From Subhiksha to Paytm: How valuation craze trips start-ups

Few would dispute the customer convenience that Paytm products brought in over the years in the world of finance. For shareholders, however, the experience hasn’t been half as pleasant.

The company pioneered app-based payments with its now ubiquitous Paytm and broke the establishment stranglehold in the domain of transactions by international payment system operators. The familiarisation of the QR code among merchants broke many barriers.

Whatever may be the business, the value of it is in general determined more by the profits it makes rather than the novelty of it. In a technology-driven investment climate, factors other than profits are peddled to be metrics for valuation.
One 97 Communications, the parent company of Paytm Payments Bank, was one among them that grew by leaps and bounds to keep private equity investors happy and command a market value of $20 billion when it was floated on stock exchanges.

Years ago, Aditya Puri, the founder Chief Executive of HDFC Bank, was quite skeptical of the business model and questioned how it could be sustained when customers are being added through incentives of cash back rather than being charged fee for services?

In a world where the game was to show the growth in new customer addition and profits projected into the future, Paytm Payments Bank is said to have indulged in sharp practices, the penalty by the Reserve Bank of India (RBI) shows.Questionable management practices to get higher valuations are not new either. Every economic cycle brings with it businesses that are adding value to the economy, but those dynamic entrepreneurs also indulge in management practices that eventually break their enterprises – as WeWork in the US and retailer Subhiksha in India remind us of such innate frailties.Part of the problem is with investors, especially those in private equity, which rush to any good idea and pump-up valuations with meagre investments even when the financial metrics aren’t in place. Byju’s, for instance, soared to $22 billion only to plunge to a few hundred millions, or WeWork, which has gone into bankruptcy, had a gravity-defying value of $47 billion on private equity commitment.

Private equity investors expecting to double or treble returns in many cases prod the promoter to `create value’ through acquisitions, product launches and expansion that actually don’t add value, but help showcase sufficiently to dump the risk on public markets.

Whether it is Subhiksha or Paytm Bank, there can hardly be a disagreement on the business, but the compromise on governance led to their collapse.

The responsibility for governance does not lie just with the CEO. Even if the entrepreneur deviates, the board of directors and the shareholders are supposed to put brakes on bad management practices. When PE returns trumps governance business will wobble one day.

Investors in One 97 Communications had occasions to raise governance standards when founder Vijay Shekar Sharma issued ESOPs to himself, holding stakes in group ventures in personal capacity.

Yes, at the heart of humans is greed. But when valuations overtake the value proposition that made one an entrepreneur to start with, the journey doesn’t end well.