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How secondary transactions are evolving in Indian start-up ecosystem
In this EY India Insights episode, we examine how secondary deals in Indian start-ups are priced, with valuations increasingly aligning with primary rounds.
In this episode of EY India Insights, we explore the evolving dynamics of secondary transactions in Indian start-ups. Challenging the prevalent belief that secondaries are typically priced at a discount, the discussion highlights emerging evidence of valuations aligning with primary rounds. Navin Vohra, Leader, Valuation, Modeling and Economics, EY India, shares insights on what this means for market maturity, investor confidence and liquidity in the Indian start-up ecosystem.
Key takeaways
Secondary transactions in Indian start-ups are increasingly aligned with primary valuations, reflecting stronger investor confidence and enhanced market maturity.
In high‑growth start-ups, strong demand and performance often outweigh investor rights, reducing the need for discounts in secondary transactions.
Absence of discount in secondaries signals better liquidity, fair value and an evolved start-up ecosystem for founders and investors.
For founders, strong performance means they can achieve liquidity through secondaries without discounts, reflecting fair value for their business.
Navin Vohra
Leader, Valuation, Modeling and Economics, EY India
For your convenience, a full text transcript of this podcast is available on the link below:
Welcome to EY India Insights, our podcast series where we explore the trends shaping businesses today. I am Pallavi, your host for today and in this episode, we explore secondary transactions in Indian startups and challenge the common belief that they have been at discount.
Drawing from the latest report, many of these deals are priced in line with the primary rounds. To understand more on this, we are joined by Navin Vohra, Leader, Valuation, Modeling and Economics, EY India, who will be sharing his perspective on what this means for founders and investors.
Hi Navin, a very warm welcome to you and thanks for joining us today.
Navin
Thank you for inviting me.
Pallavi
What are secondary transactions in Indian startups?
Navin
There are two types of transactions – one is primary and the other is secondary. If a startup is raising money and it wants money for its expansion and working, that would be a primary transaction.
However, if an early set of investors who bought into the company earlier, or founders or employees who get ESOPs are selling their securities, which could be equity or convertible preference shares, it is called secondary. So, during an early stage in a startup you will have only primaries mostly because you know you are just investing in the company. And as the startup matures, you will have a set of investors who invested earlier who may want to get out now, get some liquidity, monetize their stakes, and then you will have secondaries also.
Pallavi
Could you also tell us why fundamentally secondaries are a discount?
Navin
We should understand that unlike traditional companies which take their funding through equity shares, for startups, most of the funding is done through convertible preference shares. What it means is that there are certain rights given to investors in each round, and two of them are critical.
One is the liquidation preference and second is the anti-dilution right. These two rights establish a floor value for the investors, which means that if there is a valuation drop in the company, they will at least get the money they have invested. It is a set of rights which is not typically present in pure equity.
What happens is as you do a primary, you will get a fresh set of superior rights compared to the previous round. Ideally, from a theoretical perspective, you would want to invest in a superior right than the previous round, which had a lower liquidation preference. Hence, fundamentally, there can be a discount in a secondary to a primary round or at the same time.
Pallavi
Referring to our latest study, which shows that most of the secondary transactions happen at or near primary evaluations, what does this reveal about market maturity and investors’ confidence?
Navin
This liquidation preference is a downside protection right to ensure that the investor will get his money back. But if the company is growing fast, then the investor does not need it as the company’s valuation is already increasing, especially if the company is highly in demand and is looking forward to an IPO.
If it does a primary and investors are keen to buy into it and they think that in the near future, valuations will only increase and there may be a liquidity event also, then there would not be any discount in a secondary compared to a primary, because you think that the valuation will go up and these rights do not have much value.
Also, what happens is that as companies mature, their requirement for primary funds come down. This is because initially they need a lot of funds to expand and develop the market, so they are investing money and not earning profits. But as they mature, they become more profitable and their cash flow generation increases; so, the primary requirement goes down.
But if the secondaries are available and if investors are interested, there is more demand and supply. That also causes the discount to vanish. There is also a converse scenario where you think that if the company has a binary outcome – either it will succeed or will completely fail. If it completely fails, even then the rights that convertible preference shares have do not have any value.
There is another reason, in some cases, you will not have value for discount for secondaries. But it is because companies have done well, there is a lot of demand from investors, and even the investors think that the liquidity event is close by, so why sell at a discount.
These are some of the factors causing lack of discount in India.
Pallavi
Thank you, Navin. In cases where discounts do occur, what are the key factors driving them and why are they generally limited?
Navin
First, rights are there. Also, if I am early-stage investor and I have invested for a few years now, my fund life is getting over, or I have a liquidity requirement.
For instance, I am a founder and need some liquidity, or I am an employee who has some ESOPs and need some liquidity. If I think a liquidity event like an IPO is not coming up soon, I may be happy to sell at a discount, because that is the only way to get liquidity.
Most importantly, there is a discount for liquidity. So, unlike listed companies, these are unlisted shares, so there may be a limited pool of investors who are interested in buying the company's shares. They will buy only if shares are available at some discount to the primary. These are some situations where we think that the company is not going for an IPO for another three or four years, maybe because it is still making losses, still growing, so it may take time. Perhaps, the conditions in the capital markets are not conducive for an IPO for such a company. In such cases, if a selling investor, whether a founder or an employee or a previous round investor has a requirement for liquidity, then some discount will be there. There are a few situations when discounts are available.
Pallavi
What are the broader implications of these trends for founders, existing investors and new entrants looking at the Indian startup ecosystem?
Navin
If I am an employer or a founder, there is no systemic discount. There could be a perception that there is a discount always, but not in India, which is a good thing because what it means to a founder or an employee is that if the company performs well, at the time when they want liquidity, they can get it without any discount. They do not have to pay a penalty for selling shares in the market.
That is a good aspect for anybody who is an early-stage investor or an employee or founder. Sometimes they have an equivalent need, so what they are showing is that if the company is performing, the market will support in getting a fair value for the shares. For the new investors, this is a vote of confidence in the company. When you are new to the company, you do not know it very well and you have some information asymmetry. But if you see that the early shareholders are willing to sell only without any discount, that shows that they are confident about the company, its management, and its future prospects. That gives you further confidence in the company.
Overall, if most of the transactions are taking place at the same value as primary, and there is no discount, it shows that the ecosystem has evolved well and primaries and secondaries transactions are priced similarly; there is no penalty being put for liquidity. It shows that there is fair amount of liquidity in the market. And that is a good sign for the development of start-up financing.
Pallavi
Thank you, Navin. That brings us to the end of this episode. Thank you so much once again for joining us and sharing all your perspectives.
Navin
Thank you, Pallavi.
Pallavi
Thank you to all our listeners. We hope you found this discussion helpful and understand much better the evolving dynamics of the secondary transaction in India Startup ecosystem. Thanks for listening. Until next time, this is Pallavi, signing off.
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