Investors want to both give and not give Byju's more money

The best trades are opportunistic

Some investors might embrace the jump while others might sit it out.

Sometime mid of last year people got to know of a bunch of financial soups edtech company Byju’s had found itself in. It had been overstating its revenue, its auditor was unhappy and had resigned, it was late in filing its financials by two years.¹ It had also defaulted on a $1.2 billion loan in the US and had been sued by its lenders who were dead set to recover every last penny from the company.

Basically Byju’s wasn’t doing well financially. And well, most of it was a result of its own doings. Given this situation, if you happen to be a Byju’s board member, it’s not the most pleasant place to be in. In some sense, you are responsible. The company fell into this mess on your watch. You were the investors’ representatives and you clearly didn’t do a great job in keeping an eye out for their interests.

But you might not be responsible. Byju’s is a company with an assertive, even firebrand founder in Byju Raveendran, and such firebrand founders often receive a free hand from venture capital investors to run their company whatever way they like. Sometimes, the founders deceive their board members.

As a board member, how you go from here depends on what you’re willing to admit. Do you own up to your mistake? The founder may have done all the bad things but ultimately you were responsible. You’ve now got to admit your folly, switch course, even poke your nose in everyday company affairs which you wouldn’t have thought to do earlier. As a board member, you guide the company out of this. You would influence other board members, ratify the decisions you think are good, reject the ones that are bad. Do your job! But you do have to admit that you were responsible. Not easy.

The alternative is that you claim that the founder did stuff that you had absolutely no flipping idea about. You’re not responsible, you’re the victim! In this case, one of the things that might seem reasonable to do is resigning from the board. “Wow the founder really duped me here,” is the message you want to send out.. “On a moral level, I can’t be part of this anymore.”

Three large Byju’s investors—Prosus, Peak XV Partners and Chan Zuckerberg Initiative—who were on the company board chose the second path. They resigned from the board last July.

Sure, the board-resigning investors didn’t want their reputation at risk because of the crap Byju’s might have done. But the flip side of resigning from the board is that you no longer have a say in decisions which require board approval. And sometimes you might really not like those decisions.

Earlier this month Byju’s announced that it was raising money from existing investors via a rights issue at a 99% drop in valuation. The board-resigners didn’t like it too much. From TechCrunch:

A group of Byju’s investors on Friday voted to remove the edtech group’s founder and chief executive Byju Raveendran and separately filed an oppression and management suit against the leadership at the firm to block the recently launched rights issue in a surreal moment for the startup, once India’s most valuable.

At an emergency general meeting (EGM) that concluded earlier today, a group of investors including Prosus Ventures and Peak XV Partners voted to change the leadership at the startup. The participating shareholders — whose combined ownership in Byju’s exceeded 60%, according to an investor source familiar with the matter — also passed the resolution to reconstitute Byju’s board. (Two people close to Byju’s disputed that participating shareholders held over 60% ownership in the firm. Neither of the sides have issued an official statement on the figures.)

Byju’s board-resigning investors had stepped down last July but got around to coming together, voting to remove founder and CEO Byju Raveendran from the company only last Friday. They are also suing him in the NCLT. The trigger for all this was the rights issue which they obviously did not like, because, well, it forces them to either invest or get diluted out of the company.²

Any major fundraise that a company does must get its board’s approval. Byju’s board has three members at the moment—Byju Raveendran, his wife, and his brother. The board-resigners should’ve remained on that board! Maybe they could have stopped the rights issue from happening in the first place.

An opportunistic trade

One story of the ongoing Byju’s episode, also the story that I’ve touched upon, is that Byju’s investors don’t like Byju Raveendran and want him out. The investors are on one side, Raveendran on the other. Another story though is that while all this is happening, Byju’s seems to have successfully received a commitment of $200 million from existing investors.

From existing investors! So maybe a more accurate framing of the ongoing episode is that some investors are on one side, and Raveendran and some other investors on the other. These other investors want to give him more money.

Byju Raveendran and his family own around 26% of Byju’s. They’re going to invest in the rights issue (of course). The board-resigners own about 30%. They’re not going to invest in the rights issue (probably). That leaves about 45% of the holding with shareholders who we have no idea about.³

The way a rights issue works is that investors get a right to buy shares proportionate to their holding. But if certain investors choose not to exercise that right, then other investors can buy shares more than they would have been able to otherwise.

If the board-resigning investors who own 30% aren’t going to invest, then the mysterious 45% investors can chip in extra in their place. But why would any investor want to give the company any more money? Of course, one reason is always that there is an element of sunk cost. When Byju’s raised $250 million in 2022, that’s exactly what I’d written. The investors had already given Byju’s too much money and the stakes were too high to back out then.

But there’s more this time around. This particular instance the valuation is so low that the investors who choose not to invest lose everything. Conversely, the investors who do invest stand to get a lot more bang for their buck.

Here’s what the numbers roughly look like:

1. Byju’s is raising $200 million and its post-money valuation will be $225 million.⁴

2. Raveendran & family own 26%. So they’ll have to put in about $50 million (26% of $200m).

3. This leaves $150 million. A large chunk of shareholders (including the board-resigning investors but surely there would be more) would not exercise their rights and would not invest. So the investors that do invest, would have to chip in this $150m.

4. But for this $150 million, they will get 66% of the company. (Going by the company’s $225m valuation.)⁵

So, sure, there is a large chunk of investors who desperately want to boot out Raveendran and stall this rights issue. But there is also a chunk of investors (or at least an investor) who is looking forward to the large investors sitting out of the rights issue so that they stand the chance to grab a majority stake in the company.

Byju’s is fighting its board-resigning investors in two courts at the moment. In the Karnataka High Court, to get its investors’ meeting and vote to remove Raveendran from the company invalidated. And in the NCLT, where the investors filed the suit to get Byju’s rights issue invalidated. I don’t know how this is going to end but I do know that the end date of the rights issue is in two days and no court is this fast. It’s unlikely either court decides in time.

So probably the rights issue will happen and the investors who don’t invest get booted out automatically? The funniest outcome would be if the rights issue goes through anyway and the board-resigning investors invest more money even while fighting the company in court. Because the sunk cost is too huge to ignore.

Cover Photo by Juan Gomez/Pexels

1. Indian companies, even the ones that aren’t listed, have to file their financials with the Ministry of Corporate Affairs annually. The timeline isn’t as strict as it is for listed companies, and a lot of companies really skimp out on it, but not usually the prominent ones.

2. Here’s how to think about this. Byju’s is a pie of a certain size. The company first massively reduces the size of this pie. So whatever portion of the pie you owned becomes close to nothing. Now, Byju’s wants to increase the size of this pie again. But this is a fresh pie. If you buy a piece, you’re part of the new pie. If you don’t, you end up holding the minuscule piece of the old pie. In other words, you’re diluted out.

3. Some reports, including the TechCrunch one I linked to earlier in the post, say that 60% of Byju’s shareholders voted to remove Byju Raveendran. Raveendran himself says that this figure would have been closer to 45%. The true figure could be anywhere in-between, leaving 15–30% of smaller investors who aren’t accounted for.

4. If a company’s worth $100 but someone gives it $500, the company’s pre-money valuation was $100 but post-money valuation is $600. Because that cash is worth something.

5. The true figure would be this 66% + a part of their earlier stake which would be small and negligible.