With veterans in the financial world calling out accounting practices of startups, sky-high valuations of unicorns could start heading south. The manner of revenue recognition at some companies, including Byju’s, has raised eyebrows as has the practice of adjusting Ebitda (earnings before interest depreciation, tax and amortisation).
TV Mohandas Pai, chairman, Aarin Capital, and former CFO at Infosys, has pointed out that providing an adjusted Ebitda can be misleading.
Companies, Pai observed, could adjust the Ebitda in any manner, leading to a lack of comparability and reliability, ultimately resulting in “misleading and mistrust”.
“Startups should follow the accounting practices laid out by the regulators and make disclaimers available.
“If they’ve got a set of parameters which is judged by investors and which is what gives them the earlier valuation, they should disclose this,” Pai told FE.
India’s most valued start-up Byju’s reported a dramatic rise in losses and weak growth in revenue for FY21, in results that were reported to the Registrar of Companies (RoC) 18 months late.
The edtech major made changes to its revenue recognition accounting practices in FY21.
Ankur Bansal, co-founder and director of venture debt firm BlackSoil Group, pointed out that the accrual principle has often been a methodology for playing fast and loose with revenue numbers.
“Since the Ebitda is usually negative, revenues are often the key driver of valuations,” he explained and so companies are incentivised to boost revenues by way of creative accounting practices.
There is now concern that the poor performance of some companies after listing has to do with them following different accounting practices prior to the IPO which led to their overstating their revenues and profits.
The CFO of a large private sector firm pointed out startups must be asked to disclose past deviations from accepted norms so that investors in the IPO can get the true picture.
“PEs may be willing to invest at sky-high valuations but the rest of us would like to value the business correctly,” he said.
Driven by the fear of missing out (FOMO), private equity and venture capital (VC) funds haven’t cared too much about the price they’re paying, much to the delight of founders.
A managing partner at a consumer internet-focused early-stage VC, said: “When the basis of the valuation, a mathematical formula, gets divorced from reality, then you make up anything and people believe it,” he said, speaking on condition of anonymity.
Early warnings from tech stock meltdown in US stock markets late last year haven’t stopped investors from paying top-dollar valuations.
Hotel aggregator OYO, which is gearing up for an IPO, recently reported a net loss of Rs 350 crore in Q1FY23, though it posted a positive adjusted Ebitda of Rs 7 crore at a 40% annual margin.