College friends start a tech company.
Website has good ‘traction’, ‘user experience’ and ‘users’ in industry.
$50 Million in Series-A funding secured from leading VCs.
Company valued at $500 Million.
Expands to 10 cities.
Changes in senior management take place.
Business model pivoted.
Operations reduced, employees cut down, salaries reduced.
Users lose faith, investors lose money.
Company IPOs, gets acquired or goes into oblivion.
This is an amateur description of the fad, we call ‘start-up’ in India.
I passed my Chartered Accountancy exam last year, which made me eligible to sign balance sheets of companies ensuring true and fair view of their data. However, keeping in mind of the recent developments in the Indian internet industry, I find that all the sleepless nights I spent studying and gaining knowledge on how to value a company, how a rational investor should think and how the financial markets work, were completely baseless.
Some of the so-called unicorn companies show a trend; one of the largest service providers for hotel room aggregation in India does not actually own any rooms, one of the largest ‘e-retailer’ in India has no actual stock of its own, the biggest ‘taxi’ service actually owns no cars. Figuring out how these companies are valued so highly remains a mystery. The companies claim to value its technology. If this were the case all companies in the industry, with the similar technology would have the same value. However, that is not the case. Companies being valued based on their customer reach is illogical. Having a huge customer reach will not necessarily guarantee you revenue. There is no guarantee. Throughout my course I had learnt about most of the ways of valuing a company- the discounted cash flow method, the intrinsic value method, the dividend and growth method etc. But these companies seem to follow none.
None of the big e-commerce companies in India have posted a positive looking balance sheet since inception. Yet, they are showered with more and more funding. There is no outflow of net cash, there is no dividend, yet the promise of a bright future keeps the money flowing. The sole theory which might explain this is that of F-O-M-O, the Fear Of Missing Out. This make-belief concept has investors fearing that they will miss out on the next Facebook. Rationality, meanwhile, has taken a back seat.
The idea should be to build sustainable companies instead of just sustainable products, to generate positive cash inflows instead of just positive user experience, to create societal value instead of just market value. The way forward has to be concentrating at the bigger picture rather than concentrating to receive funding!
For my love of analogies, I would like to portray the whole situation between the said companies and their stakeholders (customers, employees and investors) in the form of the final game of a tennis match. This would try to serve as an example to sum up the stages of Internet companies in India.
Companies with a ‘cool’ appeal serve its users with a new age product at a low cost. Everyone gets hooked to their uniqueness and freshness. Users get inexpensive goods/services and employees get fat packages.
Stakeholder: 15, Company: 0
Investors get excited; pour in more money with lesser stakes. Companies volley users with tremendous discounts and smash the media with the valuation bubble.
Stakeholder: 15, Company: 15
The owners go on back foot and start liquidating their ownership in the hands of Series A, B, C investors at premium price. The seed investors sell their shares to the next series investors. This leads to bigger offices, bigger names and leads to bigger discounts.
Stakeholder: 15, Company: 30
By now, the company is completely in the game. A brand name has been created, market captured and companies acquired. Investors start feeling the heat and getting restless; they ask for returns. To return the ball to the investor’s court, the company starts losing its employees and reducing the discounts.
Stakeholder: 15, Company: 40
The company has served throughout the game so well, the public is ‘anticipating’ an IPO now. The investors create an image that this is going to be the biggest ever IPO and they see hope for their returns. Costs are cut in hope to put up a green balance sheet. IPO released, the excited public buys shares at a premium. This premium is a perfect smash that compensates for all the discounts ever given to them. Investors exit with hefty returns and founders are happy with salaries. If the market becomes a monopolistic market, then there is hope for some returns to the shareholders and this means 2% of the companies shall control 98% of the market. The small companies are either acquired or over-shadowed. If the market does not function like this, then the shareholders become like those of Jet Airways where there has been no dividend ever received since IPO and only way to earn is through speculation and trading.
This is actually how the most start-up stories end nowadays.