Direct listing of startups: A road to prosperity | OPINION

By Dr. Jaijit Bhattacharya

Last year, we saw a plethora of high-performing startups being listed on Indian exchanges and thereafter, their value crashing anywhere from 40% to 70% of their listing price. This has led to trillions of rupees of wealth or Indian retail investors being eroded.

To analyse this further, let us look at how the startup funding ecosystem operates. To begin with, funding entities called angel investors or angels, bet on the idea that a startup promoter brings in. A cheque is written to the startup company, largely based on the idea, and the startup goes ahead and builds what is usually termed as an MVP or a Minimum Viable Product, that encapsulates the key features of the offering.

The Angel investor obviously takes tremendous risks and hence receives a large number of shares in return. As the startup moves towards market outreach, it requires more funding and goes for what is referred to as pre-series A or series A funding, which provides funding to test the product’s acceptance in the market. Obviously, such funding happens at a higher valuation than angel funding, as more value has supposedly been added to the startup company. This goes on for further rounds of funding such as Series B, Series C and so on.
In each round of funding, the valuation goes up till largely if either of the following three things happens. Either the company turns profitable and does not require any further funding and starts providing dividends or the company turns profitable and therefore goes for an IPO, i.e. An initial Public Offering, which implies it lists the company on a stock exchange for the retail investors to invest in, or the funding ecosystem finds it difficult to fund the quantum of funds required and hence the startup is forced to seek funds from the stock market through the IPO route, even though it is not profitable.

Also, when an IPO happens, it provides a route for the Angel investors and all subsequent investors to sell their stake and book their profit. Now if the share value tanks after the listing, what we see is that the profit booking of the initial investors has happened at the cost of the poor retail investors of the public stock market.

When the investors are foreign investors, it implies that profits booked through this route are taken out of the country, leading to net capital loss. Now, this is ironic as India, being a capital-scarce economy, has welcomed foreign capital in order to tackle the capital scarcity. However, we actually see more capital going out of the country, as companies get listed on the domestic exchanges.

What is the way out of this situation? What are the best practices of other innovation economies such as Israel? Clearly, what needs to be done is to allow the direct listing of startups in stock markets outside of India. It protects Indian investors from loss of capital, enables more capital to be infused into Indian startups and enables greater flexibility and market access to the growing startups. It also enables better global linkages and the benefits thereof.

What is Israel’s position on this, given Israel is a pioneer in churning out tech startups? Israel for long has adopted the position that its core competency is to create new startups that will challenge existing companies. Hence, it will focus on continuing to create startups and follow through the process of either getting them sold to larger companies from bigger economies, usually from the US, or getting them listed on stock markets of bigger economies such as the US or the UK.

This completes the innovation process, and the capital accrued from the process is then reinvested into the journey of the next innovative startup, some of which may even challenge the previous startups that were sold to companies in other countries. This is the process of constructive destruction, through which the entire economy grows, and India would start accumulating larger and larger amounts of capital.

Allowing the direct listing of startups in stock markets outside of India is a critical step in the direction of India becoming a destination of capital from the current situation of being a capital-scarce economy.

This article first appeared in India Today,