The ‘choice’ factor in startup valuations

Steep start-up valuations have become a global concern, with many stocks disappointing investors postIPO. Many believe the valuations often do not commensurate with a start-up’s competitive market share, size, pricing, customer base and growth rate. What shakes the very foundation of a fair valuation is misleading accounting reporting structures and presentation of accounts.

In India, the accounting regulatory bodies have laid down certain principles for presentation of accounts for consistent analysis and to present a true and fair view of a company’s books for shareholders and other stakeholders. But there is scope for manipulation of this if not carefully scrutinised.

It is noticed that certain regulations have been tweaked by startups to their advantage for securing funds from investors. In such cases, investors end up losing their money.

Collectively, more than 27 Indian Accounting Standards prescribed by the ICAI attempt to ensure truthful, consistent and fair presentation of incomes, expenses, assets and payables. These have been, to a large extent, embraced by the Ministry of Corporate Affairs, thereby imposing compliance to these standards for consistent reporting for all.

However, due diligence exercise by investors primarily focuses on the numbers presented, not on the accounting principles followed in the recognition of revenue, expenses and capitalisation.

Globally, more than 20 percent of the companies have seen a sharp decline in their overall valuation owing to irregular and inconsistent reporting methodologies. This has been observed at later stages than the early stage, which points to the fact that these deficiencies get highlighted on professional scrutiny. One reason for this is that most accounting principles that are mandatory are applicable to bigger sized companies only, hence the reporting of certain heads becomes mandatory only in later stages.

Very recently, a celebrated global startup booked discounts received in negotiations while renting of properties as revenues—this is misleading as this has no tangible impact on cash inflow.

Technology companies resort to similar manipulations wherein proportionate completion methodology gives misleading revenue and profit numbers.

Revenue recognition principles for sale of goods, rendering of services and proportionate completion of work have certain rules to be followed as per Indian Accounting Standard 9. But this is applicable primarily for companies with more than Rs 50 crore turnover. Others, may adopt a different approach that suits them.

More than $4.88 billion has been invested in the first half of 2019 in Indian startups. But a shift has been observed in the investment pattern—from investing into pre-revenue to revenue-earning startups. This makes reporting and presentation of financials all the more critical in decision-making. Any startup with a less than a certain threshold limit of turnover has the elasticity of “choosing” the reporting methodology. Investors have to be beware of this. (The author is Founder,

Anbac Advisors)