Five Star Business Finance IPO:  Executional Excellence Compounds

When you write about the past through the lens of the present, it’s easy to see how the dots connected. On very rare occasions you see the dots connecting, in real time, as the story unfolds. When we met the founder and team of Five Star Business Finance, it was clear they had a strong focus on executional excellence, a ton of grit, and some simple but strongly-held beliefs about maintaining a high bar on business quality that would set them up for consistent growth over the long term.

When a prepared mind meets an opportunity

Our partnership with Five Star started in August 2017, when Sequoia Capital India co-led the company’s Series C round. The opportunity arose serendipitously during a no-agenda catch up in Chennai in April 2017 with Five Star Business Finance CEO Rangarajan Krishnan, who was then the COO. We had first met Ranga in 2009 when he was a fast rising young banker at Spark Capital and later built a relationship of mutual respect when we worked closely together at India Shelter Finance Corporation, a portfolio company Spark Capital had helped raise capital for. In 2017, Sequoia Capital India was looking closely at non-banking financial companies (NBFCs), so we called Ranga to see if he was free for a filter coffee on a routine trip to Chennai.

The timing couldn’t have been better.  When we told Ranga about our thinking on non-banking financial services, he informed us that Five Star Business Finance was about to kick off a fund raise process; he recommended that we take a serious look at the opportunity. A group of us, including GV Ravishankar,  Sakshi Chopra and Ishaan Mittal, had just spent  several weeks scoping the NBFC landscape and zoning in on the MSME lending market opportunity, so we had come with a prepared mind. As they say, luck meets you if you are willing to walk half the way! The following is an unedited paragraph from our internal memo:

“The sub-team on Financial Services has spent the last few weeks connecting with over 10 privately held NBFCs (mostly across MSME, CV Finance, Education Finance, and Housing Finance), spoken to several analysts covering the sector and scrubbing several public market NBFC comps to crystalize our thoughts on the sector and identify high potential companies and sub-segments. We believe MSME and affordable housing are the top two neighborhoods to focus on to start with, followed by used vehicle finance and lending to educational institutions (niche). The key criteria we have used in filtering opportunities are a stellar team, strong reputation amongst lenders, feedback from peers/regulator and strong business metrics. Amongst the set of companies we have met, Five Star stands out as a clear winner amongst the scaled-up companies.”

Five Star was a relatively small company and had closed FY17 at about INR 85 cr of revenues, INR 19 cr of profits on INR 465 cr of AUM. But the metrics were all trending well and there were signs that this company had a special financial profile, with high return on assets and a healthy gross non performing assets (GNPA) profile that was improving steadily. But what really convinced us to recommend an investment here was the founder, D. Lakshmipathy. Pathy, as he’s called, is an energetic man brimming with confidence. He was an outsider to this business and came in to take over the reins 15 years prior to Sequoia Capital India’s investment. At that time, Five Star was a tiny, family-run NBFC with no clear path to growth or scale. Pathy brought a sense of purpose and ambition to the business and once he had access to venture capital funding, there was no turning back. 

Great execution leads to great outcomes

It was evident from the moment we met that Pathy was super clear about what the company did well and how he planned to capitalize on that. And he was not distracted by trends or market buzz. Pathy was always proud of the fact that Five Star’s credit model had not changed since 2002. In fact, despite all the developments in technology and the market’s focus on alternate data sources, Pathy felt that it was thanks to the “physicality” of their credit process, which included home visits, interviews and detailed references, that Five Star had strong and improving credit quality. He was clear that while centralized credit methods may seem to be hard to scale, that framework played a critical role in ensuring the culture of good credit would not get diluted. 

Pathy also made a strategic decision early on to bring in seasoned, dynamic professionals to help scale Five Star. This marked a different approach to the way many family run companies in traditional sectors typically operate. Several years before he even thought about raising a growth round, he recruited Ranga, who was a sell-side banker, as COO – and later elevated him to CEO – and Srikanth G, who spent time at Citibank, as CFO. A core leadership team with experience, ambition and drive formed around Pathy that went on, in turn, to build out the depth of talent needed to scale the business.

No straight line to success

Cut to 2022, twenty years after Pathy took over the business. Five Star now has more than 5000 cr of AUM, representing a compounded annual growth rate of  40%, with a significant profit profile. Since Sequoia’s investment in 2017, the company faced many headwinds, including demonetization linked disruptions going into 2017, GST implementation and related issues, a sector-wide NBFC liquidity crisis in 2019 and, more critically, Covid linked disruptions and government-mandated moratoriums on consumer loans repayments in 2020/21. Despite all these hurdles, Five Star kept evolving its operations to ensure they overcame each challenging market environment successfully each time – at times sacrificing growth to remain laser focused on quality of book, which they held sacrosanct as the bar for performance in a lending business. 

IPO and beyond 

At Sequoia we think of ourselves as partners to founders from Idea to IPO and beyond. In most companies, we have the privilege of partnering from a very early stage. However we have also found that sometimes we can intersect a high quality company at a later stage in their journey and we discover that we have a strong alignment with founders on how to build the business. In those cases Sequoia Capital India is still able to invest meaningfully or lead multiple rounds of financing even after starting the relationship at series B/C stage. Five Star is one such example where Sequoia Capital India co-led Series B, participated in Series C and also invested from multiple Sequoia Capital funds early last year.

Five Star is today a public company. This important milestone offers a moment to step back and reflect on the distance the company, and its team, have traveled since 2002, when Pathy took over the helm to  provide critical leadership and direction. Indian public markets have over 6,000 listed companies, and Five Star is now in the top 5% in terms of market cap.  Our gratitude to the team at Five Star for their hard work and continued commitment to building a high quality, well governed, responsible lending company that cares for their customers, employees and shareholders deeply. Sequoia Capital India continues to remain both a large shareholder and strong supporter in their journey, and we wish them many years of compounding ahead!