The rise of Indian Start-Ups | Understanding the valuation Game | Shivaji Hari

In recent years, India has witnessed a surge in the number of startups. Companies like Flipkart, Paytm, Oyo, Swiggy, and Zomato have become household names, and have received millions of dollars in funding from investors. However, despite the massive investments, many of these startups are still struggling to turn into a profitable venture.

Unacademy, a startup that was launched in 2015, is currently facing losses. Similarly, Paytm, which was started in 2010, has left its investors at a loss of 70%. Other startups like Swiggy, Flipkart, Freshworks, Byju's, and PhonePe are also facing similar challenges. This begs the question, how are these startups able to raise millions of dollars in funding despite their huge losses?

The primary focus of any business is to make a profit. Yet, even though they are facing losses, Indian startups have received staggering amounts of funding. In 2019, Indian startups received $13.2 billion in funding, followed by $10.9 billion in 2020, $35.2 billion in 2021, and $24 billion in 2022. Most of the amounts raised are burnt as expenses. Of late startups have found it difficult to raise funds and have started cost cutting. This points towards an alarming trend, where a significant number of people are likely to lose their jobs while startup founders are earning crores of rupees in salary.

So, how are these startups able to raise money despite their losses?

To understand this, we need to take a closer look at the startup ecosystem in India. Let's consider the case of Flipkart, which was started by Sachin Bansal and Binny Bansal in 2007. At that time, the concept of startups was still new to India. Sachin and Binny started Flipkart by selling books, much like Amazon. However, the early years were full of struggles.

By 2012, the startup scene in India began to change. Many startups had emerged, and companies like Paytm and Oyo had secured large funding. By 2016, things started to get even more competitive, and the Indian startup ecosystem began to change rapidly. This is where the startup bubble, a game where things often look different from reality, started to gain pace.

Most startup founders talk about values, good products, customer satisfaction, and problem-solving in their interviews. However, the reality is that in most of the cases, startup founders and their investors know that their startup will never be profitable. So, what is it that they are hiding from the public?

In the initial stages, startups raise funding for three reasons - seed funding, product development, and product testing. The seed funding is typically raised from friends and family or angel investors. Once the product is developed, a lot of money has to be spent on testing it, which is again raised from friends and family or angel investors.

However, the game changes when a venture capital (VC) firm invests in a startup. In this scenario, startup equity comes into play. For example, suppose two founders start a company with 900 shares, each owning 500 shares. They raise 1 crore rupees by offering a 10% stake in their company to an investor to whom a high growth and promising story is told.

This means that the investor receives 100 shares, and the founders and early investors own 900 shares. Suppose the startup's valuation increases to 20 crores after the initial funding round. If they raise another 2 crores in the next funding round, the startup's valuation increases to 40 crores, and the investor's 100 shares are now worth 4 crores. But why does the valuation increase in each round? The key lies in story telling.

Startup Valuation

In the business world, the valuation of a company is often based on its profits, assets, and discounted cashflow. However, startup valuation is based on other factors. There are three main factors that determine startup valuation: active users, potential growth, and GMV (gross merchandise value).

Active Users: This includes daily and monthly active users, which can be measured to determine the popularity of a startup.

Potential Growth: Investors look for startups that have high growth potential, which can be measured through various metrics such as revenue growth rate, market size, and competition.

GMV (Gross Merchandise Value): This is the total value of goods or services sold by a startup. In the case of a startup that sells products online, the GMV is calculated by multiplying the total value of goods sold by the commission earned by the startup. For tech startups that do not sell physical products, daily active users or growth potential is used to calculate their valuation.

Let's say you have a startup that makes a mobile app that helps people find local coffee shops. You have 100,000 daily active users who use your app to find coffee shops near them. You also have a potential for growth because there are still many coffee drinkers who haven't heard of your app yet. Finally, your app generates revenue by taking a small commission on each coffee order made through your app. Let's say your app generated a gross merchandise value (GMV) of $1 million last year.

Based on these factors, investors might value your startup at $10 million. Even though your startup might not be profitable yet, investors are willing to invest in your company because they see the potential for growth and the large number of active users. If you can continue to grow your user base and increase your GMV, your valuation could rise even higher in the future.

To increase the valuation of a startup, it must either increase GMV, show high potential growth, or increase the number of daily active users. Startups burn a lot of investors' money in marketing to achieve these goals. As a result, most startups are not profitable and may never become profitable. The startup ecosystem is a game of venture capitalists and not founders.

In the startup world, investors are typically looking for a big return on their investment, which means they want the startup to eventually be sold or go public so they can make a profit. This is why startups often focus on growth rather than profitability in the early stages. They want to attract more users, increase their GMV, and show investors that they have the potential to become a big company.

Once a startup reaches a certain size and has a lot of users, it may be acquired by a larger company or go public through an IPO (initial public offering). This is when the original founders and investors can sell their shares in the company and make a profit.

In conclusion, a startup's valuation is not based on traditional business valuation methods such as profits, assets, and discounted cash flow. Instead, it is based on active users, potential growth, and gross merchandise value. In the venture capitalist's view, startups are not about profitability, but rather about finding a good exit. The majority of startups do not focus on profitability because they know that as long as there is a greater fool in the market, they can always get a good exit. Startups burn a lot of investors' money in marketing to get the most users or increase their GMV to the maximum and their valuation to touch the sky.

Summary

The rise of startups in India has been significant in recent years, with companies like Flipkart, Paytm, Oyo, Swiggy, and Zomoto receiving millions of dollars in funding from investors. However, despite the massive investments, many of these startups are still struggling to turn a profit. One way startups in India are able to raise money despite losses is by reducing costs, which is often achieved by terminating employees. However, if a startup is underperforming, terminating employees can result in a further decline in performance. Startup valuation in India is based on three main factors: active users, potential growth, and gross merchandise value (GMV). Investors are typically looking for a big return on their investment, which means they want the startup to eventually be sold or go public so they can make a profit. This is why startups often focus on growth rather than profitability in the early stages. They want to attract more users, increase their GMV, and show investors that they have the potential to become a big company. Once a startup reaches a certain size and has a lot of users, it may be acquired by a larger company or go public through an IPO.

 

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