Investors determine their investments in various companies based on a variety of criteria. Ultimately, the investor wants to see the startups scale and grow to be a large enterprise. In order to be able to do this, the company must have certain fundamentals right. Having sat through several hundred pitch sessions, these are some of the things the investors look at, often in the order below but not necessarily.
Like the industry
Do I like the industry that this business is in? Animal husbandry might be a highly potential industry but if I personally have no interest in the area I am least likely do go in there and make an investment. On the contrary if travel is something that I like, despite the fact that seven hundred people might be taking a crack at the same problem, I would still perhaps invest in the segment. All you need to do it take a look at the portfolios of most investment funds to see this philosophy at work. Our personal biases matter more than any data.
Like the market
I might like travel and I might think that there is a market for it everywhere in the world! Even so, if you were to start a tour service in Siberia, which by the way is underserved, I might not be necessarily jumping on board the bandwagon. We all want to be playing in the markets that we like, where we have connections and we have the ability to affect the destiny of the business. While data might point us in another direction, we would still gravitate towards markets that we like. Just go search for Siberian tour operators, you will find all 10 of them. And then you will feel so bad for not having undertaken the tour to Siberia, its gorgeous!
Like the founder
People invest in people because people like people. At the end of the day, all said and done we invest in people. To me Airbnb sounds like a dumb shit idea even today! If someone came to me pitching Airbnb, I would probably chase them away, unless… Its the energy and the charisma of a person that guides your judgement on whether to invest in them or not. We all get carried away by the founder, the pitch and the energy. Even the best of us has fallen prey to it. If you are not a likeable person, you are shit out of luck. There is no way that you are going to land money.
Like the business
What you are going to be doing comes after this. Invariably the business plan with which you would enter the business and the business plan with which you would exit it will not be the same. So, while we see what you are doing with your business it is how you are doing it which is more important.
Like the Modus operandi
Which brings us to the how? How are you going about doing what you are doing? Does it seem scalable. Ok it isn’t but would you flip to a direction that perhaps is? Are you mentorable? Would you listen? What happens when I poke holes at what you are doing? This will determine the anatomy of the relationship going forward once the investment is made. So how things are going to be done matters.
This has been my experience, would love to hear from others.
Have you ever heard how the PR folks are excellent spin doctors, this is precisely the story of Zoomo. The PR guys made martyrs out of a suicidal group.
In India, they wanted to create a platform for used car sales. Selling used cars is probably a staple business in most countries. You have to have really poor business acumen to not be able to sell used cars. Hell, if Olx can have used underwear being sold on their website, used cars should be a cinch.
Instead, the protagonists here failed to find sufficient traction and returned the money to the VC fund. Good for the fund. Bad for entrepreneurship.
The fundamental tenet of entrepreneurship is to keep trying. No company would have ever pivoted, had they given up and returned the money because ‘data did not support them’.
These guys built something, expected it to be a walk in the park, which it was not. They gave up.
This kind of entrepreneurship should not be idolized.
In a commerce class in school, I was taught that the point of a business is to earn a profit. Online retail startups have certainly caused me to question this notion.
Money, money everywhere; not a cent to be earned!
I find it quite amazing that there is immense investor confidence in a business that is unable to turn a profit even with millions of users on board. The best (perhaps the only) analogy for the current online retail scenario would be the airline industry.
When airlines started flying people in the 40’s; there was a lot of excitement about growth opportunities, and the loss-making nature meant that governments owned most airlines – more as status symbols rather than viable businesses. Eventually, private companies got into the game and operating running airlines as well. At the time, it was believed that with increasing connectivity between several cities as well as an increasing number of people using airlines, it was expected to become a viable business and a profitable business. But, as time progresses, we can see that this expectation has not been met. On every occasion, other reasons have been blamed for the lack of profitability in the sector: SARS, 9/11, hijacking, disappearing planes, and so on. Nonetheless, airlines have not been able to consistently turn a profit. This has resulted in many mergers and acquisitions, amalgamations, and even bankruptcy.
The only type of airlines that have been successful are the ones which have specialised in a very specific segment (corporate/business customers) or geographical region. The sad consequence is that one of the bigger airlines always acquires the profitable operation and tries to scale it, resulting in its inevitable decline.
Online retail, by comparison, is a far more recent phenomenon. Ideally, it should be compared with retail, which is what it promises to replace. To date, the success (in turnover) of online retail has relied on discounting. Walmart also relies on discounting, and by relying on any means necessary (paying extremely low wages, providing hard terms to manufacturers, etc.), they have managed to run a business that is highly profitable.
With Flipkart securing a funding of $1 billion, followed instantly by Amazon announcing to pump $2 billion, there has been a lot of commentary about online retail and the opportunities that lie ahead.
I think the point of a business is to create value, and that value creation results in profits. A retailer makes it easier for you to explore a multitude of products, compare brands and buy them. The online retail industry provides nearly the same service offering, along with the added convenience of being able to shop from home. The only difference is that the retailer sources the goods at a lower price than the one at which it is sold to you. Unfortunately, the selling price of products on online retail platforms is lower than their purchase price.
Is it not amazing how similar the profitability trends seem? Essentially, there is none.
US Airways Vs. Amazon
Different industries, same struggle.
Now, I understand that for certain businesses, in order to be profitable, you need to have a minimum base of customers. Social Networks are shining examples of how that works. Having said that, if you cannot make something work profitably with 20 million customers, how will ramping that number up to 100 million make any difference? Even if you do make a profit, the margins are going to be in the low single digit percentages. I find it hard to justify investing billions of dollars to generate a profit in the millions (and most likely tens of millions, and not hundreds).
This chart sourced from an IATA’s 2013 report shows how well the returns have worked out for the airline industry. Investor value destruction!
I believe the online retail industry is headed the same way, at least from the point of view of “all-under-one-roof” retailers.
Similar to the case of airlines, there is some oasis of hope. There are online retail firms, not unlike the airline industry, which specialise in a very narrow segment of product offerings. DollarShaveClub, Bonobos, NastyGal, Diapers.com, and closer home, Myntra.com, are examples of models that work well. Unfortunately, similar to the airline industry, these smaller firms, which will never have very high turnovers, are acquired by larger players, since it makes for a nice press release and helps keep investors at bay. At the time of acquisition, the larger firm tries to “integrate the business” and benefit from the “synergies”, and end up running the business to the ground. If they leave it alone, it may just work – it has shown success in its current form after all! This has happened time and again in the airline industry; it remains to be seen how it plays out in online retail.
So why the investments? Well, if we come back to Flipkart, the investors invest a large sum of money into the company because it furthers the company’s chances of an IPO. If the company is sitting on $500 million in cash in 12 months’ time and files for IPO, they will certainly be able to sell through the IPO and exit neatly. The CEO, on behalf of the investors, made clear the hopes that would be sold to IPO investors – A $100 billion valuation. So, even if they project a $20 billion valuation at the time of listing, which would be close to three times the valuation at which the funds were raised (if rumours are to be believed); as compared to $100 billion, it will still appear as though there is still more value to be unlocked. And as far the current investors are concerned, 300% in 12 months is not too bad a deal, is it?
If Amazon were to be used as a benchmark, the possibility of running an online retail business with decent profit margins seems remote. To add to that, Amazon itself has always been ready to enter into a price war with anyone who strays into its territory, since its investors seem quite satisfied even if the company posts a loss. Therefore, if profits ever exist, they will always be extremely low.
Will Flipkart be able to keep hopes up without turning a profit? Well, only time will tell!
I have always thought that investors had the easier end of the bargain. They had people coming to them to present their proposals, which they would evaluate based on their knowledge and accept or reject. All that changed since we put in place a Student Project Grant at VIT University, Vellore.
The premise was that there are a lot of engineering students who have great ideas that they wish to pursue but are unable to find the base seed money that they need to get off the ground. We thought if this support was provided they could get going. We had planned to support between 5 and 10 student projects. Bare in mind, we were just trying to stimulate the eco-system not profit from it!
Well… It was not all that simple. What was even more surprising was that we faced problems with sourcing quality proposals!
In the first round of call for proposals, we got 24 proposals out of which 4 were given the grant. In the next round we got 33 proposals, out of which we have still to approve even one. Looking at the odds we might have to seek a third round.
The first challenge was that most proposals although extremely great research projects but did not make good business proposition. They lacked any kind of validation (Technical, Consumer, etc.).
50% of the proposals were rejected for this reason alone.
Then there were proposals which were extremely great on paper, but we did not feel that the students would be able to execute the Project that they were proposing with the kind of resources, financial and otherwise at their disposal.
This ensured that another 35% of the proposals left aside.
Then can the few which seemed interesting enough. There was a possibility that those projects could see the light of day. The ability to execute was there, but we felt that there was a lack of sincerity. In the sense that I had my doubts that they would follow through on it.
This took out about 7% of the proposals.
With that gone, we have a very small basket of proposal that we are actually supporting. Not to mention, there is money left behind in the grant.
So the fun does not end there. So, we went like, this needs an eco-system boost and there needs to be more exposure and education about Startups and what is possible. We setup The Blueprints Club as a means of reaching out to students and giving them learning and support.
Guess what happens?
We get a dozen students who are actually working on a real product and even have a prototype ready! They are just too vary of trying to do a real business with it. I got to see some real amazing stuff, which may be ripe for commercialisation; if only the students would be willing to take a plunge! We tell them there is grant available.
At this point you get three categories for students:
Those who wanted to apply for the grant, but did not really bother about it
Those who will go ahead with a startup idea ONLY if they get the grant
Those who don’t want the money at all; all they need is inspiration!
This got me thinking, is this the same problem that most VC Funds face in India. People with ideas and probably capabilities as well, just lacking the inspiration or the courage to go out there and build a business!
Is this really the problem that confronts VC investors in India?