Why top Fintech startups are drenched in the red despite growing their business

The lifecycle of a tech startup starts with a disruptive idea. Add some angel funding to get the initial employees and a place to sit. Top it up with explosive growth in user adoption and entry of venture capital investors. Then, add some late-stage investors such as private equity firms as the startups get ready to take on the legacy bigwigs of the domain followed by a public listing as the companies start making money or are at the cusp of doing so.

An underlying aspect of these ventures is that the tech stack and asset-light nature of the business model takes care of most of the cost pressures of the traditional ways of doing business. To be sure, they do tend to spend on customer acquisition, be it with discounts or ecommerce or with cashback offers for payments.

But these expenses tend to shrink over time—or at least they should be—as customer stickiness kicks in. Paytm and PolicyBazaar, which have become synonymous with digital payments and insurtech thanks to their early entry into the respective segments, were also moving in that direction.

They also crossed the milestone of entering the public market. But here’s the big difference. Even with massive scale and asset-light business models, their balance sheets are still awash in the red.

What’s more, in the short-term of next one to two years, at least, they are unlikely to churn out any profit either.

We analysed the financials of these two companies to deconstruct their costs and check what exactly they are spending the huge sums on. The main element that is keeping these companies in the red is stock-based compensation to employees, especially the founders.

PolicyBazaar

PB Fintech, the company behind PolicyBazaar and PaisaBazaar, has used the power of technology and data to create India’s largest online marketplace for insurance and loans.

The company’s revenue from operations has grown at a compounded annual growth rate (CAGR) of 44% over the last four years. Insurance premium collected rose 53% CAGR and disbursals of loans rose 23%. To be sure, business was affected in FY21—the first year of the pandemic—but it was back to pre-Covid levels in FY22.

However, the company’s consolidated expenditure more than doubled to Rs 2,370 crore while total revenue climbed a relatively modest 62%. As a result, net loss climbed over five-fold to Rs 833 crore from Rs 150 crore in FY21.

PB Fintech had two big cost heads: employee expense and advertising and promotion expense.

These two cost heads comprise nearly 90% of the expenses incurred by the firm. And these two more than doubled last year, outpacing the revenue or business growth of the company.

The real culprit is not even the salary, wage and bonuses. This grew less than 50% to Rs 600 crore. But employee share-based payment expenses rose six-fold! In fact, the company’s share-based compensation was higher than what it paid as salaries and bonus last year.

Cofounders Yashish Dahiya and Alok Bansal exercised options worth Rs 974 crore last year. CEO Sarbvir Singh, too, exercised ESOPs worth nearly Rs 70 crore last year, ballooning the employee benefit expense.

All three continue to hold a large chunk of ESOPs that would continue to bloat the wage bill and keep earnings, if any, subdued.

Moreover, the fresh options under ESOP 2021 that would vest in tranches over the next five years, is dependent on the company having an average market cap of $5 billion. This would be triggered if the current share price doubles.

Paytm

One 97 Communications, the company behind Paytm, will carry an unforgettable tag in the foreseeable future. When it listed on mid-November 2021, its stock crashed by over a quarter, making it the biggest-ever fall in a decade for any scrip on the listing day.

With increasing apprehensions on its path to profitability, the stock was dumped through the year. Its share price decline marked the steepest first-year slide globally among IPOs that raised at least the same amount that it scooped up, since Spain’s Bankia’s 82% crash in 2012, according to Bloomberg data.

In fact, the firm fared better than PolicyBazaar when it came to balancing revenues with expenses. As against PolicyBazaar whose expenses rose much faster, Paytm’s expenses rose 59% as against revenues that climbed 65% last year.

The two biggest sources of leakage for Paytm have been payment processing charges and employee benefit expenses. The former rose 44% but the latter more than made up for it by rising over two-fold.

Just like PolicyBazaar, wage growth was outpaced by share-based compensation. The latter shot up over sevenfold last year, while salaries increased by around 45%.

During the year ended March 31, 2022, the company granted 27.4 million ESOPs, of which 21 million with an exercise price of just Rs 9 apiece went to founder Vijay Shekhar Sharma, which is subject to achievement of certain milestones and will vest equally in four tranches. This would get added up in the employee benefit in the medium term, likely keeping the company in the tunnel of loss.

The management has given a guidance of ESOP-linked costs to be around Rs 750 crore in H2 FY23, Rs 1410 crore (FY24), Rs 1000 crore (FY25), Rs 440 crore (FY26) and tapering to Rs 140 crore (FY27).

Endnote

Numbers show the real reason why India’s most well-known fintech startups are bleeding heavily is that they are rewarding their founders. One can debate on the right and wrongs and the quantum of rewards but founders do deserve to be incentivised. What it means now is that shareholders would hope that the founders bring that much chutzpah to continue creating magic with their venture and not get out soon after hitting their century!