Money matters. More so when it’s not yours. It has an even further impact when investors’ valuation becomes a measure of your success in a capital-starved world. This third issue of our Entrepreneurship and E-Commerce series focuses on these money-matters.
In the previous two issues (do have a look at them above), we illustrated how smaller startups need to differentiate their services and specialize in a particular niche. The established ones should mentor and oversee their growth, consequently turning themselves into holding companies. The idea here is to form a large and connected ecosystem, within which there exists a “super app”—a setup that provides a one stop-solution for all customer requirements including retail, travel, payments and various other daily transactions. With RBI’s launch of the Universal Payments Interface (UPI) that converts your smartphone into a virtual bank and its extremely easy to use features, India today stands at the cusp of another revolution, less disruptive than the 1991 LPG reforms, but with a potential that can equal the scale of impact of those reforms.
The stage is set for the pieces of the puzzle to fall in place. All that is required now is investment to scale up and reach that stage from where a major proportion of India’s 1.28 billion population can be accessed. If only, it were that easy! According to estimates by Goldman Sachs, Indian e-commerce startups require further investments to the tone of $20 billion to become sustainable and maybe break-even, having already consumed (read burnt out) $6 billion worth of investor money.
Getting funding is never easy. Despite Morgan Stanley’s estimate of $6.6 billion for the total funding (by private equity and venture capital firms combined) received in 2015 (implying a 50% year-on-year growth), the picture isn’t that rosy. With investors now starting to understand the dynamics of the Indian market and learning from their mistakes, they have become even more skeptical of the Indian entrepreneur approaching them for funds.
Earlier they had been found guilty of not doing proper due diligence before splashing out the cash, which led to startups burning more and more injudiciously. Founders would get money based upon their idea, without having to explain how they plan to actually implement it. Exit route seemed to be the least preferred item on their checklist. Result? A few years down the road, some startups vanished, some were made to vanish by the bigger players and profitability seemed to have a new, rubbish definition. Look at the number of startups that got a high Series A and/or B funding, but even their existing investors refused to invest in them in the later rounds. In some cases the founders managed to pull some strings to rope in Angel investors at the onset, but failed to draw PE/VC firms in later rounds. They had to eventually call curtains when they realized that their ideas found no takers in both the consumer and capital markets.
All this, solely because the due diligence that should have been done before the initial investment was carried out after the first 2-3 rounds. Realizing that operationalization is not feasible after having burnt a few hundred million dollars is not what you want as an investor. What they want today is an efficiently thought-of plan to operationalize and scale up the venture.
Even more interesting are dynamics like the cross-linking between the investors and startups. Bigger startups are investing in greenhorns, and investors have parked money in different ventures, many competing within the same niche. What can be its implications? This we’ll discuss when we talk about agglomeration and the M&A spree going on in the Indian startup space.
For now, let’s focus on the investors’ angle. The PE/VC conundrum. What is expected of them and what are their expectations?
We all know it is the currency that does the talking today. The influence of investors on the decisions of the firm cannot be denied. The question is the degree of that influence. For an entrepreneur who is into all this because of his own passion and vision, his idea in which he saw an opportunity, to what extent is it okay to let the investors decide for his part? True, the entire concept of accelerators and venture capitalists is to help novices gain some foothold, but there needs to be a line. Entrepreneurs need guidance regarding operationalization and understanding the market dynamics, but today this leverage is turning into a liability at an alarming rate.
This, when most of the startups today are SaaS platforms. Now let us take a peek into the future. With the advent of big data and the internet of things, these platforms would need to evolve to inculcate machine to machine communication, real time data collection and processing. New startups that’ll rise would have to have them as necessities. Real time systems are complicated, much more complex than a simple website accompanied by some back-end analytics processes. And they are expensive.
Where does the money come from? Investors. Seed funds, angels, accelerators, private equity firms and venture capitalists. How much can they invest? This needs to be a function of the feasibility of implementation of the idea and not the risk appetite of the investors. Along with the idea, entrepreneurs need to come up with a plan to best monetize it. Irrational investing can convert a boom into a bubble, as we have seen on numerous occasions, more so in the internet domain, where it isn’t easy to gauge the real value of the service. The info-graphic below gives a glimpse of some developments in this domain in the year that passed.
So, data shows that the amount of capital flowing into Indian startups has been decreasing consistently over the past three quarters. This shouldn’t come as a surprise, given the increasing apprehensions of investors, fuelled by a weak global economy and an overall bearish sentiment. Investors have realized that the honeymoon phase of the Indian startup ecosystem is now over. It’s time to reconsider and re-evaluate.
For instance, look at the valuation scenario presently. GMV is an incomplete measure of a firm’s market value. It doesn’t take into account, the efficiency with which a firm is carrying out its operations within the limited funds it has. The investors should be looking at this capital efficiency, a more apt measure of which firms are a better investment option. Use the GMV by capital raised ratio (i.e., GMV per dollar invested) and the biggest Indian unicorn, Flipkart, falls out of the top three. Shopclues, Snapdeal and PayTM take the top three spots respectively.
Further, on one hand only 3 Indian unicorns are valued at greater than $4 billion (namely Flipkart at $11 billion, Snapdeal at $6.5 billion and Ola at $5 billion), while on the other hand one of them, Flipkart was devalued by $4.2 billion by Morgan Stanley. Making, let alone being swept off, this much money is beyond the wildest dreams of many Indian startups today, but Flipkart is unfazed by it. Now this is power. The power that comes from being backed by deep, confident pockets of the who’s who of the investment world.
But, with great power comes great responsibility. Investors are definitely looking upon India as their gold mine. Dedicated funds have been set up and organized by many global investors and firms, exclusively for investment into Indian startups. Once they start maturing, they can reap huge benefits. After all demographics do play a role. Who would have ever thought that Walmart will one day no longer be the world’s largest retailer? Look at Alibaba today. But to reach this maturity both big and small firms alike need investments, albeit on different scales. Investors have started becoming choosy. In 2015, Softbank Capital, the VC arm of Japanese Softbank Corp. decided to change its investment strategy. They shifted their focus from the small fish in big ponds to the big fish in smaller ponds. Softbank is one of the major investors in Indian firms, and has announced plans to scale up its Indian investments to $10 billion, having invested $2 billion in 2015 itself. Its notable holdings include Snapdeal ($627 million), InMobi (a 35% stake), and Ola Cabs’ ANI Technologies ($210 million). With Chinese players like Alibaba, Xiaomi and Foxconn also looking to invest in India, opportunities are knocking on the door.
What about the minnows? Tapping into the imagination (read funds) of these big, ambitious investors is mostly out of their means. And crowd-funding isn’t much in vogue in India. Here is where the government comes in. With the “Startup India, Standup India” Action Plan launched in January 2016, the government is looking to support the small scale startups in standing on their feet. Tax relaxations based on the age of the startup will also go a long way in this regard. With SIDBI (Small Industries Development Bank of India) setting aside a Rs. 2000 crore “fund-of-funds” for startups, the smaller startups are happy. They can obtain easy capital at an affordable price. The investors can then take over and help them in scaling up strategically. Meanwhile they can also continue to invest in unicorns till the exit route is clear and profitable. Thus investors are happy. The unicorns can then invest in or maybe take over and guide the smaller startups operating within their niche, and therefore both of them are happy. This is how the cross-linking dynamics within the startup ecosystem will come into play. Right now it is a complex maze of cross-organizational shares and holdings, which will only clear up with maturity and experience. It requires a lot of patience and collective deliberation.
Thus, consolidation is surely the way forward. As my economics professor puts it, stability can only occur in a system if every consequent step is of a smaller magnitude than the previous one. Apply this, and you know that the cash burn needs to dampen and eventually die down. Investors and entrepreneurs both need to realize this and act accordingly and responsibly. Then only can stability be achieved within this setup. Happy Investing!!