Startups: Part 5 – Down & Dirty of the Money Game.

From the attention the Startup series has been getting I’m a’thinkin’ that is topic is one of interest to say the least. Why would it not be the case? With successes that can be stacked in the “wildly successful”, “mind-boggling”, “beyond wildest dreams”, categories, everyone who is anyone is part of the Startup ecosystem. And the side we see, or rather what is talked about is the successes, not the glaring failures. These failures, one has stated before, affect the entire ecosystem, from promoter, to investor, to employee, to the client, to the regulator. Take heed then people, for when we say successes, we usually mean, how much money the Startup has attracted by way of funding.

Is it time then to talk about the down and dirty of Startups? Methinks it is, and therefore we shall. So should we be calling this Startup 101? That’s more appropriate, so the nomenclature sticks. Startup 101 it is.

I used to do this rather popular checklist (gleaned from various sources) for traders back in the day called “19 Rules for Traders”. Since this article, blog or “piece” as the cognoscenti are calling it these days, is not about my days as a prolific trader, you only get a glimpse of said rules, and that too with the intent of giving you an idea of how this “piece” is going to develop. You may choose, basis this glimpse, to check out any time you like.

So then the “rules”. Follow The Trend – The Trend is Your Friend, Let your Profits Run, Cut your Losses, Never Average a Losing Position, and so on. I’m sure some of the bright lot reading this “piece” will see the proverbial lights coming on and say, these rules for traders can be extended to apply to investments in Startups. True dat my friend, absolutely.

Startup 101

Rule # 1 – Startup success is not measured in the money attracted by way of funding.

I can see several in the audience going, really? Well I’ll be blowed, didn’t so and so startup get an obscene amount of money just recently? Didn’t so and so, well-known PE/VC/Investor pump in millions into so and so startup? Yes, money did move from one place to another. Somebody, usually the promoter/s got rich quick, because a certain other someone, took a “punt” on the future success of said business.

Rule # 2 – The “Punt” isn’t the Measure of Success – Profits Are.

Really? Success has two parts init? Success for the Promoter is getting in new cash, in exchange of a high valuation of the Promoters initial investment. Success for the Investor, that poor sod/s, who took the “punt”, depends on profitability.

Again, really? Well, this time I have to say I’m rather confused, therefore I am compelled to give a “well maybe” answer. The grounds for my defence on this, the measure of success, comes from my education, from my experience, and from prudent business practices. Prudent business practice says, Profitability is the only real measure of success of a business venture.

So then, should we boldly be examining the success of the investment in terms of the profits the business generates, or should we declare success of the investment based on the “exit” or “divestment” to some other investor, who is induced to come in at an even higher “premium” to the initial set of investors, despite the fact that the business is not yet making any real profits?

Logic dictates a resounding NO in response, but we have thrown all investment logic out the window by now have we not? Heck, we are Investment Gurus, we are acting in a fiduciary capacity insofar as we are taking substantial monies from a group of investors, and making all these substantial investments in ventures that have not turned a profit, and are not expected to turn a profit in the foreseeable future. This is the good old “Cash Burn” game where we are perfectly comfortable in “burning” investor cash (not mine, someone elses cash), all in the hope that something will change, and miraculously profits will flow, just like manna from the heavens.

Ah, not liking this are we? Profound arguments and justification will emerge at this stage, stating “Sumir, you’re so clueless”…. cash burn is essential for marketing expenses, for development expenses, and so on. Well yes, but what percentage of our money (oops I forgot, not ours) are we burning and when will this burn stop? Yet other arguments will emerge and they will say, this is not really about unit profitability, but look at the bigger picture, we are getting points of presence, we are getting substantial data, we are understanding customer behaviour.

My dear friend, yes, yes, yes, to all arguments, but lets not forget whose money are we playing with. Oops, we kinda forgot that tiny detail, didn’t we?

Let’s deal with data then, damming data. Just how many of big-ticket investments are in the money? Is Ola making money? Is Flipkart making money? Is Uber making money?

What do we do when we have a competitor? We buy them out, we merge, we increase market share, we buy out competition? What happened to Myntra? Didn’t they merge with Flipkart? Is the merged entity making any money? Why did they merge? To compete against Amazon. Is Amazon making money? Read this, Amazon India has doubled its India losses.  We are told that Amazon globally has increased its losses four fold. Now read this rather interesting fact. Losses of Flipkart, Amazon and Snapdeal would have allowed ISRO to go to Mars 24 times.

So who has been investing in these companies? In some way, shape or form its an investor. Arguably these are HNI investors and have invested in a fund of sorts. Is the fund making money on these investments? Not meaning to pick on a man I have tremendous respect for, let’s look at Ratan Tata’s investments as a VC/PE investor.

Loss-making Enterprises

RNT Losses

Valuation Game

w-tata-investment3

Valuations are Rising Despite Accumulated Losses?

So if we are to believe what we read in the papers, we are told that each time RNT takes a “punt” valuations jump. Jolly good this, but what basis? Why this spike? Defies the principle of prudent business practice.

I’m of the opinion that, the virtual world, or virtual economics has left the good old brick and mortar economics way behind. It is no longer about unit based profitability, its purely notional. The trick then is to agree a valuation between the Promoter and Investor. I know my math, I’m actually pretty good at it, but I daresay valuation math escapes me completely.

Glaring Examples

Ola and Uber have made my commute that much easier, in so much as I don’t have to “request” a “Kali- Peeli” (Yellow and Black) to go from point A to point B. I just pull up the app, book, get a fare estimate, complete ride, pay. Now let’s take a look at the business model, if you’re not in violent opposition to it.

The model is rather simple: Rate/Km is established, Rate/Km is paid x times the Km covered. Fare is then shared between aggregator and driver/owner. Incentives are paid (I’m hearing incentives are going or gone). Drivers/Owners who were on to a good thing, are now thinking, hey it’s not as appealing as it was portrayed, or when this started off. Owners/Drivers have taken loans, have EMI’s + maintenance + fuel costs + driver wages to pay. The initial math isn’t quite adding up, so there is this growing discontent. The “Kali=Peelis” have lost out to the Ola and Uber wave, so they are reeling too. So money isn’t being made as envisaged, not by the Owners/Drivers, nor by Ola nor by Uber. Question then. Who exactly is making money at the present time? Seems to me, nobody, or not nearly as much as projected. Yet, Ola has received funding of around USD 1.5 Billion and the current valuation is running at USD 5 Billion give or take? Is there money to be made, on an investment of USD 5 Billion? I’ll be damned if I can predict, though I have really serious doubts, much like Macbeth when he fights his doubts about the witches words, as Great Birnam Wood seems to move to High Dunsinane Hill.

The whole point to my mind is simply this, who is going to be left with the baby? Isn’t that what happened and continues to happen when markets are overheated, and stock prices are sky-high? The Smart Money sells, and the ones holding the short straw are the lay investors. My feeble and rather unsharp mind seems to want to draw parallels here. Sky high valuations, huge monies invested at sky-high valuations, where is the exit, and if and when there is an exit, who will be left with a broken business model, who will be licking the wounds, what will happen to the thousands of stakeholders (investors and cab owners alike). Ever heard of “caveat emptor? Will this lead to some sort of bailout? Will the government have to step in at that point? If it is the government, who bears the brunt? Isn’t it the taxpayer?

Yes, I paint nothing short of a doomsday scenario, but simply because I can’t get my mind around to understanding how monies will be made, at least in the traditional sense of the money game.

Call me slow, call me dimwitted, call me anything but stop for a few moments, if not more and think rationally. It’s not looking good.

Don’t get me wrong, the Private Equity and Venture Capitalists are a great source of Risk Capital, and do work and make available funding for projects, in most cases, where the business model does not allow for funding through traditional models. At some point there needs to be a soul-searching, a pragmatic assessment of where all this money is going and what will become of these humongous sums, and perhaps some degree of regulation around the valuations, the eligibility and so on?

Where does VC cash flow to?

The maximum VC cash goes to technology, healthcare and media. This seems rather skewed does it not?

3 of 4 Startups Fail

By now it is well established fact that 3 out of 4 startups fail, the data coming out establishes this fact. If that is indeed the case, shouldn’t we then be questioning certain well established appraising techniques? How are startups appraised? Is it on the basis some hot technology? Is it on the basis of the degree of sincerity and capability of the Promoter? It is market potential? More often than not, the assessment swings basis the quality and pedigree of the Promoter. Yet startups are failing all around.

I can’t say I’m a Capitalist, I can’t say I’m a Socialist, I guess I’m somewhere in between, but I can say this, I am a firm believer is the older and perhaps dated models of doing business, from assessment and appraisals, to how we run businesses. I would only urge that, we are judicious in defining what success constitutes.

Next up: Why do Startups Fail?

If you’ve been reading the series, you will find that I’ve been associated with Startups in some way, shape or form like forever. Instead of merely using Google to pull out reasons why Startups fail, what I’m going to do instead is reflect on my own startups and those I’ve been closely associated with, and try to analyse the reasons for their failure, and perhaps suggest ways and means, such disasters can be averted. It’s a rather ambitious and maybe audacious attempt, so let’s see how this pans out.

 

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