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Startups and Unicorns | We have met the enemy and they are us

Investor ecosystem is as much to blame as founders for the governance deficit in many unicorns 

April 28, 2022 / 06:24 PM IST

In summer 2019, Adam Neumann, the cofounder and then CEO of WeWork, cashed out over $700m ahead of the company’s initial public offer (IPO). The IPO never happened and the rest is history. In India most founders and investors were appalled by the excesses at WeWork. I have had the privilege to know and work with many great Indian investors who would be appalled if anything like that happened to their cos. So then, why do we have governance problems in so many unicorns minted since WeWork?

In the VC world, founders who siphon off money are as bad as founders who ramp up valuations with flimsy economics and focus merely on personal secondary exits. Investors who knowingly overlook ethical conflicts and misalignment of incentives are as bad as those who are cheering out of ignorance.

It’s very easy to blame all this on founders. But from my experience working with the same set of founders for 15 years now, I can say that a lot of well-meaning founders have been systematically corrupted by us — the venture capital investors, angels, and ‘Super Angels’.

As the United States started printing trillions, the market was flooded with easy money. The pandemic boosted the revenues of most digital companies, which went on to sell shares to public investors, and this became a favourite hunting ground for all sorts of money managers. If you are raising money every year, you need portfolio companies that have a proven track record of raising and multiplying valuation every six months. There was a lot of demand from the US for fast multiplying Indian cos, which smart early stage funds from India were happy to supply. During the pandemic all firms expanded a lot, and internal competition to grow led to an ‘eat-what-you-hunt’ culture.

Funding Hack


So ‘hacking’ the next round of funding has now become institutionalised. How did this lead to a systematic corruption of young founders? Instead of counselling young founders on how to build a great business, formal coaching programmes have been set up solely to hack the next round of funding. Invitee speakers for such programmes are selected on the basis of how well they raised money — private and public — particularly if they did it without much underlying value creation. That is the trick that everyone wants to learn.

How does this happen?

Step 1: VC funds a mercenary founder. Usually these businesses add no real value except adding another layer of discount or freebie on something that is already there. Delivering food or knick-knacks at Rs 150 order value without any charges can be a big market, even if there is no need of additional players. Only in mercenary set-ups will rocket scientists be hired to optimise ‘arrow’ buttons for discounts that enable hyper-growth.

Step2: VC and founder together arrive at a plan to hack a number into hyper-growth — usually GMV/GTV/Downloads — something that will be acceptable to an incoming global VC. This hack could take the shape of buying GMV from existing players in a B2B industry or by selling a dollar for 95 cents, for example. Or unleashing thousands of sales people while maintaining pretensions of being a tech co. Or adding the value of transactions on your accounting app.

Step 3: Use the stellar reputation built by the fund to attract global investors. The promise is implicit. The COVID-19-driven FOMO-induced extra competitiveness into fund managers perhaps.

After raising a few rounds every 4-6 months, the founder is now within reach of the unicorn title, and usually aiming to be ‘fastest’ unicorn. It’s tough to meet founders who wants to build any other type of unicorn.

For younger founders, it becomes like playing a game. You win the game by raising the most money without doing much apart from perhaps hacking metrics such as gross transaction value (GTV), gross merchandise value (GMV) or app downloads. You win if you raise $50-100 million. Your rewards are big secondary exits ($2-10 million each round), and more importantly, invitations to coach other founders. Of course, the big cars and fancy lifestyles are par for the course.

Founders running 2-3-year-old companies without any meaningful achievements are given meaningful secondary exits. VCs then encourage these founders to do angel investing. Unicorn founders are invited to participate in Series A/B/C rounds of new companies, it’s all in the club. All the recipients of this angel funding cannot wait to enter the club themselves.

It’s very hard to resist the temptation of playing a game where the stakes are so high and rewards so lucrative. We have reached to this point with well-meaning individuals and good intentions.

A Slippery Slope

However, this game cannot sustain beyond a point. The pressure to sell more dollars at 95 cents increases. There is a clear Income per capita problem in short run and in terms of land-grab, Big Tech has a free run at squeezing local startups. At some point the founder also questions the intention of investors, who never seem to ask questions about the quality of the business.

Many founders stop believing in their own companies. By now, some founders understand that their business is either not going anywhere or will not justify the capital raised. Many don’t realise, and continue to live in their make believe world. Yet the end result is the same. They are diluting fast, and have raised so much that they are in single-digit ownership. They have reconciled to living on secondaries, do the bidding of investors for growing fast, and enjoy their club perks. Meanwhile, the investors have made it to the top.

Founders now solves more for secondary and personal lifestyle and to keep the façade going. Sometimes, they add new businesses or flip the business model. As more mercenaries join the melee, the founder starts getting nudges on how to get really creative about the impossible growth targets. A highly-celebrated founder running a flaky business is far more susceptible.

External diligence would have stepped up. There will be two possible outcomes. One, there was just high burn in a crappy business, and the company will shift goalposts till it becomes a zombie unicorn. Two, there is a governance problem and the company will be merged with another zombie unicorn. In a rare instance, the greater fool theory will play out.

A Waste Of Potential

India, along with its entrepreneurs and VCs, has tremendous potential. Fighting human emotions like greed, lust, and envy are very tough in a start-up ecosystem bonded with loose social contracts.

Still, the media, society and founders need to celebrate great businesses and not forward-looking valuations. Perhaps, we should redefine what a unicorn means. Perhaps, media should publish lists of companies by their revenues and growth, and not by external valuation. Secondary exits can perhaps be restricted to once in 4-5 years or for emergencies, and angel deals by founders should ideally be limited. Founders need to look up to real successes — India has so many great cos to learn from — and aim to build something lasting.

Founders can learn a lesson or two from family-owned businesses that want to build for their next generations, and hence rarely think short term. Funds need to focus on collective alignment on performance and stop incentivising based on mark-ups. There are a few leading names in the VC world who have spoken up, and hopefully more will join. Finally, limited partners (LPs) must stop looking at India VC as an asset class that can scale and absorb unlimited amounts of money.

Anand Lunia is general partner, India Quotient. 

Views are personal and do not represent the stand of this publication.
Anand Lunia is general partner, India Quotient.
first published: Apr 28, 2022 04:01 pm
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