In a conversation with Ayush Parakh, Director, Kreo Capital, SmallCap Spotlight explores the factors behind the surge in companies going public. Key drivers include bullish market sentiment, availability of capital, and post-COVID pent-up demand. However, smaller companies face challenges like lack of history, governance issues, and valuation difficulties.
Ayush also discusses signs of early listings and the crucial role of merchant bankers in IPO success, emphasizing due diligence and investor relations.
Tune in to the conversation below.
Rumela Banerjee: Hi, this is Rumela Banerjee. Today, we will be speaking to Ayush Parakh, Director at Kreo Capital. Thank you for joining us, Ayush.
We have been seeing a surge in listing activity by companies. What do you think is causing so many companies to go public?
Ayush Parakh: So, the rush or the frenzy that we see over companies going public, that is more because of a combination of multiple factors, which if I have to broadly list them down, would be, number one would be the market sentiment right now. So, the market is very bullish and it is performing very well.
So, that is something that is leading to these many companies going public. Another is availability of capital. So, there’s a lot of capital available and people are actually investing into the stock market like never before.
So, banks are experiencing a dip in their deposits, which were the fundamental instruments to invest, I would say, five years ago. Bank FDs and bonds, that money is not coming into capital markets. This along with better valuations and good companies, good startups, all of this is leading to the pent-up demand that was there because of COVID and all those factors that has now also been released into the mainstream, leading to a good number of companies trying their luck in the limited space.
Rumela Banerjee: What are the challenges you often encounter, especially when it comes to taking smaller companies or SMEs on the exchanges?
Ayush Parakh: When we speak about the smaller companies moving to the exchanges, one of the biggest challenges that we face is generally there is a lack of history, which is a key factor by which an investor judges the company. So, there’s a lack of history because these are some of the newer companies or not having much of a financial track record, say maybe only of the last three years or five years. So, that is something which is a challenge.
Another challenge is the governance part, wherein right now what they’re trying to do is trying to get their product off the ground. So, the product marketability is yet to be tested or maybe it is yet to be tested on a bigger sample size. Cumulatively, another thing that is affecting is the governance part that I spoke about, that these companies are not very well governed, not in terms of there are huge gaps, but the internal processes are lacking, which is something a company takes care in the next stage, once they have surpassed their growth stage.
So, that is something more of a challenge that we get here. And one challenge would obviously be the smaller the company, the valuation is always a challenge because they would want to value a similar company on a bigger scale, but that might not always be possible.
Rumela Banerjee: What do you think is the sign of a company listing too early?
Ayush Parakh: There are a couple of signs that you know, which we can very well tell if a company has listed too early or it was not ready for the IPO market. Number one, what the challenge that we face is the performance of the company financially would be weak. The story that is floated in the prospectus might not translate into cash flow after listing because again, the governance part plays a key role in that, but the financial cash flows do not match the company’s growth prospects. The business model is unproven and is a one-off case based on which they have tried to scale up, but that scale up is not possible because the problem they might be trying to address might not be that big a problem and which you know, when taken across the country, might not apply to all of them.
Another issue that we face is they are generally dependent on a limited number of clients or a limited number of revenue streams. So expansion proves to be difficult beyond a certain point and they’re lacking in corporate governance. So once that pressure of transparency and accountability kicks in post the listing, that is where they might succumb to that pressure.
Rumela Banerjee: In your experience, what goes behind a successful IPO? Could you maybe share some case studies?
Ayush Parakh: So behind the successful IPO, if I have to start, the main part that I would say as per my experience would be the pre-IPO due diligence. That is something which is of very, very, very high importance and easy to overlook, but it plays a crucial role because that is where the merchant banker can actually judge whether the company is ready for an IPO or does it need some time and if it is ready, are there certain changes that are needed to make it market ready even once it is listed. So that is something of crucial importance.
However, along with that, a successful IPO also has to take into consideration that the multiple they are seeking should be in line with market expectation and it also leaves something for the investor to catch on later when they have listed or what you call the listing gains and post listing also for capital gains on those shares that are listed. There should be some amount left for the investor or you might have a fiasco like the country witnessed a year ago, not taking any names, but a big fintech corporation listed at a very high multiple and then we know where the share is today. So these are two key conditions that a successful IPO has to adhere to.
The third condition that I would say is another crucial factor is the touch point with the investor. So the more a company is involved with its investors and the more they are in touch with their sink, what the investor expects out of the company and is the company able to deliver that or not. When these parameters are met, the investor rewards the company by showing confidence even in times where the revenue might be a little down or the profit might be little long due to other macroeconomic factors.
But as long as the investor connection remains, the investor will surely reward and ensure confidence in the company.
Rumela Banerjee: You know, if you could also tell us what the role of a merchant banker in making a successful IPO is.
Ayush Parakh: So a merchant banker has to play a multifaceted role in the entire IPO process. Starting very initially when, you know, we meet a prospective client for an IPO where we feel the company is ready, we go with them back in time to where they were founded, how they have come this far. Along with that, there are multiple regulatory authorities involved, multiple consultants involved. All of those have to be taken on board and all of them have to work together for an IPO to be successful.
So that is where the merchant banker comes in who acts as an anchor between all of these. Merchant banker is also the sole point of connection between the capital markets and the issuer company wherein the company has to, you know, when they have to deal with a lot many agencies and people, the merchant banker does that on part of the company. So selecting the right set of lawyers, the right set of RTAs, the paperwork done, getting all the company ready, doing the due diligence part, all of that is something that the merchant banker has to take care of.
Along with that, the initial advisory, the valuation and pricing methodology, the compliance with various applicable laws, underwriting for the IPO, the risk management for the IPO, marketing for the IPO and making that initial investor connect wherein the company can tap into some potential investors so that the IPO performs well on the day of its listing are some of the key factors which I believe are played by merchant banker and are very crucial for a good listing.
Rumela Banerjee: How does listing, in your opinion, affect businesses or morale of employees, upper management, etc.?
Ayush Parakh: So listing affects the employees and the upper management on both sides. So there is a good side, there is a bad side. One, it leads to a greater boost in the image of the company wherein a listed company is perceived to be at slightly higher pedestal and that helps the employees and the management that we are associated with the company that is listed. So it gives you a good image about yourself, it gives you that feel-good factor and it also helps to market yourself as a company that is perceived to be compliant in all sorts of regulations and financial practices. But at the same time, it opens up the company to a lot of scrutiny from outsiders, from investors, from analysts, from competitors who now have a complete window into the affairs of the company because of the information that is all public.
So these regulatory procedures along with the accountability to the public and to all the various stakeholders involved leads to a lot of pressure and which might lead to a lot of keeping up to a standard that they have built for themselves and that might be a lot of pressure for the management and the employees as well. So there is a lot of good actually and some difficulties but once they are into the process and they are listed and if the company’s management integrity and the focus is clear, all of these challenges can be overcome and we suppose that it’s a good path to walk on. That is what I would say.
Rumela Banerjee: What happens after the listing? Are companies able to cope with the compliance requirements that come up?
Ayush Parakh: So post-listing, the fundamental pressure initially that the management or the company as a whole would go through is the price that we have allocated to ourselves which the merchant banker has also agreed to. Will the market reward it to us that this is the correct price and would we be able to sustain that? That is something that the companies always jittery upon and that is fair on their side but as long as the valuations are right, the models are correct, there is no reason the investors will not because not just about where the company is but where the company can go is something the investors look for. So post-listing, this is something that the company has to work upon.
For this, as I mentioned earlier, their connect with investor has to be absolutely strong and where the investors have to be kept in confidence about what is going on, what is not going on and once that is done, the investors are also comfortable and they don’t really stress out the company during terms when things are not so upswing. But post-listing, one thing is taking care of this. Another thing is keeping track of all the compliances that come in with the listed time.
So once you are a listed company, there are a whole lot of requirements that come in that have to be done which earlier were not applicable when the company was a private limited company. So all of these companies have to be done but with the correct team and the correct set of consultants, this is something that the company should be able to wait through and this is where actually the role of merchant banker also comes in. So it is not just till the time of an IPO but post-IPO also to make the company comfortable, apprise them about the rules and regulations that have been given to them and initially handhold them as they foray into this listed world is something that a merchant banker should do and they do this because it is a part where you have taken the company to a journey and we would like to see them to a logical end to that.
Rumela Banerjee: Talking about SME IPOs, have investor interest increased in that segment?
Ayush Parakh: I would say in a one-line answer, yes, the investor interest has increased and yes, investors are very keen to invest in SME IPOs. For this, I think there are two to three reasons. Number one reason would be these SME companies hire, sorry, these SME companies offer a higher than normal rate of return on the investment.
So for example, a company in the aerospace sector might offer a chance for a better return on my investment which is a startup company rather than an already established company like HAL or something like that. Maybe these returns actually turn out to be something that we have to see once the company is listed and how they run their operations. But yes, on the forefront and theoretically, they do offer a higher return because they are just getting off the ground and these companies are for their growth phase which the large cap companies have already seen and are past that.
So this is something which attracts people to SME segments. Second is the compliance on the investor side is a little less. It is easier to invest in these companies on the pre-IPO numbers or even in the IPOs, you get a bigger lot size.
So looking at all of that, they would enjoy investing here. Also the government and the regulators have all come out in support of these SME companies thereby offering a lot of concessions and advantages to an SME company. All of these increase an investor’s interest in these companies and that is why we see a lot of frenzy around that.
Rumela Banerjee: What does it take for SME companies to move to the mainboard?
Ayush Parakh: So an SME company though in a listed space is still operating within a confined ring if I may put it that way out of which there’s still a large world where the as you say, the main board operates. On the main board, the companies directly compete with the best of the best.
You have the giant of your segment operating there. So it’s a little difficult for smaller companies to get themselves listed there and operate which was the reason behind coming up with the SME exchange. No doubt once as it is said, once the fish gets bigger from the tank, it either has to be put into the river or get a bigger tank and that is what happens with an SME listed company once they are used to these compliances, they are used to the public scrutiny and they have established their business model, shown their strength and once it is proven that this company can withstand the very minute scrutiny offered by all the outside factors, it is then that a company is truly ready to step into the main board and compete with the giants of their industry wherein it would only benefit from the good competition and better practices that are followed.
Rumela Banerjee: All right, that’s all for now. Many thanks for speaking to us.