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Valuation has substituted value, and values

Much like old economy corporates, some startups are drunk on their past (fundraising) success, and think that investors will keep giving them money forever

February 18, 2022 / 06:34 PM IST

Anand Lunia

We have been in a venture capital bubble since at least 2014. Venture capitalist Bill Gurley first tweeted about the unsustainable burn rates around then as Softbank started the huge funding boom. Since then, hedge funds, PE funds, public market funds, and even the highly-conservative family offices have crossed over to venture capital. India, for example, attracted more VC than PE money in 2021.

There was a time when startups would aim to become profitable within 5-7 years. They hoped they wouldn’t dilute beyond a point, unless it was for inorganic growth or things like international expansion. But this discipline went out of the window as a lot of money went into competing startups, and competition intensified.

Instead of focusing, consolidating, and strengthening the core offering, most startups started diversifying into larger markets. Follow the money, as they say. As newer fund managers entered the market, the usual discipline of efficient capital deployment went away; and with regular markups driving ‘performance’ on paper — this wasn’t even necessary.

A New Culture

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A new class of startups was born. The customer for these was the next Investor. The goal was the next round. The long-term strategy was to grow at any cost, raise more than your competition, and be the only winner in the end. Board meetings would rarely discuss the question of long-term profitability, but spend most of the time on how to diversify, grow, and how to raise more than the competition. The boards would encourage founders to acquire ‘growth talent’, a euphemism for mercenaries who have mastered the art of delivering high growth given adequate burn. A new culture was born.

Coke or Pepsi almost always raise prices in tandem instead of discounting each other to mutual destruction. Because they don’t have to keep growing at unnatural rates to survive. Food delivery platforms may have figured out that an average white collar worker with a sub-150 ($2) lunch budget cannot be served a hot meal in 30 minutes by a delivery executive who earns more than this consumer. But this meal is the key driver for growth. The hope is that the per capita GDP will rise faster than inflation so that there will be money in these ‘free’ lunches. When a strong oligopoly chooses to not optimise for profits, the lunch turns a bit smelly.

You Have A Unicorn!

A new lot of e-com players have found a huge growth market at average order values of Rs 200 ($3 per order), while the e-com biggies struggle to make any money at 5-10 times the ticket size. Selling a dollar at 95 cents is stupid, but selling it at 60 cents can open completely new markets and ‘revolutionise consumer behaviour’, and voila! you have a unicorn.

Early gains by global funds in India have given them a lot of credibility. These funds lend a stamp of credibility when they invest in a startup. When this highly-credible startup promises hyper-growth in short term and profits in long term, global investors are happy to write a huge cheque over a video call. The valuations of these companies keep going up, and they become ‘leaders’ and ‘top performers’. The credibility is reinforced. Now every investor wants to be with the leaders and top performers. Even the highly-conservative Indian family offices could not resist the lure of investing in such ‘leading unicorns’.

Delusion of Success

As entry into these startups became tough due to high demand, investors started becoming ‘founder friendly’ by giving huge secondary exits. As talent became scarce, companies became employee-friendly — huge salaries, bonuses, and ESOP buybacks.

Founders and management teams have been riding this ‘growth tiger’ long enough to believe that this is how startups are supposed to be. Their rewards come from secondary exits, and social recognition from being ‘unicorns’. Even their self-actualisation is linked to raising more than their peers. Bankers are passé. On February 12, hedge fund manager Abraham Thomas wrote an informative article titled the ‘Minsky Moment in Venture Capital’. The article will be appreciated by founders and investors alike, but they will eventually conclude that it does not apply to them.

In my only chance interaction with Tata Trusts Chairman Ratan Tata in the guest lounge at the 2016 Mumbai TieCon, while waited for Madhuri Dixit to vacate the stage, he mentioned that corporate executives have high stakes in defending their old ways, the way they have achieved success. The same is happening in startups now. They have become ‘successful’ with high growth-high burn for so long that they just can’t understand any other reality. They dismiss any talk of running business in a ‘new’ way. They don’t believe that frugality, efficiency, focus, or profits are necessary. The delusion is so deeply entrenched that founders actually measure the value they have created per day. Valuation has substituted value, and values. The toxicity that we see as reported in the media is just the tip of the iceberg.

Can The Disruptors Be Disrupted?

In a 2012 magazine interview, Amazon boss Jeff Bezos is reported to have said, ‘your margin is my opportunity’, referring to old economy companies who assumed that their fat margins were permanent. The current lot of startups is fast approaching the same stage of evolution, smug in the comfort of raising money every six months. Are the disruptors ready to be disrupted? The late US academic Clayton Christensen would have loved to model this. Will a new lot of highly-efficient startups come to the fore, and say, ‘Your Burn is my opportunity’?

Anand Lunia is general partner, India Quotient. 

Views are personal and do not represent the stand of this publication.
first published: Feb 18, 2022 02:54 pm
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