If you’re a company that wants to buy another company, but you don’t have the cash to actually buy it, you might take a loan from a bank and keep the company you just bought as collateral. If you then realise that you’re unable to pay back this loan, your options look like this:
- Give up your collateral! You took a risk, it didn’t work out. Suck it up and move on.
- Sell some equity in your company to investors, then use that money to pay back the loan.
Option (1) is straightforward and convenient. But it means that you lose the shiny company you just bought. With option (2), you get to keep the company you bought, but you lose part of your own company, because you sell a stake in it. If you’re desperate for the money (which you are), and if the funding market isn’t great (which it isn’t), you might get a bad deal.
In 2021, Pharmeasy bought a 66% stake in Thyrocare Technologies for ₹4,546 crore ($550 million) from its founder Arokiaswamy Velumani. Velumani then reinvested ₹1,500 crore back into Pharmeasy for around 5% of the company.  Effectively, Pharmeasy spent ₹3,046 crore ($370 million) in cash to buy up Thyrocare.
Pharmeasy borrowed most of this ₹3,046 crore and kept its stake in Thyrocare, which is a listed company, as collateral. It now owes Goldman Sachs about ₹2,500 crore ($300 million) which it is, of course, not able to pay back. Yesterday, CNBC-TV18 reported that Pharmeasy decided to go with option (2) and raise more money by selling some stake to investors.
Down but not out
API Holdings, the owner of PharmEasy, in an all-investor meeting on July 17 has agreed to do a rights issue of Rs 2,000 - Rs 3,000 crore, sources with direct knowledge of the matter told CNBC-TV18. The sources further said that the PharmEasy parent has also approved the Manipal Group’s proposal to invest the shortfall amount if all investors do not end up participating.
The board of API Holdings is said to have approved Manipal Group’s binding offer but only to the tune of non-participation by existing shareholders. Manipal Group’s family office has offered to invest up to Rs 1,300 crore, sources said.
… Depending on the amount of funds raised, the post-money valuation of the company is expected to be around Rs 6,000 to Rs 7,000 crore.
Complicated! Pharmeasy is clearly a confused, non-committal piece of work. Pharmeasy owes Goldman Sachs ₹2,500 crore. It’s planning to raise maybe ₹2,000 or ₹3,000 crore from existing investors. In case these investors don’t (or can’t) invest the entire amount, Pharmeasy will sell its stake to Manipal Group, which is not currently an investor. Manipal will invest ₹1,300 crore at a valuation of around ₹6,000 crore to ₹7,000 crore ($730 million to $850 million).
Pharmeasy’s last funding round was at a $5.6 billion valuation two years ago. Now, it’s going to be around $800 million which is 85% lower. A down round, that is, raising money from investors at a valuation lower than your previous funding round, is a bit of a taboo in startup circles. One reason for this is purely cosmetic. If a startup that a venture capital fund has invested in reduces its valuation, the fund then has to tell its own investors that it has made a loss, which doesn’t look very nice. But another, more practical reason for the taboo is that down rounds basically squeeze the company out from the hands of older investors.
Here’s how it goes:
- Let’s say you own 50% of a company at a ₹1000 valuation.
- If the company now reduces its valuation by 85%, it reduces the value of your stock by 85% too. But hey, that’s okay, at least you still own 50% of the company.
- But if the company now sells away 20% of its stake to investors that aren’t you, your 50% stake goes down. The total pie is limited, after all. If 20% goes to other investors, your 50% stake goes down to 40%. 
Manipal Group is willing to invest ₹1,300 crore ($160 million) at $800 million, which means that it would get 20% of Pharmeasy. If Manipal gets 20%, older investors that also don’t invest get stifled. So obviously, they’re not going to be happy. From ET Prime last week:
PharmEasy’s plan to take a 90% cut in valuation in an upcoming internal funding round has not gone down well with all shareholders. It will be one of the biggest value erosions and among the first such downrounds for the unicorn if the round goes through.
But some shareholders are also looking to put up a counter offer to the share price, sources told ET Prime. Some investors believe PharmEasy could be worth more than USD500 million, and hence they would want to push up the price in the range of INR15-INR 20 per share.
There is a strong view among a section of investors and analysts that the proposed price is below par, and there could be some resistance to the proposed downround. Some of the early investors have maintained a studied silence and there is likely to be some behind-the-scenes action before this round goes through. “There is much drama now. The company is clearly more valuable than this,” said another early stage VC investor, requesting not to be identified.
Yess, drama! Though I’d have expected a lot more. This drama is pretty tame in comparison to whatever is happening over at Byju’s. Anyway, Pharmeasy has given its existing investors a choice. Either pay up the money that it needs, around ₹2,500 crore, or it will raise money from Manipal Group even though it’s a cheap stake sale that cuts them out. It’s obvious though that the choice here is a farce. If older investors were willing (and able) to invest this large an amount into the company, this down round shenanigan wouldn’t have happened in the first place.
Old investors are new investors
There is some drama to it. Pharmeasy and Manipal Group have some common investors. Temasek Holdings and TPG combined own about 18% of Pharmeasy and a mammoth 70% of Manipal Group. Manipal is Temasek and TPG! It’s not a random outside investor but Temasek-TPG, older investors themselves, trying to stifle all other investors. More from ET Prime:
Some reports also suggest that the two common investors in Manipal Health and PharmEasy — Temasek and TPG — are pushing for consolidation. After the rights issue, Pai, TPG, and Temasek would together hold more than 35% stake in PharmEasy. They would be in a position to take a controlling stake by buying shares of the existing early backers in secondary transactions. They may explore offering a decent exit to early investors by paying them a significantly higher price vis-a-vis the rights issue.
Once Manipal invests in Pharmeasy, Temasek-TPG combined will own a large 38% stake in the company. That would give them enough power in the company to convince other investors to sell them their stakes. Sure, the valuation for this sale would be more than the $800 million at which Manipal is buying its stake, but it’s definitely not going to be anywhere near the $5.6 billion valuation Pharmeasy had earlier. Is it going to be a “decent exit” for the investors who sell? I don’t know. You could call it that. Or you could also call it a mercy killing.
Why is Thyrocare so important to everyone here? Pharmeasy could very well have sold off Thyrocare, paid off its loan, and called it a day. I guess the opportunity to buy Pharmeasy for cheap is too alluring for Temasek-TPG to pass up on.
 This was a bit of a weird transaction. Pharmeasy could’ve easily given Velumani cash and stock, instead of giving him cash and then asking to him to invest it back into Pharmeasy. The reason they did this though is that had they given stock to him, it would be at a $2 billion valuation, the last valuation it had raised money at. But when Velumani invested his money back into Pharmeasy, he did so at a $4 billion valuation—that’s double! A fund way to increase your company’s valuation, I guess.
 Technically, an older investor’s stake goes down at every funding round, regardless of whether it’s a down round or not. But when it’s a round at a higher valuation, the size of the pie goes up too. So the value of the earlier investor’s stock goes up, even if the % stake goes down.