No, TAG isn’t worth $100mn. And here is why it might never be

Pakistan’s fintech startup TAG has claimed to have raised $12 million in a seed round at a valuation of $100 million, international news media outlets announced recently. This is not strange news for people following the business and startup space in Pakistan. 

These companies often get astronomical valuations in massive rounds raised. What is also not new news is that these valuations are often not very realistic, and even when they look realistic, they are never exactly what they seem. The case of TAG is somewhere in the middle. 

Armed with a young and hungry founder known for his grit and no-nonsense attitude, TAG is a fintech startup gunning to become a digital bank in Pakistan. For now, the startup is in the process of launching a mobile wallet through which users will be able to transfer funds, pay bills, receive payments, withdraw funds at ATMs and conduct POS transactions via debit cards. The startup also claims to have arrangements with corporations that will disburse salaries digitally into their employees’ TAG wallets. 

Just three months after its launch in 2020, TAG secured an in-principle approval for the Electronic Money Institution (EMI) license to operate as a digital wallet from the State Bank of Pakistan (SBP) in November last year and was granted the approval for the pilot this year in August. 

Similar to TAG are fintech startups NayaPay and SadaPay, also mobile wallets and competitors to TAG, which also plan to provide funds transfers, bill payments, and card transactions. The unique proposition of all these wallets is that compared to banks, these wallets will have an enhanced digital experience for customers with considerably lesser fees. While SadaPay is also in the pilot phase, NayaPay has received a license for its commercial launch this month. 

Another fintech company, Finja, has also received approval for commercial launch, making it one of the only two fintech startups which have the regulator’s approval for commercial launch. Finja is more focused on providing payroll management and credit services for professionals and MSMEs.

While various media outlets have announced and the founders and investors have endorsed that TAG is valued at $100 million, the company’s valuation really is still undecided. TAG’s recent venture round was led by New York-based Liberty City Ventures, along with participation from Canaan Partners, Addition, Mantis and Banana Capital. Previous investors in the pre-seed round were Quiet Capital and Fatima Gobi Ventures. 

As quoted in a media report, Polymath Digital doubled down in this round while Khwarizmi Ventures and the co-founder of Plaid William Hockey also participated. 

The valuation confusion

According to investor communication published on AngelList, a revered online platform that connects investors with startups, the startup TAG had raised $10 million as SAFE (simple agreement for future equity) investment at a valuation cap of $100 million and was raising more at the same cap. 

Here’s where the problem is: the announcement means that the actual worth (valuation) of the company is $100 million, but in reality, for the seed round, TAG had raised $10 million as SAFE investment at valuation caps of $60, $75, and $100 million. 

Before we move on to explain details about TAG’s seed round, we’ll try to explain what a valuation is and how it is not the same as a valuation cap.

Valuation is simply the actual worth of the business quantified, which is why some startups not only in Pakistan but across the world have exhibited tendencies to exaggerate their valuations – the actual worth of their business.  Because these startups, mostly early stage, do not have a certain net income, of course then, exaggerating their worth helps them appear stronger, gain traction, attract talent, evoke investor and media interest (not necessarily positive), secure partnerships, and scare off the competition. 

Startups that have not launched their products yet in the market have a lot to gain from such announcements, and that seems to be the case with TAG, which like SadaPay and NayaPay is yet to launch its wallet.

Startup founders can raise new funds as equity or non-equity. In the rounds which are equity-raised, investors get shareholding based on the actual value of the company and purchase shares at their actual worth. So if a company was valued at $10 million and an investor invested $1 million, the investor owns an absolute 10% of the company. Equity rounds in which shares are traded at actual value are also called priced rounds. 

In contrast, a non-equity funding round does not give an investor any shareholding in the company at that point in time but is converted into shareholding in a later equity-based round. Non-equity-based rounds are raised by early-stage startups which do not have sufficient internal cash but need it to grow the business.

It is also difficult to value a startup in its early stages because the startup has not grown enough to be valued accurately. So startup founders raise such non-equity-based rounds at early stages which helps them raise funding, all the while keeping them from losing any shareholding at that point in time. Non-equity rounds are very popular with early-stage startups because there are fewer complexities associated with such fundraising compared to a priced round. 

The round can be closed with speed, giving startups quick access to funds during the early growth periods.  Moreover, investors participating in such rounds, because they are not getting any shareholding, do not get governance rights, allowing the founders to glide their startup with little interference. 

Non-equity rounds can be raised as convertible notes and SAFEs. Both convertible notes and SAFEs guarantee funds but are converted into equity during a later stage priced round when the startup has grown. Then, there are data points available to value the company and institutional investors come in, do exhaustive due diligence, and investors, prior and the new ones, get shareholding based on the actual worth of the company. 

Early-stage investors, because they are taking a risk with their investment when the company can not even be valued, want to be rewarded for their investments. So non-equity-based financing rounds come with investors or founders setting a valuation cap which provides an incentive to the investor that if the company is valued above the cap, the early investor’s shares would fetch a better price than the later investor in the priced round. 

For example, if an investor puts $500,000 in a startup as SAFE investment, the investor agrees to be putting in the money now but will get the shareholding during the priced round. This investor also sets a valuation cap of let’s say $5 million at which his investment will convert in the next priced round. So if the startup is valued at $10 million in the priced round, his shares would convert as if the valuation was $5 million (the cap) and not $10 million (the actual valuation), giving the investor a lower price per share as an incentive for being an early investor.

Contrarily, if there was no valuation cap and the priced round valued the startup at $10 million, both the early investor and the new investors in the priced round are buying shares at the same price, while the risk for the early investor was higher because he invested when the investment was riskier. A valuation cap, therefore, is simply the highest price at which shares of the early-stage investors would convert in the next round, increasing willingness to participate in a funding round.

This does not mean that the company is actually valued at that amount. So coming back to TAG: according to our information from AngelList, there were investors in the fintech startup’s seed round who invested at valuation caps of $60 million, $75 million, and $100 million as SAFE investments. 

There were investors who would have invested, let’s say $100,000 at a valuation cap of $60 million in TAG’s recent round. There would be others who would have invested at a valuation cap of $100 million. So when TAG raises the equity or priced round next and the actual value of the company is revealed, the early investors would convert their investment into shares at the valuation cap at which they invested.

So let’s say if TAG is valued (hypothetically) at $110 million in its priced round, which happens in let’s say a year’s time, the investors who invested at a valuation cap of $100 million would convert their earlier investment into shares at the $100 million valuation (the cap) instead of $110 million (the actual valuation), giving them a better price per share. 

The ones which invested at a valuation cap of $60 million would get an even better price per share. On the downside, if the actual valuation goes below $100 million, a pre-agreed discount rate (usually 20%) kicks in for these investors. So if the actual valuation of the company falls below the valuation cap and is let’s say $50 million in the next round, early investors get a discount; these investors get to convert their investment into shares at a share price that is discounted by a fixed percentage. In none of the above scenarios does it imply that the startup’s actual worth after the seed round was $100 million.

As already mentioned, it is normal for investors in SAFE rounds to not conduct as thorough due diligence as in a priced round. This also seems to be the case here as TAG founder Talal Gondal, in his interviews with foreign media outlets, said that this round was closed in two weeks, which is clearly not a sufficient time to carry out detailed due diligence which would be essential if it were a priced round. 

Profit reached out to TAG to see any document to confirm that the funding amount was $12 million and to confirm if and how the valuation, as claimed in media reports and endorsed by the founders, was $100 million, but no response was received. 

Essentially, valuation caps depend on how well a startup is able to negotiate, and according to some, how well the startup could capitalize on investors’ fear of missing out. In the early stages when there is no revenue, such negotiations matter. 

The market value of a business is driven by how much an investor is willing to pay to get involved in a funding round. And investors are willing to pay a high price to invest in YCombinator startups.

YCombinator is the most prestigious startup incubator in the world and has produced globally successful startups such as Stripe and Airbnb. Because the incubator is prestigious and has produced success stories, other investors assume (probably rightly so) that if a startup went through YCombinator, it is a good startup and the bet then is that because the startup went into the YCombinator, it has a high chance of succeeding in the future; therefore it’s an investment opportunity that should not be missed. TAG is among the very few startups from Pakistan that went into YCombinator this year in June.  

So if an investor gave TAG let’s say an investment of $1 million in the seed round at a $60 million valuation cap, that investor made a bet that TAG’s chances of success are high because it went into YCombinator, but would still want a valuation cap and/or discount to protect the upside and downside.

Now there is a different level of tolerance of how much higher an investor can expect the next round to be. Some investors would expect it to be three times higher, and others would expect it to be only 20% higher, so investors could naturally fix different valuation caps. 

Then there is this interesting dynamic with startups that if they get a known investor to participate in a funding round, and that investor participated at a valuation cap of $60 million, the next investor would want to invest knowing that the startup went into the Y-Combinator and a known investor participated in the round. The new investor is betting not just on the startup and its team, but also on the YCombinator and the existing known investor. 

The startup can this time allow the second investor to participate in the round and negotiate a higher valuation cap. So the second investor would come at a higher valuation cap of let’s say $75 million. The price for the second investor is higher. If the startup gets a valuation of $80 million in the priced round, the investor that participated at a $75 million valuation cap gets his shares converted at a price that would be higher than the investor who invested at a $60 million cap. The first investor is converting at a better rate than the second investor.

When the third investor comes in, the startup can again negotiate a higher price of let’s say a valuation cap of $100 million. So the investors that are the last cheque in, are willing to pay a higher price by agreeing to a higher valuation cap so that they can participate and invest in an early-stage startup that they perceive is good because it went to YCombinator and because of a few known investors that participated in the round.

Because such deals are rare, investors would not want to miss out. The valuation cap and the market value of the startup in terms of the price it was able to fetch from an investor go up, but in reality, the actual valuation of the company still remains undiscovered.  

The basis for valuation and possible misrepresentation

It’s really the founder and the core team which forms the basis for an investor to gauge the trajectory an early-stage startup is going to go and how much it would be able to grow. And as people who have interacted with Talal tell us, he is someone who is at the top of his game when it comes to running his fintech startup.

It was the founder who ideated TAG and got it the in-principle approval from the central bank within a matter of three months while it took some of the others a year or more. In an earlier interview, Talal told Profit that he knew how to work his way around bureaucracies.

It was Talal who got TAG into the YCombinator, a feat many others in Pakistan would fail at, and after getting his startup into the most prestigious incubator in the world, made it, as we have learned, one of the most popular startups from being very unpopular in the beginning. And because he is the founder, he was the one who naturally led the negotiations with investors.

Coming from a political family in Punjab, Talal has the right political connections and has built the right team at TAG, consisting of people who have served in influential positions in the government. For instance, TAG has on its board a former general of the Pakistan army and a former finance secretary, Tariq Bajwa, who served as the 19th governor of the State Bank of Pakistan between 2017 and 2019.

The profiles of the people on the team are stunning and such profiles usually make it to the boards of big businesses in Pakistan. Having such people on a startup’s board would look like an anomaly but it makes sense once you realise who the competitors to TAG are.

Yes, other wallets are competitors to TAG, but all these wallets have one competitor in common: the banks, which get the first say in policies and dominate the financial services landscape. Without such people with you, matters are most likely going to get dragged for you or derail completely if your competitors have these people but you don’t. 

The financial services industry in Pakistan is dominated by big banks which lend to the government primarily, and corporations, ignoring retail consumers most of the time. As a consequence, Pakistan has a large unbanked population which fintech startups like TAG, SadaPay, and NayaPay are trying to bank on. 

“Pakistan lags behind in tech adoption. One of the key segments happens to be fintech, which is currently a greenfield. Incumbents (Banks and telcos) have been complacent. They employ complex revenue models and have moved away from innovation. Most of the banks do not offer mobile banking. The ones that do have poor products, limited applicability, complex designs, and unreliable operations. These Banks still employ outdated systems and have failed to evolve. They have not graduated into the 21st century tech-wise. Therefore, incumbents are in a vulnerable position to lose to an innovative, challenger bank,” wrote Talib Rizvi, executive director TAG, in his commentary on the financial services sector and the rise of fintech companies.  

The problem, however, is that banks also have well-entrenched lobbies in the financial system and banks look at fintech companies as competitors, which makes things difficult for fintech startups. This is perhaps why one of TAG’s other competitors also has former government officials on its board. 

Fintech SadaPay has Waqar Masood, former federal finance secretary and former special assistant to the prime minister, on its board. On the other hand, Nayapay is helmed by the scion of an old and prominent business family in Pakistan with all the right connections. 

From a business perspective, the mobile wallet space has not yet been cracked by any player. Previously, Inov8 tried to do it through FonePay and Finja tried to do it through SimSim in partnership with Finca Bank, but both of them failed to create a serious dent in digital payments. Traditional banks which already dominate, have been creating hurdles for fintech companies by refusing partnerships, all the while improving their own digital muscle. 

With the right political connections and a team to get things done in the financial services landscape dominated by banks and where going with the government is not easy, Talal surely looks set to make a headway with TAG.

“If someone can crack wallets, it’s Talal,” a source told us. 

Talal has been able to create a perception around TAG in front of investors too that his startup is the only one that can dominate the market, and for his competitors, he can sometimes be completely cutthroat. For instance, from the investor communication available to us, one of the investors in TAG said about SadaPay that it was led by an “American who is completely out of his depth” in Pakistan. The likelihood of the investor knowing and perceiving something like this about TAG’s competitor on his own is slim.

Documents shared around on Whatsapp groups and the Pakistani startup community also claim that the founder of SadaPay was not completely clean with his records in the US.

Investors are not setting valuation caps out of thin air. They see the team, the founder’s passion, the market, and what the founder tells them are the good indicators that will make growth possible. And since there is no due diligence in early rounds, investors believe what is told to them. All this helps create a perception about the future prospects of the business but this perception could be exaggerated about TAG and this is where we would bring possible instances of misrepresentation by the founder, to portray a better image and the opportunity thereof for TAG to become a successful business and secure investment. 

While there is no solid data to project the future valuation of the company, startups can give an idea about the future growth to investors by stating factors that would make their growth possible. For instance, TAG positions itself as a ‘neobank’ in a country of over 220 million people, most of whom are unbanked. Pakistan’s 3G/4G users are increasing which means that the number of phone users that will potentially use TAG mobile wallet is also increasing. All these indicators help get a sense of the direction the startup is going to go.

Then some updates from the startup have helped investors make investment decisions. For instance, TAG said that it had gotten approval from the State Bank of Pakistan to launch operations, but without specifying if TAG “has gotten approval” means they have secured the complete license or TAG is only referring to the “in-principle approval’ or approval for the pilot. The EMI license from the State Bank of Pakistan under which a fintech company can operate a mobile wallet has three stages: in-principle approval, approval for pilot, and approval for commercial launch. 

All three stages have different requirements and the final decision to grant the license rests with the State Bank of Pakistan. If by approval, TAG means a complete license, that has not happened yet. And if it means in-principal approval or pilot approval, it is not a guarantee that the license will be granted. 

The central bank’s disclaimer at the in-principle approval stage regard states: “In-principle approval letters are granted to EMIs based on the information submitted by them and a review of their application for in-principle approval under Regulations for EMIs (Electronic Money Institutions). It must not be construed as an endorsement of the EMIs proposed business model, financial viability, etc. by the State Bank of Pakistan.”

“State Bank of Pakistan will not be responsible for any financial, legal, and reputational loss to any entity or individual who has established a business relationship with the respective EMI based on the in-principle approval letter,” it reads further. 

TAG received in-principle approval from the State Bank last year and received pilot approval this year in August which qualifies it to test its products and services with limited customers. The commercial launch is only going to come after the SBP is satisfied with the pilot phase of TAG. The startup has yet not disclosed how far away they are from the commercial launch, in a question sent by Profit.

Another update cited as the basis for valuation was that the fintech TAG had “secured a major public sector contract that would allow us [TAG] to eventually onboard 1.2 million active users over the course of next year and bring us [TAG] ARR of $8.4 million.”

According to TAG’s pitch deck available with Profit, the only public sector contract that the fintech company claims to have is with the Frontier Works Organisation (FWO). Frontier Works Organisation is Pakistan’s military-run organisation that undertakes construction projects. Under the contract, TAG would be digitising salary disbursements for FWO.

While TAG has claimed to investors that it had secured a major contract, presumably with FWO, sources close to TAG confirmed to Profit that no final contract with FWO was in place and as of now, there were only negotiations going on. In fact, our sources at TAG tell us that there was no final agreement yet with anyone; other contracts are also being negotiated but none of these have been finalised.

It also remains unclear if the FWO contract alone will bring 1.2 million users to the TAG wallet as claimed. FWO only has between 7,000-8,000 employees as Profit has learned, and most of them are blue-collar workers, most of whom use feature phones and cannot really have TAG mobile wallets on these phones.

The number of mobile wallet users that FWO can bring TAG would, therefore, be significantly less. 

TAG claims to have another contract in place with Fatima Group, Pakistan’s leading conglomerate, which is also an investor in TAG through its venture capital arm Fatima Gobi Ventures. 

Furthermore, earlier in June this year, TAG announced raising $5.5 million in a pre-seed round. However, according to TAG’s deck, the startup told investors that it raised $2.5 million in the pre-seed round. Profit reached out to TAG to understand how the $5.5 million adds up, but no response was received. 

In another investor presentation, the startup claimed that it had earlier deposited $2 million with the State Bank of Pakistan as a precondition to launch the pilot. While the startup has claimed in its deck that it deposited $2 million with the central bank to launch the pilot, as per the EMI license requirements from the central bank, a fintech company seeking such licenses is only required to show Rs200 million (~$1-1.3 million depending on fluctuating dollar rates during the last few months) as paid-up capital, of which only 10% is required to be deposited as security with the State Bank.  

Can wallets really make it big?

It started with the claim of a ludicrous valuation for a startup that has not even launched yet and led to questions like how is it possible? Earlier, a similar story with Inov8 emerged with the founders claiming a $108 million valuation for their mobile wallet FonePay. It did not end well for FonePay.

It’s actually the industry dynamic that helps explain why such valuations are hard to believe. While the TAG investment is indicative of how fintech funding is picking up, the thinking behind such investments is the belief that tech startups are going to transform the financial services industry.

The indicators with respect to financial transactions going digital are encouraging but while digital payments volumes are picking up, the increase in volumes does not necessarily mean that wallets created by fintech companies would be able to get a major share from this volume because, as elaborated in an earlier cover of Profit and we recreate briefly the arguments below, the financial services sector is dominated by big banks, which can control the future of EMIs like TAG and others.

This is also why startups have influential people on their boards who can get some obstacles out of the way. But even then it is no guarantee for success because if an EMI threatens banks and their deposits in any way, which wallets like TAG plan to do, they will meet stiff resistance from the banks which have better lobbyists and have earlier put down such wallets.

The underlying fact is that the EMI license allows creating an app-based wallet to facilitate money transfers between two parties primarily, and does not allow many scales of earning interest on deposits. So these wallets are really looking at the opportunity of creating a big business out of app-based wallets only on facilitating payments between two parties. 

The scope of such transactions is limited, however, if you consider that EMI regulations place transaction limits – wallet users cannot transfer more than Rs50,000 into their digital wallet in a single day, unless they complete biometric verification, in which case they will be allowed to move up to Rs200,000 per month into their digital wallet. In contrast, the limits of transfers at banks are controlled by banks themselves, rather than regulations. 

TAG and SadaPay are issuing debit cards that customers can use to withdraw money from ATMs, and the ATM network is controlled by banks which can further create withdrawal limits for EMIs when they use bank ATMs. Currently, cash withdrawals are limited to Rs10,000 per day and banks charge an ATM withdrawal fee. Since the limit is low compared to banks’ ATM cards, the cost per transaction is high if you have a wallet card. Effectively, wallets become expensive for users. These users are unbanked because banking is expensive, and form the market for these fintech companies to capture. 

On the other hand, putting money into a wallet is also going to happen through a bank, which can again set limits on how much money can be deposited into a wallet account and in fact ask for a fee for such deposits. It can also happen through branchless banking agents of EasyPaisa and JazzCash, but both these players are notorious for keeping their wallets closed loop. 

Essentially, EMIs like TAG are creating a product that competes with basic banking services without providing value for these services. Now an EMI can upgrade itself to a digital bank and TAG has publicly announced that it plans to become a digital bank, but the law in this regard is not final yet and it is anybody’s guess what its final shape would look like. 

The functions of the State Bank require it to be mindful of the depositors’ interest first, followed by the interests of conventional banks that take these deposits. Naturally, the financial services system is dominated by conventional banks with better lobbyists for regulations that claim to be in the interest of keeping the depositors’ money safe. In turn, the State Bank is likely to find itself persuaded by such arguments more than that of the EMIs. The State Bank also has its limitations: if it allows the EMis to deliver the same services as conventional banks which have a higher requirement for paid-up capital, it would be unfair to these banks and their investors. 

Then the Prudential Regulations do not allow specialisations which means EMIs would have to create general products, which means they would be competing with banks head-on. Some niches have been created, for instance, Finja is into lending primarily, and for most others, it is an uphill battle in a market that is heavily tilted in the favour of the incumbents, even with a regulator that has moved significantly in the direction of allowing innovative companies room to operate.

So it is imperative to understand that the power rests with the incumbents for now who are not likely to let it go anytime soon. The only play fintech companies are left with is to not threaten banks where they dominate. So if TAG wants to disburse salaries for corporations, it essentially threatens banks’ business with corporations and if that happens, banks are not likely to cooperate and the State Bank is also less likely to be friendly to a mobile wallet’s lobbying.

Big banks have been around for decades, and have better lobbyists than the new players, who can persuade with forceful arguments that all purport to be in the interest of protecting the depositor. So fintech companies really have a chance in the financial services industry if they do let’s say salary advances, as Abhi Finance does. Banks are currently not interested in this space. Then micro-lending for small businesses is lackluster which banks have left unserved. 

With increasing VC interest in Pakistan’s startup space, EMIs might succeed in securing high valuations in future priced rounds, however, with banks’ dominance, getting a good return on these investments might not have the same likelihood.