Are we building the right kind of companies?

It’s been two years since WeWork co-founder Adam Neumann gave what’s become one of the defining quotes of this unicorn-fuelled era of venture capital: “No one is investing in a co-working company worth $20 billion,” he told Forbes, referring to the company’s valuation at the time. “That doesn’t exist. Our valuation and size today are much more based on ‘energy and spirituality’ than it is on a multiple of revenue.” That he got away at that time with this crazy statement was more a reflection of the prevalent greed fuelled by heavy-funding rather than anything else. But what eventually happened at WeWork is for everyone to see. The end result (Blow-up of $39 billion of the company’s value, roughly the value of Delta Air Lines Inc.) was a watershed moment for Silicon Valley.

 

For years, investors salivated over all-powerful founders who promised disruption and demanded control. After WeWork’s spectacular flameout, investors have grown sceptical of the model. The language used to describe the company in its failed IPO bid was widely derided. The prospectus was dedicated to the “energy of we,” and the company’s mission statement was to “elevate the world’s consciousness.” Seriously? It is a real-estate play at the end of the day!

 

Please don’t get us wrong. The article is neither about WeWork or its valuation. WeWork has been a disruptor in their space and deserve all the respect. The inherent value is still there, whatever the underlying number might be. What we are talking about is the ‘Grow at any price, whatever the consequences’ model’.

 

We might be fooling ourselves if we think that it is only Western phenomenon. Let’s make the discussion a bit more interesting & a bit more personal. Let’s look within us, our own ecosystem. India has had the perfect concoction for a number of years now – an abundance of capital, more than 400 million internet users and a thriving entrepreneurial ecosystem.

 

Whether it’s mobile payments or food platforms or education learning apps, almost each segment has seen a lot of entrepreneurial activity. Each startup in these verticals today faces dozens of competitors in their category. Good news is that many of these sectors are beginning to see traction in India, which has resulted in investors backing a large number of similar players. This has meant more marketing spends; to create awareness among consumers and stand out in a crowd, many firms are heavily marketing their services and offering lofty cashbacks to win users.

 

But even as more VC funds (new-age Asian investors like Baidu, Tencent, and Softbank, who had made a lot of money in the consumer tech sector back home), many with bigger checks — arrive in India, the focus has shifted to growth and winning at any cost. But the financial performance of startups remains a cause for concern. What is especially troublesome for these Capital rich, profit starved startups is that there is no clear path for how they would ever generate big profits.

 

Indian tech startups secured nearly $14 billion in 2019, more than they have raised in any other year. This is a major rebound since 2016, when startups in the nation had bagged just $4.3 billion. The eminent recipients of a slug of capital were the likes of Flipkart, India’s largest e-commerce player, ride- hailing company Ola, digital payments firm Paytm, budget hotel chain Oyo and later on the food delivery ventures Swiggy and Zomato. Also a swath of other early stage startups sucked in too much capital too soon.

 

It’s clear that Indian startups have done a great job of raising capital. The worry is that majority of these businesses are still losing tons of money and some of them are doing so on every transaction they make. Billions of dollars have gone into creating businesses which are clocking massive losses compared to the revenues generated by them. Has over capitalisation led to the wrong kind of company building? In the quest for relentless growth fuelled by discounts and promotions, are these companies really focused on how they will become financially independent. What if this private capital were to run dry? The combined losses of just five of India’s most funded and celebrated internet firms—Paytm, Flipkart, MakeMyTrip India, Swiggy, and Zomato—during last financial year was more than $1 billion.

 

There is this well publicised case of a highly-funded hyperlocal delivery startup. Similar to other venture capital-funded firms, it has lost a lot of money. That is, I guess OK. However, what might not be OK is the fact that the company lost 222X more money than it’s operating income! It is mind-boggling. How does one explain spending Rs. 225 to earn Rs. 1? As a delightful irony, it earned almost 4 times more by trading in mutual fund & interest deposits than from its core business!

 

Are we building the right kind of startups? When an ecosystem is driven by investors and valuations, where raising a new funding round is of prime importance, companies fall into the trap of dressing up their pitch decks for the next presentation to scoop in the millions and billions of dollars. It’s like running on a treadmill, if you stop, you’ll fall head on. But these behemoth startups with deep-pocketed backers are creating a crisis of sorts for new, upcoming ventures. If a VC has taken an $800 million bet or $2 billion bet, they are not going to suddenly shut the tap off. Because of significant follow-on rounds required for large companies, there is a direct and negative impact on money being poured into the small, early and new ventures. They’re not getting funded as much as they should. Hence the seed funding is taking a hit which ultimately will lead to narrowing of the good-quality funnel of startups.

 

It is safe to say that it now is the time to course correct. 2020 is going to be a critical year for the highly capitalised startups. What happens to them will have a significant impact on the overall ecosystem.

Ashish Bhatia, Founder & CEO, India Accelerator