Alphabet, Microsoft, Amazon, Facebook – all these global giants have something in common. All these global tech giants started their journey as humble startups and are currently listed in the NASDAQ stock exchange. These companies have seen significant growth and success following their IPOs (initial public offerings).
So this begs the question – Are stock markets essential for the startup ecosystem? Or, in other words, can weak stock markets hinder the growth of startups?
The tech startups have proved to be heavily reliant on successful IPOs. Usually, a startup raises capital in multiple rounds at its early stages. Founders, private investors, venture capital firms, future funds, and such high risk-tolerant investors provide the capital for expansion and continued operations of these startups. As most startups operate on a loss for the first few years of their existence, these investors cannot withdraw their capital through dividends. So, they rely on the company’s eventual IPO to gain a return on their investment.
Hence, a stable and large stock market that can inspire smaller investors to participate in these IPOs is essential for these early investors to actually invest in startups. And the innovative and successful startups usually issue large IPOs.
Google (Alphabet) collected $1.7 billion through its IPO in 2004. Amazon raised $54 million, $18 per share, through its IPO in 1997, before becoming the global giant it is today. Since then the stock price has reached $3,338.65, demonstrating the potential of a growth stock. The same scenario is visible in the case of Microsoft. The company entered the stock market with a $61 million IPO in 1986. Today each IPO stock is worth more than 500 times its initial price.
The case for Bangladesh
Dhaka Stock Exchange (DSE) is the largest bourse in Bangladesh with 578 listed companies. The current regulations incentivise investors to invest in dividend stocks, preferably stocks that provide high cash dividends. The rating system also incentivises companies to provide cash dividends. The most prestigious Category A stocks are companies that pay 10 per cent or higher dividends annually. On the other side of the spectrum, companies that do not pay dividends are categorised as Z.
This structure clearly discourages investments in growth stocks. Growth stocks are stocks that rarely pay any significant dividends. Rather they reward their shareholders through capital gains, increasing the value of each original share. This also benefits the companies by allowing them to retain more cash which can later be invested towards growth. Stocks of most major startups fall into this category.
Another issue is DSE listing regulations which mandate that only companies that have profits prior to the listing can issue an IPO. This can turn away startups as many do not make a profit for years. For example, Amazon became profitable in 2001, four years after its IPO. Spotify is yet to become profitable. Still, it had one of the most successful IPOs in the tech industry in 2018. Its $1 billion IPO has since become a benchmark for similar companies.
Therefore, such practices in Bangladeshi capital market make the stock market unattractive to up and coming local startups.
What locals think
Mr. Rubaiyat Farhan, founder of a local startup TiGrow, expressed his frustration at not having a reliable capital market. He said, “Our stock market has not helped with creating an investor pool who are willing to bet on a company for a long haul understanding the details of their structure and operation. There are very few real investors in the market due to unreliability of the market.” His complaints are backed by the low trade volume and falling number of BO (beneficiary owner) accounts in DSE.
As of October 2020, 37 per cent of the 2.8 million registered BO accounts had zero balance. Foreign investors withdrew Tk 13.99 billion from the stock market in FY 2019-20 alone. Certain exodus of investors has negatively impacted the market capitalisation of the entire stock market. An unstable stock market cannot properly facilitate startups as they cannot inspire confidence in the investors.
On the limitations of the stock market in facilitating startups, Mr. Rubaiyat Farhan added, “The startup ecosystem thrives on investors having long-term visions, which isn't present here.” The current state of the stock market in the country is not startup-friendly. It limits the opportunities for early investors to make an exit. This, in turn, limits initial investments in budding startups. Globally, startups are seen as a driver for innovation. Rahat Ahmed, Founding Partner and CEO of Anchorless Bangladesh, said, “For Bangladeshi stock exchanges to be a viable listing destination for startups, they would need to modify some of the qualification rules as well as offer advantages over overseas exchanges such as Singapore and even Hong Kong.”
As it stands, the local stock markets cannot help local startups grow. To drive innovation and build a more solid startup ecosystem, the local bourses have to improve themselves significantly. They also have to change their regulations to remove barriers for startups to go public.
Md Rafid Fayaz is a freshman at IBA, Dhaka University.