There are people in this world who are so powerful that you
cannot even imagine. And all of this revolves around capitalism. Flipkart - a
startup that was started 15 years ago but it still has never seen profits. Paytm
- a company started 10 years ago does its IPO and all its investors are at a
loss of 70%. Cred, Unacademy, Swiggy, Zomato, none of these startups have ever
earned profits but they still continue to get funding. But have you ever
thought about in spite of such heavy losses, how these startups get crores of
rupees of funding. Business is all about profits. But more than 80% of Indian
startups, in spite of being lossmaking, earned $19.7 billion in funding in the
last 7 months.
This points towards a very dangerous thing. In the upcoming
years, not 10 or 20 thousand but lakhs of people will lose their jobs. But you
know what?
Interestingly, whereas people will lose their jobs, startup
founders will earn crores of rupees. I know what you are thinking.
How can this be possible? If employees are being fired, then
definitely business would be underperforming or the company would be reducing
costs.
In such conditions, how are startup founders earning? What's
happening in the startup ecosystem that most people are unaware about?
And most importantly, what are the powerful business lessons
that we can learn from this case study and implement in your business. This video
is brought to you by Trade X about which we'll discuss later.
This story starts in the year 2007. Then, no one in India had
even heard the word startup. Then, two people, Sachin Bansal and Binny Bansal start
a website called Flipkart. Sachin and Binny, like Amazon, started Flipkart by
selling books. And it has to be agreed upon, the early years of Flipkart were
full of struggles.
But by 2012, many things started to change in India. Not one
or two, many startups had opened. Companies like Paytm, Oyo had gotten big
funding. 4 years later, by 2016, things start to get really dirty. This is
where a lot of things in the Indian startup ecosystem were going to change.
The game that was until now hidden from the world was slowly
gaining pace. And from here, many lives were going to change. The startup
bubble, a game where things how things look is very different from reality. You'll
find the majority startup founders in interviews talking about value, good
product, customer satisfaction, problem-solving. But the reality is, startup
founders and their investors know in 95% of the cases that their startup will
never be profitable. But what is it that these startup founders are hiding from
us, common people?
Because at the end of the day, whether the startup is
profitable or not, startup founders are getting super rich. Well, to understand
this, you'll first have to understand why a startup gets funding. In the initial
stages, a startup gets funding for these 3 reasons.
1.
Seed Funding : To start, there's some money
required which startup founders raise from friends and family or some angel
investor.
2.
Product Development : You have to develop your product. If the
product isn't developed properly, then it won't be possible to test it in the
market. For this too, startups raise funding initially.
3.
Product Testing : Once the product is made, a
lot of money has to be spent on testing it for which startup founders raise
funds initially.
And in most cases, this money is taken from friends and family
or from angel investors. But this game changes when a venture capital firm
invests money in a startup. Before understanding this, let's understand how
startup equity works.
For example, me and my friend Vaibhav start a company by the
name of Saini enterprises in which we create 1000 shares. Those 1000 shares are
divided equally, that is 500 shares for me and 500 for Vaibhav. Suppose, we
want to raise money for our company and we approach an investor by the name
investor X. For a certain amount, for example, 1 crore rupees, we offer 10% of
our company's stake. So, in total, 10% of 1000 shares, we'll issue 100 new
shares which will be given to investor X.
That means the total shares in the company is 500, 500, and
100, 1100 hundred shares. Investor X will get our company's 100 shares and in
turn, we'll get 1 crore rupees.
As soon as we raise this money, a multiplier is added to our
company's valuation. Ideally, multipliers of tech startups are 10x to 20x. That
means if a startup raises 1 crore rupees, the startup's valuation increases by
10 crore rupees. We worked hard, our startup's valuation is 20 crores.
Now coming to the next round of funding where i have 500
shares, Vaibhav has 500 shares and our investor, investor X has 100 shares. In
this round, we raise money from a new investor and this time, we're raising 2
crore rupees.
As soon as we raise this 2 crore, our startup's valuation will
increase by 20 crore rupees that is 20 crores + 20 crores = 40 crores. Our
startup's value is now 40 crore rupees. And the first investor, investor X their
10% stake, for which they paid 1 crore rupees, its value has now increased to
2.8 crores.
I'll tell you how. In the start, when Vaibhav and I started
the company, both of us had a 50-50 percent stake in the company. And then when
we got our first investor and gave them a 10% stake for 1 crore rupees, our
stake diluted to 45% each and the new investor got 10%. But when we brought in
a new investor, investor Z, from whom we raised 2 crores for 10% stake, all our
stakes would be diluted to give them that stake.
The new breakdown becomes 41.7, 41.7, 6.7 and 10%. And as
the company's valuation is now 40 crores, so the first investor, Mr. X, their
6.7% stake, becomes 2.8 crore rupees out of 40 crore rupees.
But the question is, how does the valuation increase? In
business world, a company's valuation is based on profits, assets, and
discounted cashflow. But that's not the case in the startup world. The
valuation of startups is based on these 3 things.
1.
Active Users : This includes daily and monthly
active users.
2.
Potential Growth of the startup : How much
growth potential the startup has.
3.
GMV, i.e gross merchandise value : See how the
concept of GMV works. For an example, I have an online store where I sell
various sellers' products on which I get 10% commission. This 10% is
technically my revenue.
But suppose I sold goods worth 10 crore rupees. Its 10% is 1
crore rupees which is my revenue. From this revenue, when I subract all my
expenses, that's when I get my profit. Technically, my startup's valuation
should be on profit. But my valuation is based on my GMV, i.e, the 10 crore rupees
worth of goods that I sold. And in case, you have a tech startup that doesn't sell a physical product, then in
that case, your daily active users or your startup's growth potential is
measured to calculate your startup's valuation.
Startup is a game of venture capitalists and not founders. I
repeat. Startup is a game of venture capitalists and not founders. A venture
capitalist firm doesn't invest in a startup for 10-15 years. The average investing
period is 2 to 5 years in which they find a good exit. In a venture
capitalist's view, entrepreneurs are divided into 2 categories.
1.
1st generation entrepreneurs : These are the
entrepreneurs who have raised a few rounds of funding, like Unacademy's Gaurav
Munjal and Meesho's Vidit Atrey.
2.
Proven Entrepreneurs : These are the entrepreneurs who have successfully
exited their startups, like Flipkart's Sachin Bansal, Paytm's Vidit Shekhar
Sharma and Freecharge's Kunal Shah. That's why the majority of startups haven't
thought of figuring out profitability. Because they know that as long as
there's a greater fool sitting in the market, they can always get a good exit.
But how does this exit happen? And if they want to exit, for
years why have these startups been in such huge losses? I'll explain with an
example. In the startup world, venture capitalists trade on valuation.
Equity sell off That means selling off your share of equity,
and exiting the company. And this exit is mainly in 3 forms.
1.
We See Sell Off : That means when you raise your
new funding round, then your old investor sells some part of his stakes to the
new investor and exits a little from the company
2.
Acquisitions : Like Facebook acquired Whatsapp
for $19 billion, Instagram for $1 dollars and recently, Zomato acquired
Blinkit. Through this acquisition too, a startup sells itself to a big company,
both, its founders and investors take an exit.
3.
Public Offering : That means exiting from the
startup through IPO. Now the question is, how will the valuation rise? Well,
very simple. Either increase GMV or show a high potential growth or increase
the number of daily active users.
And to do this, startups burn a lot of investors' money in
marketing. So that they get the most number of users or to increase their GMV
to the maximum and their valuation touches the sky. That's why, most startups
were neither profitable then and nor will they become so. Why?
Because earning a profit was never their aim. But as you
know, surviving on investors' money is not practically possible for any
startup. That's why when there's excessive cash burn, investors create pressure
on startups to either pump up the valuation or to make the business profitable,
so that excessive cash burn is no longer necessary. And this is where they
start bulk firing. Because seeing the stock market performance of companies
like Zomato and Paytm, everyone is clear about one thing.
The pumped up valuations in private market don't exist in
the public market, that too at a time when startups haven't figured out how
they will earn profits. This brings us to the most important point.
What are the business lessons that we can learn from this
case study and implement in our business.
1.
Learn to look at the true picture : Don't get excited after looking at a
startup's valuation. In the majority of the cases, the startup valuation that
you can see is a pumped up valuation. Because most of the startups never really
figured out where to earn profits from. The biggest examples are Zomato and
Paytm who are showing a very bad performance in stock market today.
2.
Don't get fascinated : So, there are two things. Never get too
excited after seeing a startup's valuation. After seeing a founder's story and
wealth, don't get too fascinated. Because they only show you what you want to
see. Most founders won't tell you the actual reality. While companies are
drowning in startup ecosystem,
in the telecom sector, Jio is doing something so powerful that
in the coming times, once again every telecom player's sleep would be gone.But
how? What is Reliance Jio doing that will give them a huge competitor
advantage?
Well, if you want to know this let me know in the comments section and I will write the content on it.
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