the Startup.

1) Ideation: The entrepreneur has an idea/dream project and starts to works on it to change it into a reality.

2) Boot-Strapping: The Entrepreneur decides to invest their time and money into the business without any outside Funding and participation.

3) Seed-Funding: The Entrepreneur then decides to collect funds into the initial phase of the company from people who trust his Business.

4) Pre-Series Stage: During this stage, the Entrepreneur raises a bridge round to fund their immediately liquidity crunch or to prepare/setup for a higher latter round via spending on marketing channels.

5) Series Stage: At this stage, the Entrepreneur decides to raise an official big round at a certain valuation arrived with the discussion of the lead investor and the Investment Banking team. The round is generally raised with the purpose of Expansion.

6) Initial Public Offering: Finally, the startup, post raising Funds from Series A to E on a general scenario decides to launch the shares to the general public which is also an exit opportunity for the earlier investors.

Post the decision of the Initial Public offering, the timing and the valuation of the issue is discussed with the hired Investment banking team so that the best value can be derived from the market at the best valuation possible. This involves everything from targeting the expansionary zone of the business cycle to timing the IPO around the peak of the indices boom.

The team post consensus then decides on the fully distributed, pre-money, and post-money valuation of the company.

So, What are these fancy terms fully distributed, pre-money, and post-money valuation?

Let’s imagine a company with 1000 shares is going to issue 200 new shares as part of its IPO. We have an exit multiple of 15 and a forecasted EBITDA of Rs. 100.

Fully distributed valuation = Rs. 100 * 15 (EV/EBITDA) = Rs. 1500

IPOs are usually valued at a 20% discount, which will be computed on the Post-money valuation.

i.e. Post-money valuation * (1+IPO Discount) = Fully-distributed valuation

Here, Post-money valuation = 1500/1.2 = Rs. 1250

So, implied offer price of IPO = Rs. 1250 / (1000+200) shares = Rs. 1.041 /

Share

Therefore, implied cash raised = Rs. 1.041 * 200 = Rs. 208.33

The company will then pay ~4% fees to the Investment Banking team for helping to raise the funds.

Fund Raising fee = 4% * 208.33 = Rs. 8.33

Therefore, IPO Proceeds to the company = Rs. 208.33 – Rs. 8.33 = Rs. 200

Pre-money valuation is the value of a company before accepting new proceeds.

i.e. Pre-money valuation = Post-money valuation - IPO proceeds

Hence, Pre-money valuation =Rs. 1250 – Rs. 200 = Rs. 1050

Post these numbers are decided, the shares are floated in the market with a launch of an IPO which will be an exit opportunity for all the Private Equity Investors offering them a very high multiple.

So, the question now arises should you invest in an IPO? The answer is that an IPO is a crucial milestone of the company where it raises funds from the market probably last time unless an FPO is launched. Hence, just tracking the IPO calendar and buying stock when a new company goes public is a not a good move. If you do not have much time at least cover 3 metrics - company’s landscape, growth prospects and peer valuations before making your investments.

Tip: Always have double thoughts on investing in companies garnering to much positive attention as extreme optimism biased may lead to extreme valuation which may imply that the risk-reward is not favourable. For example: Double check valuation before investing in IPO’s of very well-known brands, generally very over-priced.