Startups with small profit pools should think twice before launching their IPOs

• Experts say that public markets will want at least ₹100 crore in EBITDA or ₹50 crore in PAT. So the minimum market cap is in the $100 million range.
• Startups with very small profit pools should evaluate listings on the SME exchanges.
• These startups can be risky for investors—particularly those in the retail participants, who may not possess the knowledge to navigate such volatile markets effectively.
  

There’s a new word that has entered the lexicon of startups – profitability. During the pandemic, when money was literally available on tap, startups found newer ways to burn the cash. Now that the bubble has burst and even the most celebrated decacorn has fallen from grace, founders are now learning the meaning of ‘profitable’ growth. Many startups are now announcing that they are profitable, even if the pool of profit continues to be very small. From being a fad, profitability is no longer optional as many startups are looking to tap public markets.

In August 2023, Meesho became the first horizontal e-commerce company to turn profitable and Zepto soon followed with its own plans to cut cashburn ahead of a public listing. The question is: Can a modest profit attract investors to these new age cash guzzling businesses?

Experts say that public markets have also become more selective. Look no further than the performance of Nykaa, Zomato, PB Fintech and Paytm after they listed. After the first batch of companies hit public markets, many market experts believe that turning in a small profit will not be enough to get sky high valuations. Mukul Gulati, president and CIO of Zephyr Management, says: “The Indian IPO market will want a certain size. They may want at least ₹100 crore in EBITDA or ₹50 crore in PAT. So the minimum market cap, you know, we’re talking about $100 million at the time of listing. If the profit pools are small for a long period of time, I think it’s going to be hard for any such company. There are exceptions, and exceptions are what sometimes ruin people.”

Many founders cite the example of Amazon and how its profit pool remained small for a prolonged period of time as it was in investment mode for a long period of time. Meesho, a homegrown e-commerce marketplace, in August announced that it was the first horizontal e-commerce company in India to turn profitable. Investors looking to participate in India’s ecommerce story will need to keep in mind that the valuation will continue to be premium even for those startups that are turning in a small profit. In conversation with Business Insider earlier, Dhiresh Bansal of Meesho had said that the investment phase of new-age companies is slightly longer but they generate very large pools of cash over a period of time.

For some of these new age companies that do not have a clear roadmap to profits can also look at SME exchanges for listing. Explains Abhimanyu Bisht, General Partner, CapFort Ventures: “SME Exchange is emerging as a very good option for startups which are building a steadily profitable enterprise since the early days of their businesses. We have seen in the past couple of years few tech businesses, which could have also raised some private capital from VCs and have been running profitably since a while, going on to raise from the public market investors via the SME exchange. The stocks' performance shows confidence of investors in the company's future and their appreciation in how the business has been built so far. This is in turn becoming a good avenue for VCs to get an exit from investments which are being run well as a growing business but might not be attractive to larger private capital investors.”

Many argue that new age companies looking to tap public markets with small profits should be seen as long term plays. Srikanth V J Tanikella, managing partner, Pavestone Capital, says: “While traditional metrics emphasize profitability, these firms prioritize scale, innovation, and market disruption. VCs often support this approach, valuing potential market dominance over immediate profitability. However, sustained success demands a clear roadmap to profitability, scalable operations, and market resilience. Evaluating these ventures involves assessing disruptive potential, market traction, and sustainable growth strategies.”

One of the greatest exceptions is Amazon but it is one of the rare examples where analysts have correctly believed that when the company stops investing, it will be profitable. In many years, Amazon has done that to prove its point. Most companies who are telling a similar story to investors are living in fantasy land, says Gulati. Companies that are actually not profitable or minorly profitable because they don’t have the market leadership or the pricing power or the industry structure. It doesn’t lend itself to profitability. If profit pools are perpetually small, companies will continue to struggle to go public. And if they do go public, their stock price will not do well.

Primary markets are increasingly being tapped by startups that, despite their modest profits, are looking to raise capital. These enterprises can pose risks for investors—particularly those in the retail sector, who may not possess the experience needed to navigate such volatile markets effectively. Explains Sunil Shekhawat, CEO, Sanchiconnect, “There's a concern that this trend is merely a mechanism for initial backers to exit, transferring the investment risk onto less-informed retail investors. Should these startups lack a concrete strategy for profitability and sustained growth after their IPO, the repercussions could be severe, not only for individual investors who may see their investments diminish but also for the broader startup ecosystem. Excessive hype on social media can mislead retail investors into backing these ventures without fully grasping the business fundamentals, leading to significant financial losses.”

Investors have burnt their fingers with such in the past. A prudent approach for startups would be to adopt a more economical operational model and establish a clear, achievable path to profitability before pursuing a public offering, thereby safeguarding investor interests and maintaining the integrity of the startup ecosystem.