The Indian startup space has seen huge activity in recent times. As per an article in the Business Standard, about 3,100 startups have received investor funding. Large well known ones like Flipkart have grabbed headlines. But there are many smaller ones that are also growing rapidly. Most of them though are not profitable yet. They have grown with the help of huge amounts of venture capital (VC) funds.
This business model is clearly not sustainable in the long run. As and when these firms start turning out profits, the VC investors will look to exit. The preferred mode would ideally have been via IPOs. However, as we had written in the 5 Minute WrapUp a few months ago, startups like Flipkart will face problems listing in India. This is because India's IPO rules are quite strict when it comes to firms that are not profitable. But market regulator SEBI has announced a new institutional trading platform for startups. Will this lead to a flood of startup IPOs? Not quite.
The reason is multi-fold. India as yet does not allow FDI in multi brand retail. Thus, these firms operate as marketplaces and many are registered in Singapore. Under the old rules or the new ones, listing a Singapore firm would have been hard enough. Then there are FEMA regulations that have to be complied with. Foreign investors in such firms would also face trouble taking back their money abroad due to capital convertibility issues. SEBI's new platform does not solve any of these problems. In fact, the new rules require at least 25% of pre-issue capital to be held by qualified institutions. It is not clear how many Indian startups satisfy this criterion.
Thus, we would not be surprised at all if these firms were to ignore Indian markets and list on the NASDAQ in the US. Would this really be a bad thing? Not according to us. We believe, as long as these firms do not have a strong moat around their business, they would be high-risk bets for retail investors. If some of these startups were to eventually list on the Indian markets, retail investors would be well advised to be extra careful when evaluating their IPOs. It might make sense to completely avoid them.