India’s startup IPO frenzy has spawned many unicorns – on paper – even as profits remain scarce.
A key driver is our tax code. Dividends are taxed heavily (corporate tax plus personal tax), whereas long‑term capital gains are much lighter.
In effect, taking money out of a firm via dividends faces nearly a 52% tax burden, while selling shares at a profit incurs only ~12–15% tax (indiatoday.in).
This big gap (“tax arbitrage”) means founders and investors prefer pumping cash into growth, not profits.
Nithin Kamath of Zerodha recently posted about it on Substack – highlighting the need to understand why IPO bound companies focus on showing higher growth and higher valuations by burning more cash.
Higher growth also means higher PE multiples and higher valuations.
The result: highly unprofitable IPOs for retail investors that pump up valuations for exits, leaving retail investors with big risks.
Dividend vs. Capital Gains: A Tax Tale
Nithin Kamath (Zerodha) summed it up on social media: “If you take money out of a business as dividends, the effective tax rate is 52% (25% corporate tax + 35.5% on personal income). Through capital gains, it’s just 14.95% (with cess)” indiatoday.in.
In practice, India taxes company profits at 25%, and then dividends at the investor’s high personal rate (plus cess), whereas long-term gains on listed equity are taxed a flat 10% (plus cess and potential surcharge. Even generous estimates put equity LTCG tax around 12–15%.
The upshot: many startups never pay dividends, preferring to plow every rupee back into growth. Founders and VCs know that an eventual exit via sale of shares (capital gains) is much friendlier tax-wise than dividend payout.
As Kamath explains, the strategy is to “reduce corporate tax by showing minimal profits or losses. Spend on acquiring users, build a growth narrative, and then sell shares at a higher valuation while paying much lower tax. In short, why earn and distribute profit when you can “spend to grow” and keep shareholders happy with sky-high valuations?
Case Studies: IPOs on Red Ink
This tax incentive plays out in real IPOs:
Zomato (2021): The food-delivery startup raised about $1.2 billion in its IPO and saw shares leap 66% on debut reuters.com. But behind the hype, Zomato was burning cash. In FY2020 its revenue was ₹2,743 Cr but losses were ₹2,363 Crinc42.com – roughly 86% of sales.
(By comparison, a profitable firm would be celebrating a 14% net profit margin!) That cash burn continued post-IPO: for example, Q1 FY2023 saw revenue ~₹1,414 Cr with a ₹186 Cr net lossreuters.com. Zomato’s growth story (massive order volumes) hides the fact that it’s still not profit-positive even after going public.
Paytm (2021): The fintech giant’s IPO was India’s largest (~$2.5 billion) but also controversial. Paytm reported FY2021 revenue of ₹3,187 Cr against a ₹1,701 Cr losslivemint.com.
Despite losses, Paytm was valued at about $18.7 billion at listingreuters.com – a sky-high multiple of its (tiny) profits (and huge losses). Analysts immediately warned that Paytm “lacks a clear path to profits”reuters.com. In fact, early investors (SoftBank, Ant Group) took the opportunity to pare stakes in the IPO, booking gains even as the company burned cash.
Delhivery (2022): The logistics startup Delhivery also hit the market with losses. In FY2021 it reported revenue ₹3,647 Cr and a widening loss of ₹416 Cr reuters.com. Yet its IPO was pitched at over $5.5 billion valuation reuters.com, and existing backers (SoftBank, Carlyle) sold shares on the way up.
Investors piled in during the IPO (it was heavily oversubscribed), betting on future growth. However, the fundamentals still showed no profit on the horizon – just a higher burn-rate to maintain market share.
These examples highlight a pattern: eye-popping valuations despite little or negative profits. Startups rationalize this by focusing on metrics like user growth or market expansion, arguing that profits will come eventually. And indeed, the market has rewarded them: “Unprofitable growth gets valued at much higher multiples than steady profits,” Kamath notes.
He cites an example: a company doing ₹100 Cr revenue at 100% growth might get a 10–15× valuation, whereas a profitable one at 20% growth gets only 3–5×indiatoday.in. In plain terms, investors have been willing to pay more for “growth” firms even if they make no money – because the payoff comes from future share sales, not dividends.
Growth-at-All-Costs Behavior and Investor Risks
What does this mean for company behavior? Quite simply, burn more cash to grow faster. VCs encourage startups to keep spending on marketing, subsidies, discounts and hiring, rather than trimming costs or building profitsindiatoday.in. It’s a war chest strategy: grab market share now, hope to win big later. In industries like food delivery, fintech, or logistics, this often means multi-year losses – anathema to traditional businesses. All told, many listed startups in India post loss after loss quarter after quarter, with no dividends in sight.
For retail investors, the risk is two-fold. First, there’s valuation risk: if growth stalls, there is no profit cushion. Stocks like Paytm did fall post-IPO when investors questioned the lofty pricingreuters.com. Second, there’s sustainability risk: unprofitable firms may struggle if funding dries up or competition gets tougher. As Kamath warned, an extended market downturn “could easily expose the weakness” of businesses built on tax-driven spendingindiatoday.in. In other words, betting on the “growth story” could turn sour if companies can’t eventually justify their price with profits.
Government Intent and Unintended Consequences
Why did policymakers make dividends so costly to take out? The likely intent was positive: by taxing dividends heavily, the system was to discourage cash hoarding by companies and encourage reinvestment and expansion. In fact, as Kamath noted, the rule was probably meant to make firms “spend money and not just accumulate and distribute”indiatoday.in. The idea being growth, jobs and infrastructure would follow.
However, the unintended consequence is clear: it also incentivized “growth at all costs”, sometimes at the expense of profits or resilienceindiatoday.in. Instead of measured growth fueled by savings, many startups learned that loss-making is tax-optimal. Industry observers now debate whether the tax balance should be corrected. On one hand, low capital-gains tax has democratized wealth creation for those who can hold equity. On the other, it may be warping corporate incentives.
What Retail Investors Should Ask Before an IPO
Given these quirks, retail investors should do due diligence before chasing an IPO. Key questions include:
- Is the company profitable (or near profitable)? Or is it burning cash indefinitely? High growth is good, but only if there’s a path to profit.
- How large are its losses relative to revenue? If losses vastly exceed sales (like Zomato’s 2,363 Cr loss on 2,743 Cr sales inc42.com), the IPO gamble is bigger.
- Who’s selling in the IPO? Are founders/VCs exiting via Offer-For-Sale (OFS)? If insiders are offloading shares, retail buyers should ask why.
- What will IPO proceeds be used for? Are funds earmarked for growth (marketing, capex), or for plugging a cash burn hole? A high burn rate is a red flag.
- Are revenue and growth projections realistic? Are they based on actual profits or just expanding user counts?
- How is the business model sustainable? What if customer subsidies or discount-driven growth stop? Will the firm still survive or need more cash?
- What are the valuation multiples? (P/E, P/Sales, EV/Gross Profit.) Compare with similar companies. A very high multiple means huge expectations baked in.
While a little wit is healthy (“unicorn” itself sounds magical), investors should keep feet on the ground. The tax rules might be favoring capital gains, but the harsh truth is: ultimately it’s profits (or lack thereof) that determine an investment’s fate. Going into an IPO, remember that growth is not free – and in India right now, it’s expensive for anyone who tries to exit with a profit.
Sources: Recent analysis of tax impact on startupsindiatoday.inindiatoday.in and financials of IPO-bound companies (Zomatoinc42.com, Paytmlivemint.comreuters.com, Delhiveryreuters.com). These data and expert comments highlight how tax-driven incentives shape company behavior and investor risk.
