What are Start-Up Companies? What are its Characteristics and How Do We Analyze Listed Startup Companies?

In this article, we will be discussing what are startup companies, what are its characteristics, and how one should analyze the startup companies. So, let’s get started!

What is Start-Up?

A startup or start-up is a company or project undertaken by an entrepreneur to seek, develop, and validate a scalable business model. In India startup is growing very fast and being listed on the stock exchange.

Characteristics of the new-age startups

1. In startup companies, their OPEX is like CAPEX- In a traditional business. For example, in a manufacturing company, the establishment expenses including land, building, setting up machinery, etc. are capitalized in the books of the company. However, these businesses aim to dominate the platform for which getting more and more customers to use it is important, and hence, the CAC (Customer Acquisition Cost) can only be routed through a profit and loss statement, Since the cost required for this like marketing, discounts are P&L item as per accounting conventions.
2. In the early stages of the company, incurring a high amount of expenses on marketing and promotion is necessary to gain visibility. Once the company manages to get a big market share, these expenses come down but till then this will be a major hit on the profitability of the company. For example, the advertisement expenses of Zomato were 88.43% of the total income in 2019 and reduce to 24.88% in 2021.

Source: Zomato Filiings

How can you evaluate the performance of these companies?

1. Growth

One of the key things to see would be growth. Companies like Zomato, Nyka, etc. at their current stage will always be scaling at a high rate. Scaling is much easier in this business model compared to traditional businesses. Example:

Source: Zomato Filiings

2. Sustainability

Having consistent repeat customers is a hallmark of any business and this is especially important for these new-age companies since there are virtually no switching costs. Yet, Nyka has Managed to increase the share of existing customers in its Gross Merchandise Value (GMV). Example of Nykaa Contribution to GMV:

Source: Nykaa Filings

3. Unit Economics:

Unit economics is the profit/loss for a single average order. Zomato has turned this from a loss of Rs. 30.5 in FY20 to a profit of Rs. 20.5 in FY21. A company earning a profit on an average order is a good sign. Examples of Zomato’s Unit Economics are as follows:

Source: Zomato Filiings

4. Contribution Margin:

The contribution margin is the profit earned by the company before excluding indirect expenses like marketing, employee costs, etc. below is the Q4FY22 summary of Paytm’s contribution profit. These metrics however are not standard accounting metrics and companies might use their discretion in the classification. Example of Paytm:

Source: Paytm Filings

How one can value these Companies?

Some of the most popular and widely accepted valuation ratios depend on a multiple of metrics like profit after tax (PE ratio) or EBITDA (EV/EBITDA) ratio. However, these new-age companies might not have a positive PAT as well as EBITDA.

In such a case, it is difficult to use the metrics of profit. Hence, Market Cap/Sales could be used for this purpose.

The risk associated with startup companies:

• Growth has to sustainably increase.
• It could take a long time for the company to become profitable.
• Competition enters the space in a quick time.
• Valuation is always a concern.
• Governance may be an issue.

What should investors do?

All the startup usually makes losses or a small amount of profit in the early stages, and investors should wait and watch them grow before making any decision. Understanding the risk associated with each startup company plays a very crucial role. Hence follow due diligence before making an investment decision in any of the startup companies.

Disclaimer: The information here is provided for reference purposes only and should not be misconstrued as investment advice. Under no circumstances does this information represent are commendation to buy or sell stocks or MF.

Originally Published On: https://blog.investyadnya.in/what-are-start-up-companies-what-are-its-characteristics-and-how-do-we-analyze-listed-startup-companies%ef%bf%bc/