The Science behind Soaring Start-up Valuations with Marginal Revenue

Nowadays start-ups have been measured by their valuations. Though there are many other parameters valuation is one such parameter that is a popular way to judge the capability and success of the company. Frankly, the math behind this valuation is quite tedious but it’s the gist of the performance parameters. Every time a start-up raises funding, a valuation number comes up which rates the current status of that firm. In India, we have ~40 start-ups that have been valued at over $1 billion and there are many inline which are close to that mark.

But few eyebrows have been raised recently on the logic behind these valuation calculations. The question is why the start-ups which are struggling to turn profitable or even not to generate any revenue have been valued so high. Usually, we measure the success of the company by its revenue and profit generation but that case is not valid for start-ups. Is there a science behind it or something else?

Frankly, it’s not that simple to answer but yes everything has some logic and even this also has some. I think the credit of this indifferent valuation calculation can be given to the following parameters:

  • The pace of Digital Revolution: The change which this “digital” technology has brought is not a big surprise but the actual surprise is the pace at which the change has been done. Let it be Jio, UPI, or smartphone penetration, this digital revolution is going so fast that the growth in the related numbers is exponential. Gone are the days when we used to talk about rising in users of a particular app in a year. Nowadays growth is calculated month-on-month and that too is multifold. Simple logic here: More the users, more the eyeballs, and hence more the investors.

 

  • Vertical/ Horizontal Business Expansion: Some businesses look for long-term value which they can create from current solution offerings irrespective of whether they are generating any revenue or not. The current business of the company might not be profitable but if they expand vertically or horizontally they can generate multiple revenue options. Like Truecaller started offering small ticket size loans for all its subscribers.

 

  • Matching Demand Supply: In simple term, when there is a sudden rise in demand of a particular product or solution then it’s always good to support / back those company which can fulfill these growing demand. Pushing these firms to tap opportunities and scale them up. The growth of Edtech firms confirms the same.

 

  • Stock Market Euphoria: The stock market might not be the big parameter but it could be that catalyst which long-term investors always bet on. Thanks to the current market rally in which many IPOs got over 100% listing premium and that is what many investors might be targeting from their investments in start-up once they roll out the IPOs.

You might be wondering, why we haven’t talked about the parameters like forward revenue multiples, price to earnings ratios etc. Yes, they are very much important but the way the market is reacting, these factors have been given less weightage compared to the frenzies which are driving this market.

Irrespective of the factors we discussed above, the main focal point of all this discussion is the “Trust” that the stakeholders have in the Indian start-up ecosystem and the “Potential” of Indian entrepreneurs to run their businesses.

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