The Inevitability Of Doom – When Hype Overtakes Fundamentals
Last year in conversation with a business leader, and now marquee startup investor, the topic turned to investors in Mumbai missing out the startup bus. The assessment was that the bigwigs sitting in the financial capital saw the whole startup investment ecosystem as bag full of air, and now that valuations are touching the skies, they are experience a mix of regret for the decisions past, and FOMO for the opportunities now. With due respect to the gentleman in question – who I immensely respect – while I do agree in principle with him, the argument, to my mind, must be far more nuanced than this.
Let me illustrate my point by talking about my favorite bugbear in context of investment discussions. So often in my experience, as I have sat across the table from startup investors – both for my own fledgling ventures back in the day, as well as for my clients over the years – the question inescapably encountered is: ‘where else has this been done before?’. And God forbid, was the answer that this was a first-in-the-world innovation, the deal was DOA, no matter that on account of professional and social niceties the meeting did go on till the end of the appointed hour. This has been the source of the adage – ‘the next Facebook will never come out of India’. Sure, there may have been exceptions, but this was overwhelmingly the rule of the game. And this rule has been one of the key reasons why we are where we are.
Venture capital is about innovation, and about promoting, at an inceptive stage, ideas that have the transformational capability, but likely no market. It is about letting these ideas, and the entrepreneurs who created them, scale without the worry of initial losses so that the market can be developed. It is also about the skill and ability to create a portfolio that in the aggregate succeeds but can suffer losses in case some of the ideas are unable to catch the fantasy of the market and the consumer. However, at the end, any of these ideas need to be able to be viable and profitable ventures in the long run. A loss leader strategy is the go-to play for market capture but it cannot be a sustainable long term fundamental.
And so, we come to what has come to pass in India. Let me caveat what I am about to say by acknowledging that off late, there have been select funds and investment professionals that have taken smart bets with innovation, especially in emerging tech, which has infused a breath of fresh air into a stale echo chamber. However, overwhelmingly the playbook in the Indian investment ecosystem has been built around picking up ‘safe’ copycat ideas from other markets, with imaginary moats built around them (whither Flipkart, whither PayTM, and whither so many more) and pumping insane amounts of money into them in sequential rounds in form of what can only be described as a pyramid scheme. Most often this has resulted in the last man (or woman) in the chain holding an asset not worth a tinker’s dam. While Walmart (and Microsoft, Tencent, et al) or Rocket Internet can digest these losses; or a Reliance and Tata can buy the market for a steal, what about the retail investor?
While the government has done its bit – as it should have – in creating an ecosystem for startups to access the public markets, while protecting retail investors at the IPO stage, what about post-listing? And not just for the times when the bears come calling, but also overall in the long run. The hype built around some of these fundamentally hollow companies has been mind-boggling. While in informed and expert circles, the interest has been around the listing bump – ironically driven by the hype – my observation in context of ordinary retail investors has been of them suffering inexorable FOMO. What that has meant is that while the smart ones have made listing gains and exited, it’s the retail investors who will now be last in that chain. Does the recent hullaballoo around a ‘celebrity’ founder’s expletive ridden audio shenanigans ring a bell? While the governance, ethics and founder capabilities are a topic that are in need deep discussion as well, let’s leave that for another piece. The key point in this context is the scramble to scrape massive capital together to ensure substantive allocation, and then exit for listing gains amongst those with access to capital. And who do they exit to? The answer lies above.
In the last few months, but most pronounced this week, we have seen celebrated listed startups crash to dramatic lows – and remain on a downward trajectory. While we have seen the founders, and their PR machinery, immediately jump into action, the question of fundamentals has not once been addressed. Not in one of these cases do we see an acknowledgement that the valuations were overstated. Not one of them has been able to lay out for the ordinary investor an uncomplicated path to profitability for their publicly listed companies.
There are millions of hardworking businesspeople in this country who have painstakingly created profitable businesses. Thousands of them have built products and services that are innovative and transformational. There is an untold number waiting in the wings but lacking capital with ideas and businesses that can be world beating. And there are listed companies for all to see that meticulously work quarter on quarter to scale revenue and profits and deliver dividends for their investors. There is no excuse for these companies to be eroding investor wealth even as their founders and investors swagger away with their coffers brimming. Making money is no longer the evil that it was portrayed to be, and I remain a great proponent of wealth creation, but that is no excuse for offloading dead assets to the general public, and causing them losses which many might not be able to recoup from.
The question that needs be asked here is how to structurally address the problem of fundamentally flawed businesses listing on the back of funding and hype. In today’s magnificent world of whataboutery, there will be vested interests who will try to obfuscate the real issue by ranting that people who do not understand the startup funding ecosystem are trying to kill the market. However, far from it, not only do a lot of us understand how this ecosystem works but are also fairly well clued into the financial and business world as a whole. And more importantly, the discussion is not about preventing startups from accessing the market, but rather on how businesses with zero fundamentals and no path to profitability are prevented from using high decibel marketing and PR to obfuscate the truth.
My suggestion is that there be a structured framework brought into place by SEBI whereby as part of their IPO process, loss-making companies are required to demonstrate a path to profitability. Such a framework must include a nuanced process by which companies that fail to become profitable in a reasonable timeframe are either asked to compulsorily buyback equity from investors or are otherwise penalized in a manner that has a substantive impact. It is necessary to reiterate that this needs to be nuanced because various factors are at play, but it must be fair to investors, and must ensure that key management personnel face the music in addition to the company.
