Way back in 2008, we experienced, researched and tried to understand the subprime mortgage crisis. Probably not every one of us had any interest in the real estate business of the US. More so, none of us were interested in how much loans were being taken by customers in the US.
Just then, the world’s fourth largest investment bank Lehmann brothers filed for bankruptcy. It initiated a series of falls across the globe for a long time. Depression was a global phenomenon.
It’s been seven years since that financial meltdown, and investments have preferred startups. Since the world has emerged back from the last meltdown, start-ups have flourished. More so, tech startups.
These start-ups have seen early success with valuations upwards of $1 billion. And that’s given them a name – unicorns. Among the popular companies that qualify as unicorns since the last bubble, are Uber, Xiaomi, airbnb, Snapchat, Flipkart, Pinterest, Dropbox, Spotify, Square, Jawbone, Slack, Snapdeal, Lyft, Olacabs, Evernote, GitHub, Quikr, Zomato and a list of several more.
The list of billion-dollar plus companies is a long one. And to avoid missing out of the rush, investors have heavily invested funds in emerging tech startups. Turns out, not all is really well with this arrangement. In India, we saw a huge wave of investments into Housing.com. Then for various reasons, the company was the most sought after news. Today, there seems to be an uncertain calm. In August, it was reported that Housing would complete the layoff of about 600 employees within 3 months, due November.
According to the report, the move was a part of a restructuring plan with a three-fold rationale.
Earlier in May, Snapchat CEO Evan Spiegel, acknowledged that the tech bubble is in fact real and it would burst.
Recently, we read reports around Zomato’s plans to layoff 300 employees, or nearly 10 percent of its staff. According to reports, the company will be focussing on enterprise and full stack.
In the background of many similar announcements, we spoke to Bharat Ramnani, Associate Vice President– Valuation & Advisory Services at Aranca, a global research and analytics firm.
How real is the tech bubble?
I think the tech bubble is very much real and many of the funding deals we see today are at valuations that defy logic. There are close to 142 companies in the ‘Unicorn Club’, nearly 50 percent of which are 2015 entrants only, making it a new normal in the VC space. While many of these companies have great ideas and potential, the euphoria has surged their valuations to unsustainable levels and the ‘Fear of Missing Out (FOMO)’ syndrome has led investors to play along.
A large part of the problem is also the over-simplified way in which outside world looks at some of the deals that happen in this space. The post money valuations of various funding deals that we hear off have to be looked at quite differently. The actual money invested is usually a fraction of such valuations and is backed by much superior rights. The tendency to consider these valuations as proxy for actual worth of the business further adds fuel to the fire.
One thing to also note is that the bubble is largely limited to private markets with Venture Capital funds carrying the maximum exposure. Unlike the dot-com bubble of 2000, it is unlikely to erode billions of dollars of retail investors’ wealth.
Would it affect us in India?
Except for some fallout due to negative market sentiments, the tech bubble burst is unlikely to drastically affect the Indian markets. The startup ecosystem in India is still at a very nascent stage and those most exposed to these high-priced private investment rounds are foreign funds with deep pockets and high risk appetites. Further, nearly all these investors have hedged downside outcomes by securing additional rights.
Having said that, despite no direct consequences, a bubble burst will definitely give a jolt to the growth of Indian startups, much like the aftershocks of a big earthquake.
We are currently witnessing a strong surge of VC investments in India. In 2015 alone, Indian startups have received over $5 billion in investment from 490 investors. It has never been as easy for an Indian startup to raise capital as it is now, and this has played a key role in developing the start-up ecosystem in India. This phenomenon is bound to change, if and when, the bubble bursts, which may slow down this growth considerably.
Are Indian ecommerce businesses such as prone to a crash any time soon?
I think there is a need to differentiate between the likelihood of a company crashing and few investors losing their money due to eventual correction in the valuations. None of the companies listed above are likely to crash or go completely out of business, and there are many reasons for that.
Firstly, they have grown too big and acquired a massive scale that gives them significant economies of scale and competitive advantage. Secondly, their customer solutions and business models are innovative and have demonstrated success in the Indian market. Even the often criticized model of offering discounts to acquire customers is not bad and has proven to be successful globally. Unlike brick and mortar players, e-commerce companies do not have to invest heavily in infrastructure and the same capital is used for offering discounts to expand the customer and revenue base.
However, one can certainly argue if Flipkart’s commercial success makes it worth $15 billion or Ola’s market acceptance makes it worth $5 billion. The post-money valuations of these companies continue to spark debate and may not reflect their fundamental value. As the tech bubble bursts, the paper wealth of founders and investors can get affected but is not likely to drive these companies out of the business.
What are factors that determine success in the new wave of prominent tech startups and unicorns?
Typical success factors such as a good team, strong product, clear understanding of customer needs, vision and agility continue to be important and relevant in the current environment. However, here are some specific tips I would offer to founders in the wake of this wave:
Stay focused on the problem you are trying to solve and don’t get swayed by your paper wealth.
Raise capital if you need it and not because of what it will make your company worth.
While the money may be easy, give it due respect and spend it judiciously.
It is okay to burn cash for acquiring customers, but be clear on how and when you plan to transition to profitability.
Be open to dilution if your vision is to grow big. This is what made Flipkart different from Infibeam.
Work with your investors, they are your partners.