#9 Will Start-ups Slow Down?

More Tokenism, and Risk vs. Reward

When The Taps Turn

On the second working day of the year, Mamaearth became the first Indian unicorn of 2022, keeping up the momentum of last year, when 41 Indian start-ups joined the billion dollar club. These valuations are set by investors, when they negotiate the value at which they will put fresh capital into a business. Last year 36 bn. US dollars were plowed into Indian start-ups, part of a global flood of start up funding. The Economist reports that during 2021, Venture Capital firms (VCs) pumped 621 bn dollars into global start-ups.

I work at the bottom end of the start-up chain, one of some 10 to 20 thousand Indian angels, who fund businesses at a very early stage of their journey. Filling the vast middle between us angels and the gigantic Softbanks and Tiger Capitals of the world are seed-round investors and smaller VCs, of whom Tracxn lists 200 entities active in India. Early investors prime the pump, as it were; we help populate the universe with companies that show some traction, and the potential to productively use more capital. At the same time, we draw sustenance from the larger players, who may offer to buy our stakes. Even if a sale doesn’t happen, there is the thrill of marking up the value of our investments when a VC puts in a fresh round of money.

Unlike the price of shares traded on stock markets, these numbers are largely notional. You can sell listed shares on the market on Monday, and have the money in your bank on Wednesday night. Equity in unlisted start-ups gets priced only every year or two, when a fresh round of capital comes in; often, the incoming VC may not be interested in buying shares from existing investors. Over the last decade or so, investors have become increasingly comfortable with the illiquid nature of these markets. When unicorns are no longer the stuff of myths, it's easy to believe that you are backing the next one. 

And then, there is the flood of cheap money created by central banks, coursing around the world in the search for yield. Without this flood of funds, it is worth asking whether Uber would have survived 9 years, and hit a 50 billion dollar valuation, before it turned profitable in 2018. Our own Paytm attracted billions in funding - 1.4 billion from Softbank alone. It now has operations in fifteen nations, from  Canada to Tanzania, and Benin to Bangladesh. In India, it has removed the friction in micro-payments for hundreds of millions. But that customer satisfaction has not found its way to the bottom line yet: in the financial year 2021, eleven years after it was founded, Paytm clocked a revenue of 3200 cr, and a loss of 1700 cr. 

In a provocative piece called “Capital Is Not a Strategy”, William Janeway writes, “ the apparently limitless supply of low-cost capital” has led to the “proliferation of business models with little or no potential to generate sustainable, self-financed growth”. An academic at Cambridge, he is also associated with the private equity firm Warburg Pincus, so his is not a leftist critique of global capital. Rather he is asking the valid question of whether acquiring more capital has become the prime strategy for many ambitious entrepreneurs, “eager to spend ever-greater amounts of other people’s money to acquire customers, the goal being to emerge victorious in a winner-takes-all race.”

Do read the article, on Project Syndicate. Some of it resonates with many start-up pitches I attend, where a key part of the communication is how much money the business will raise from VCs in the next round, even before they have closed their funding in this round. 

Capital, however, is not always on tap. It is a resource, as Professor Janeway reminds us, “whose supply and cost are highly variable historically.” Since 2022 is likely to be a year when the money taps are turned down, his is a timely reminder, for both founders, and investors.

I shared the article with some fellow angels. One of them wrote back, “I like to ask founders what they will do if this round is their last one”. It’s a question I’ve often had, though seldom voiced. During the last week, I texted variants of this question to a few founders I work with. 

I guess none of them is going to be an Uber or a Paytm, because the answers were quite sober. Or maybe they were just indulging an unlikely hypothetical from an old guy who reads too much macro-economics.

One said - we need to look at better pricing, to adjust to increasing input costs; we must make enough money on every rupee of sales. Another texted, “I guess we would have to scale down growth plans. But, I also have a clear idea of how much debt we can take on, so that some growth can continue.”

Good entrepreneurs are hard-headed realists. They respond to markets, both the markets to which they sell, and those from which they raise capital. When funds are flooding capital markets, it makes sense to bank the cash, and grow aggressively. If growth capital slows, so will growth. 

For investors like me, slowing capital markets will mean working with lower growth expectations, and urging start-ups to focus on turning profits early in the game. It may also mean that ‘exits’, the ability to sell your stake to a VC, will come less frequently. IPOs may be too far down the line for early investors like me. Besides, the near-halving of the Paytm share since it was listed in November is a warning sign. I shall take to heart advice from Professor Janeway - if VCs “are prepared to liquify original investors’ holdings at a multiple of cost that is usually only available through an initial public offering or a trade sale, a partial seller would have to be extraordinarily greedy to refuse the offer.”

Reminder to self - don’t be extraordinarily greedy.

Meal Tokenism

UP electioneering underlined how significant tokenism and photo ops are to the Indian politician. 

Untouchability was abolished in 1955, but nearly 70 years later, Dalit rights are still a potent issue. Senior BJP politicians in UP resigned from the party, in protest against their government’s neglect of backward classes. Yogi’s government had to do ‘something’. 

This ‘something’ consisted of dining out at the homes of Dalit families, camera crews in tow. 

The fact that this is seen as newsworthy only reminds us of how rare an event inter-dining between the upper castes and lower castes is for our dear leaders.

The photographs also reveal how little thought went into crafting the optics. In one, the visiting diners had paper cups for their water; tokenism is all very well, but their dharma would be severely offended if they drank from the metal tumblers the hosts use. The food was served in the foil covered segmented trays that you find in roadside restaurants, or at large banquets, which makes you wonder about whether Dalit hands were allowed to touch their food.

In 2022, tokenism is well and so are inter-dining taboos.

My Risk, My Reward

Since Christmas, the number of Indians taking domestic flights more than halved, from 4 lakhs a day, to 1.67 lakhs on Jan 14th. Airlines cancelled flights, to optimise the load per trip, but this is a moving target, and the average number of passengers per flight slid, from about 125 to 84. 

This is tough for airlines, already reeling from their losses of the last 2 years, but the reason I bring this up is that the drastic pullback in travel, and possible exposure to COVID, has come from the spontaneous decisions of millions of individuals. It did not require mandates from on high.

Each of us has a different risk profile. I may be risk averse to physical threats, but a reckless gambler at Diwali teenpatti. Each of us will assess the virus risk from taking a flight differently, based on the information we have gathered on COVID transmission, on our vaccination status, and the dread we have of falling sick. Our need to take that flight also varies hugely - if you are headed home or need to travel to a sick relative, you’re less likely to cancel a flight; if you had planned a few days on the beach, or decided to meet a business associate after several months, it’s easier to defer.  

The balance we find between risk and reward is acutely personal, and impossible to model. Lockdowns and blanket bans rob us of the freedom to take such decisions for ourselves, deny us the agency that is at the heart of being human.

The government was stung by the political and economic repercussions of the ill-considered lockdowns of 2020. I hope the retreat into hands-off mode is a lesson learned, and a small step forward for individual freedom.