Anand Lunia
Feb 22, 2017
Has India’s startup story missed the capital efficiency bus?
“A startup is a temporary organization used to search for a repeatable and scalable business model”.
A great definition from Steve Blank, one of Silicon Valley’s well known educators. What keeps the wheels rolling is that startups discover these scalable models in a very capital efficient way, delivering multiple returns to investors.

An acceptable definition of capital efficiency will be “high level of financial return on capital deployed”.

The ‘return’ measures that matter early on are Revenue, Network size and Funding Valuation. Network startups like FB, Twitter built their network in the beginning and Tesla will have to build their IP early on. A really early but effective measure for instance is ‘Million users per $M of capital. During this phase also, entrepreneurs need to keep an eye on the future ‘Revenue per $M of capital’.

Avnish Bajaj, a rare Indian VC who talks returns on twitter, had written “Practical thumb rule for companies is to raise only when they are worth 10–25X of capital raised” and cited the example of Practo, Ola and Zomato.

The eventual financial measures of capital efficiency are Profits and Exit valuation.

Whatsapp was the most capital efficient outcome we have known, with 600M active users and a $19.1B exit using just $58M of capital. That translates into about $300M exit/$M of capital, 10M users/$M.

A lot of exits are happening in India, but many have not meant much for either the founders or investors or both.

Eric Paley, MD of Founders Collective has done a great analysis of tech IPOs of 2011–15 era, and he finds that the best companies don’t need much capital.

Sample of recent exits in India: Top exits (post 2011)

Clearly, something is amiss in the Indian startup story. Most of the well funded companies have not build any capital efficient sales engine, are valued ahead of time and they are likely to underperform in coming months. One company that stands out is Redbus, which used just $2M out of its $8M lifetime funding.

Too many wrong benchmarks

We have a lot of gospel to rely on, like how India is a tough country, how Indian cos have to spend $1B capital for $1B revenue etc. These benchmarks are then used to draw up plans, because its too convenient. There are board members who are only interested in really high level strategy and rarely offer inputs on how to run the company. Founders find themselves in this echo chamber where non-performance is lost in big talk.

Entrepreneur’s Dilemma and competition intensity

The entrepreneur faces very high competition intensity in winner takes all markets. Flipkart and Ola are classic examples of that. Survival needs take precedence over capital efficiency considerations. The unfortunate outcome in most of these high competition wars is that there is no win-win, as the capital raised is just too high and the entrepreneurs who are at the bottom of the capital stack look at very low returns. When redbus raised a 500K round, their competitor had 10X the money, and a lot of that went into hoardings and print ads. It took a lot of self belief to not retaliate in wake of market share concerns.

Letting the capital work

Companies raise money for 18–24 months but go back to the market in 6 months in boom times. But founders get glory, and investors get ‘up rounds’. The questionable part of these quick fund raises is that the founders sometimes take part exits, become active angel investors. redbus raised their series A round 24 months after their seed round. In fact, all the global cos above have raised money only after decent intervals, when the previous funding has had time to show impact.

Indian consumers are tough

‘Indian consumers demand highest value per $ of revenue’, remarked Shailendra Singh of Sequoia, another VC one should not miss following on twitter. Consumers have a very high bar when it comes to online cos and will not shift behavior without steep discounts and extra service.

The entry barriers are too low

Anybody with some good degrees is getting funded, and these people are not really entrepreneur material. They don’t want to work hard, and they are not it this for a long time. Similarly, the current lot of VC and angel is not always made of those who have seen great companies being built. Most of these investors push only for the next round of funding. Redbus founders got advice from their mentors that discounting is easy, just takes a split second to get on with. But building value beyond discounting in terms of things that consumers will desire will take time, focus and energy. He and his team chose the tougher path.

How do we get there

I asked for Phani’s opinion on the topic. He is not worried about the future. He feels that we are all too early, and most of us, VCs and entrepreneurs are doing our first cycle only. He expects returning founders to be smarter and more efficient in using the funding they raise. ‘Did any of the current lot of founders or investors ever ask you how you managed with just $2M for 7 years?’

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