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Are we staring at a startup bubble?

Are we staring at a startup bubble?

Sunday July 05, 2015 , 9 min Read

telescope
Image: The Hubble Telescope

Is the Indian startup space fast becoming a bubble? Let's take a closer look.

At the Goldman Sachs technology conference earlier this year, leading venture capitalist of Benchmark, Bill Gurley, expressed concerns to attendees of a possible bubble, caused by some over-valued startups in the US. His concerns were directed at the young companies that had almost magically reached over a billion dollars in valuation, which according to him, was largely fueled by investor fear of missing out (or FOMO, as the VC community knows it). He said that investors were making investments of sizes previously reserved for listed companies. Aptly framed, he said "a founder pursuing a $40 million IPO offering takes the process more seriously today than a founder raising $400 million in private capital."

Another reason for his concern was the presence of public market investors, like hedge funds, etc., investing in the space earlier catered to only by venture capitalists. Bill isn't wrong in saying that hedge funds, mutual funds, etc., have traditionally had a different investment appetite and strategy. FOMO, clubbed with this new blend of different investor classes and styles of investing, is perhaps what is fueling his growing anxiety of a possible bubble.

Benchmark has funded numerous industry-altering young companies since 1995, including Twitter, Instagram, Snapchat, and Uber, and around 250 other startups.

The Wall Street Journal’s Billion Dollar Startup Club saw at least 73 young private companies valued over USD $1 billion this year, compared to only 41 last year. Nearly half the investors, in some of the most invested startups too, were institutional and strategic investors, with Tiger Global (TG is an international firm that manages hedge and private equity funds) leading the pack with 12 investments in private billion-dollar companies. TG also raised the most money last year, $4 billion to be more specific, amounting to nearly 12% of all venture capital raised in 2014. (source)

Coming back to India, should this over-investing and over-valuing in US startups be of any concern to our booming Indian startup scene that is currently fueled by online travel, e-commerce retail and logistics, classifieds, online food ordering, radio taxis, etc.? Let's find out.

Firstly, one of those aggressive investors that Bill Gurley mentioned, Tiger Global to be specific, is also the most aggressive investor in Indian startups. In 2015 alone, TG disclosed investments in over 17 companies, investing in rounds totaling about $1 billion. Some of its investments include a $150 million round (Series H round), with other investors in Quikr, India's largest online and mobile classifieds portal. Then there was a series D round of $100 million in Shopclues, an e-commerce portal. We could argue that the exact investment exposure by Tiger Global is not known, and could be somewhat small. Or that perhaps these startups are actually worth the millions or billions they are said to be worth.

Tiger Global, among others, may have helped inflate a startup bubble in the US, but that is a significantly different market fromIndia; with a far more mature and aggressive investor community. Therefore, a race to get a piece of what is hopefully the next Google or Uber in the US might have led investors to try and outbid each other with increasingly sweeter deals to promising startups. But is TG’s strategy or tendency to overvalue being carried to India too?

In February, a reasonably well funded 'mom and baby' products portal, BabyOye, also a Tiger Global funded company, was acquired by Mahindra Retail for an undisclosed sum; in the hope of boosting their own brands, Mom & Me and Beanstalk, that have not been too strong online. BabyOye raised $12 million in 2013 from investors, partlyused to acquire another company (Hoopos.com). After an earlier round of funding in 2011, BabyOye spent extravagantly on TV advertising, using a former movie star in the ads.

Mahindra's acquisition in a bid to gain online strength seemed concerning, given that such a large group felt the need to acquire a small company with only 1500 followers on Twitter (now up at 2003 followers), to bring in the ability to sell online, even if the acquisition didn't cost them much. And at a time when a lot, if not most, of those products, were already available on Amazon and Flipkart. Did that make good business sense, or is e-commerce happening so fast that even the heavyweights of Indian industry are feeling the pressure to jump on this bullet train?

The US's popular classifieds service, Craigslist, only had one known investor ever; eBay. And that too not for too long. And was Craigslist popular enough? More than it perhaps ever expected. In comparison, a similar service in India, Quikr, has raised upwards of $350 million so far, and we can only wonder why. To buy and sell other companies, maybe?

And just then, in comes news of a possible acquisition of the nearing-a-billion-in-valuation Housing.com, by none other than Quikr. If the acquisition does happen, while it might be a progressive step for Quikr, it also leaves me wondering about the vision of these startup promoters, with growth strategies and a business direction that seem to be going all over the place. In many ways, this startup mania is turning out to be more of an exit ground for investors, rather than an effort to give the world its next great company.

Looking at the magnitude of investments themselves.Alayman could argue that 'the more the funding, the better'; after all, is there anything like too much money? Or for that matter, even a sky- high valuation. Imagine the pride and respect in your social circles when they read in bold, the value of your young company. But venture capital and investing isn’t as simple. If one funding round happens at a significantly high valuation, the next round becomes that much tougher to raise, as does getting a suitable exit for your existing investors. Of the $51 billion worth of private equity deals in India from 2000 to 2008, there have been only around 30% exits, according to a McKinsey and Co. report.

Over-investing in companies brings with itthe tendency to spend, whether it makes perfect business sense or not. As the world, and more importantly India, is getting increasingly interconnected online and socially, it is worrying to see the amount of money young online businesses are investing in expensive traditional media.Like Amazon’s catchy ad,or Flipkart’s loud and confusing oneshow, everyone’s on TV and on billboards, trying to push their way into the heads of prospective customers.

About 5-8 years ago, it was comparatively tougher for companies to scale. Building capacities, adding servers, fleet, manufacturing capacity, manpower, etc., took a lot more time and more money.

While salaries are much higher today, a lot of services and business functions can now be outsourced efficiently and effectively, allowing businesses to scale faster by focusing on their core business only and outsourcing everything else. The evolution of analytics, contractual manpower and everything in-between has also made it possible to have small numbers of people pull off tasks that previously requireda small army of people.

All this brings us back to “How do we make sense of the heavy investments into these still nascent startups?” And more importantly, will such heavy spends only on marketing guarantee a successful future for these young ventures? How much of the funding is being invested by these companies into listening to and understanding customers? Or on empathizing with problems customers are currently facing?

The notorious, multi-billion dollar Uber for instance, has an extremely light operating model, asset-light, limited overheads, and is highly scalable. But has it done anything to address woman passenger safety in countries where it operates? Not so far. Even Indian taxi aggregator Meru (2 years older than Uber) had a panic button on the app long before Uber decided to put one there. Uber waited till after unfortunate incidents occurred, before putting a feature that was so logical and obvious. So, if all that funding was spent on technology and marketing, why do customers still shower so much love on services that don’t feel the same way about them?

Between aggressive promoters and aggressive investors, the focus has gradually shifted from the customers’ best interests to the startups’ and investors’ best interests. Online food-ordering businesses too, for example, have built strong websites and apps, and have been advertising like there’s no tomorrow.But their internal processes remain shockingly primitive. Back in 2008, I had toyed with the idea of starting an online food ordering service, and had listed some concern areas that needed figuring out, in an effort to shape the idea better. While I eventually didn’t pursue it, online food ordering startups today, surprisingly still live with those same problems, despite the advancements that have happened in the interim.

The possible risks of overvalued and over-invested-in startups range from VC firms going bustto startups not being able to raise their next round of funding and/or being made redundant by other startups. And with every startup that shuts shop, it also affects a large number of other individuals and businesses (like logistics, etc.) that have come to serve these super-valued startups.

And finally, in an effort to boost entrepreneurship, India has considerably relaxed rules for listing startups in the recent past. But this bold step will take its time to see benefits, since there is poor liquidity in this space, and the experience in valuing these new age businesses isn’t anywhere near accurate.

Sky-high valuations of startups would make for interesting conversations with friends overa few rounds of beer. Butlack of clarity in funding and growth strategy in these heavyweight startups could be a matter of concern for these young stars of a new and emerging India. And India's big startup contributions to the world would hopefully be highly profitable, even more scalable, and most importantly, solely focused on delighting its customers.

About the Author:

Shrutin N. Shetty has been running A-Team Business Consulting (A-Team), a service that works as Growth Partners to enterprising young businesses in India and abroad, since 2012. He is a Computer Engineer, and holds an MBA in Finance, and is both a Design Thinker and a certified Quality Improvement Associate.)