Investing In The Next Big IPO (Public Offer)? 3 Things You Must Know...

'The more things change, the more they remain the same.'

After a spectacular rally over two years, 2022 has been a rough year for the investors. This is especially true for unseasoned, first-time investors.

The Russia-Ukraine war, high inflation, supply chain issues, FIIs exiting the market, and Fed hiking rates, dampened the sentiment this year.

While the correction caught the investors off guard, it was the highflying new age IPOs that fell the most. In less than a year of listing, some of these much hailed IPOs crashed up to 60% or more.

Now you would think this experience would make investors cautious.

I doubt it.

With just slight recovery in market sentiment, initial public offers (IPOs) are back in vogue.

Syrma SGS Technology has already hit the markets. Even in a choppy market, the issue was oversubscribed.

Another IPO issue, DreamFolks, is to open soon for subscription. Its grey market premium suggests it may also witness good demand.

While Pharmeasy has withdrawn its offer, amid some resistance to the ESOP plan, over Rs 500 bn worth of IPOs are likely to hit the market this year.

These include the likes of Oyo and Mobikwik that are either loss making or turned profitable for the first time just ahead of the IPO.

Will you remember the fate of Zomato, Paytm, Policybazaar, and Delhivery as these upcoming IPOs vie for your attention?

Most of these names took a sharp hit as pre-IPO investors (promoters, employees, and institutional shareholders) rushed to exit post the expiry of the lock-in period. They did not find value in these stocks even at beaten down levels.

Despite their fate, I won't be surprised if you are tempted. After all, there is an army working to hype them up as future multibagger stocks. And as the cycles of greed suggest, good stories are hard to resist.

But before you do get carried away, there are a few things you should know.

First, Does The IPO You Are Considering Investing In Has Enough Promoters' Skin In The Game?

Did you know that the founders' stake in stocks like Zomato, Paytm, Policybazaar, CarTrade Tech and Delhivery is less than 10%?

None of these are under promoter category. Hence, there is no compulsion to disclose buying and selling of shares in the open market.

This link between businesses that have never seen profits, where promoters have low skin in the game, and are going for reckless acquisitions, is not at all surprising.

Now, compare this with the likes of India's three most profitable unicorns (startups valued over US$ 1 bn) - Zoho, Zerodha, and Musigma.

They are entirely owned by promoters and promoter groups. And have no VC or PE investors. When skin in the game is significant, one is prudent with the use of money and wants great returns.

Here is a case where the founder said no to VC investors despite being offered blank cheques (Source: Business Standard):

• While it is tempting to take the money, you will then have to build the business in a very different way. We have never had any revenue or growth targets which we are obligated to chase once you take external capital. - Nitin Kamath, Zerodha

And this is what Nassim Nicholas Taleb has to say on the matter...

• Entrepreneurs are heroes in our society. They fail for the rest of us.
  
  But owing to funding and current venture capital mechanisms, many people mistaken for entrepreneurs fail to have true skin in the game in the sense that their aim is to either cash out by selling the company they helped create to someone else, or "go public" by issuing shares in the stock market.
  
  The true value of the company, what it makes, and its long-term survival are of small relevance to them.
  
  This is a pure financing scheme, and we will exclude this class of people from our "entrepreneur "risk taker class (this form of entrepreneurship is the equivalent of bringing great-looking and marketable children into the world with the sole aim of selling them at age four).
  
  We can easily identify them by their ability to write a convincing business plan.

Second, Does The IPO You Fancy Have Significant ESOPs At Unreasonably Cheap Price And Without Any Linkage To Profits?

This would lead to future dilution in the equity base. Especially for loss making businesses with no visibility of profits, the cost of these ESOPs is ultimately borne by minority shareholders, without getting any incentive for past growth.

Third, Don't Get Carried Away By The List Of Marquee VC And PE Investors In An IPO.

After all, most of these investors use IPO event to dump their shares on retail investors.

Look at their entry levels instead. It is likely to be much lower than the issue's offer price, even if the funding happened just a few months before the IPO.

A lot of these early investors make a profitable exit through an offer for sale at the time of IPO. It's often the retail investors who ends up holding the bag.

Hope you will keep these points in mind before betting on the next big IPO.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com.

(Except for the headline, this story has not been edited by NDTV staff and is published from a syndicated feed.)