"Good Company, Bad Investment" is an often used phrase when discussing some of the follow on financing rounds for many of the funded start-ups in India.  Over the past several years, start-ups were aggressively funded by Hedge Funds, Venture Capital Firms and Strategics.  Many of these companies tried to aggressively build product and market themselves with little regard for unit economics or even a business model.  Some of these companies have arguably built a decent product, good brand recognition and customer loyalty. What could have been achieved with $1 was achieved with $5 as capital was cheap and quick.  And companies that would typically be at a Series A or B stage valuation with a strong differentiated product with early traction, are at valuations that are typically what a later stage company would command with business model in place, revenues growing rapidly and a path to profits.  We have seen several companies with revenues under $5m being valued at the last round at $50m+ and in some cases over $100m. The reason for this is that the company raised a lot of capital in quick succession over a short period and raised $10-20m rounds at an inflated valuations because capital was available.

Today when I speak to many of these entrepreneurs, I hear that they are working on reducing burn, focusing on revenues and unit economics, but rarely do I hear the openness to recapitalise the company at fair valuations even it  means that some of the earlier investors and founders may have to take the hit to accommodate new capital at fair valuations.  In some cases, the earlier investors are happy to continue to bridge the company at the inflated valuations in the hope that the company will grow into the valuation.  Time will tell how this strategy plays out.  In other cases where external capital in important for survival or to maintain the competitive edge in the market,  the sooner the entrepreneur and shareholders realise that the best way forward is to do a hard reset on valuation and attract further capital, the better it is for all. Companies can lose momentum or lose favour with investors quickly. We have seen a recent case of Ola where they recently raised monies at a reset valuation. It was a smart move on their part.  Hope more entrepreneurs press the valuation reset button in time. One step back to take three steps forward. At the end, what is important is to build a great business which will eventually yield returns for all.

Surprising, few companies in the Indian start up space are thinking about adding Independent Directors to the boards early on. The popular perception is that when a company is thinking of going public, that is the time to bring on Independent directors.


My suggestion is to start building an Independent Board early in the company lifecycle.  While there is no magic milestone on when this should be done, generally good to start thinking of an Independent Director when the company is early in its commercialisation journey.  Having this conversation with your VCs early on is helpful.


At an early stage, an Independent Director is more a thought partner to the entrepreneur, someone who can guide him or her on how to think about commercialising a product, building an organisation, making customer introductions, and broadly bringing a fresh perspective and balance to the investors. What is important is that the Independent Director truly can dedicate time when needed and has bought into the company vision and team and is not doing this to build the resume.   For example, in one of our start ups, we helped bring on an Independent Director who has been a CMO of a large enterprise software company.  He brought a different perspective on the product, positioning and price given his experience which was valuable. In another instance, a portfolio company brought on a CFO of a Telecom Company.  He was very valuable in helping define the strategy and brought a different thinking to the table coming from a hyper competitive industry like Telecom .In another case, we helped bring on a Media veteran to help with customer introductions and refining the product pitch, etc. 


As the company grows and is thinking of going public, Independent Board Members with more specific skills to be able to lead the Audit, Nomination Committees, etc.  


In my experience a good board composition at an early stage is 5-7 Members. 1-3 VCs,  1-2 Founders/Management and 1-2 Independent Directors. Anything less than 3 members or over 9 members can cause the board to be ineffective.

The last few years Startup India has seen an abundance of cash. We had Hedge Funds doing Seed and Series A deals and various Strategic and other investors investing large monies at the growth stage. Many entrepreneurs were flush with funds early and were spending the monies in marketing companies (especially B2C) versus building them.  In the race for market share, they were building awareness before building capabilities or efficiencies.  The common perception was that "this is how the leading companies were built in China. Grab market share first and build efficiencies later." The difference in China is given the regulatory and language hurdles, international companies, rich in experience, capabilities and capital couldn't find it easy to compete there. So local companies that got funded were able to gain market share on the back of inefficiencies and below desriable service levels and then had the luxury to then work on the capabilities once they were the only one standing.

In India, being a relatively open economy, the playing field is a lot more open and allows for well capitalised international competition to flourish.  International players have the know-how and the capital. If they are able to build the right entrepreneurial team on the ground and transfer the know-how, they can be formidable local competitors.,  Local Entrepreneurs who have been lucky to raise a lot of cash early should first invest  in building differentiated capabilities over awareness as it can provide a better sustainable advantage even if it means giving up the maniacal goal of market share in the earlier days.  You still need to be aggressive in building awareness but once you have your capabilities built, you will hopefully need to spend a lesser dollars to attract customers by leveraging word of mouth as a result of better service levels and experience, the outcome of smart  investment in capabilities.

Quick recap of recent M&A - Yahoo sold for broadly 1/10th the price that Microsoft offered  several years ago,   Jabong sold for broadly 1/10th  the price that was being discussed with global ecommerce majors a few years ago.

Given the recent M&A activity both globally and close to home, I thought I would revisit the topic of exit timing which I wrote about a few years ago (http://indianvc.blogspot.in/2011/08/timing-of-exit-is-very-important.html).

I have found that it is very difficult for an entrepreneur, management and/or investors to take a decision to exit when there is no immediate stress on capital - either when there is capital in the bank or there is an impending financing round. And this challenge amplifies when the company is growing as it can sometimes make a company less vigilant on potential future headwinds the company may face.

So when is the right time for a founder/management to start thinking of an exit, despite cash in the bank?  Here are some tips -

People - There is fatigue or lack of passion at the founder or leadership level.  Or  it is hard to attract or retain key talent in the company. Or there is a strong disagreement amongst the various stakeholders on the way forward.

Approach - The approach to solving the problem is either not working or not scaling. Revenues cannot scale without scaling costs proportionately

Market - The market is either not large enough, or the competitive dynamics in the market puts pressure on current business model

Obviously the company must attempt to do whatever it can to address the challenges above and continue to build value and not give up at the sign of the first road bump. But what is important is that a timely and critical assessment is made on whether the company really has a strong  passionate team focused on differentiated and scalable business model in a large enough market or are their certain team or market headwinds in the near to mid term that will be hard to surmount and it is best to find a strategic home for the company.  This assessment is not only extremely tough in an ever changing dynamic market environment but also is emotionally challenging for the founder especially if there is strong passion for the company.  And often the responsibility lies with the investors and the board to  provide the sound and dispassionate counsel to the entrepreneur. 

As we have seen in the recent M&A highlighted above, a mistimed exit of a company can cause major loss in shareholder value, employee morale and employee opportunity cost.





 

I was speaking to an entrepreneur in our portfolio who was going through a major pivot and asked him how he was feeling given the last few months of dealing with the business model change, jittery investors, confused employees, etc. We believe in the entrepreneur and continue to back him.

His reaction was that he is more charged than ever now. He has realised his past mistakes, has learned from it. He believes his BIGGEST MISTAKE WAS NOT PIVOTING EARLIER. He believes that the problem he set out to solve with his earlier company still exists,  it is a large problem that needs to be solved. However, the approach to the problem has to be a lot more differentiated and focused.  He understands the quality of revenues matter. They should be recurring and profit yielding. Customers need to love the product at a price/cost that allows the company to build a profitable franchise. He has spent time internally speaking to his employees and explaining to them the rational of the pivot and everyone seems to be on board with the new direction the company has taken. While I am hopeful that the new direction will work, but what is clear is that the old business was not working and the faster there was realisation around this, the better.

Many entrepreneurs face the problem of product-market fit. It is the nature of company creation. When I was an entrepreneur, I faced it and had to adapt/innovate very quickly. If I didn't, I wouldn't have survived.  Many times, the difference between a failed and successful entrepreneur is not smarts or passion. It is intellectually honesty with themselves and their team early in the company's lifecycle that their current business is hitting a wall, and perception/intuition to figure out a new opportunity that can leverage the companies capabilities to create a sustainable enterprise.

I tell most entrepreneurs I meet - "Don't be afraid to fail early if you think it is not working." Admitting failure sooner can save a lot of time and capital and help direct energies towards potential problems that may be solvable. And even if you cannot think of a pivot, it is better to fail fast and do something meaningful with your life as the scarcest resource we have in our lives is time!

 

As the saying goes, Great companies are built in tough times.  There is good reason for this. When there is an unforgiving financing environment, smart companies tend to focus a lot more on costs,  more emphasis is put on generating that extra dollar of revenue for the same cost,  low cost marketing innovations emerge, new initiatives put on hold, etc. While there is no reason to wait for a tough financing environment to engage in some of these company health activities, it is invariably in such times that great foundations and cultures are built.  There is a general fear that some of the layoffs and other cost reductions will reduce company morale, etc.  To the contrary, most cost rationalisations result in a happier productive employees.

Some practical tips for current entrepreneurs to build a healthier start-up -

1. Zero base your fixed costs -  Look at every cost and see if that would have been a cost you would incur if you had to start the company today. Would you rent the office you are currently renting? Would you hire as many people as you have in each function? Is there way to convert cash compensation to more equity?

2. Restructure variable cost (for e.g sales force organisation)  - Eliminate non performing sales professionals. Make a judgement call on the cost benefit of the top performing sales team. Sometimes top performers in a past year may not be as hungry to perform in the coming year. Younger hungrier talent at a fraction of the cost of a top performer may yield similar or better performance than someone who was a past performer and is not as hungry any more. Think of replacing the expensive performers with younger less expensive potential.  This philosophy holds for other variable costs like service delivery, etc too.

3. Focus on Customer ROI  - Understand your customer need better to see what more you can cross or upsell to them with the same resource/effort. In consumer facing businesses, don't waste monies on attracting consumers if you know that they will not be yield a positive return on customer acquisition cost

4. Think "Out of the box" in Marketing - Assess if there are other ways to achieve the same touch points. Invariably every company builds a lot of flab in marketing because it is very easy to justify a marketing budget.  Innovative channel partnerships, guerrilla on the ground marketing, Word of Mouth, PR, are some of the innovations worth experimenting with.







 

Nexus was an early backer of one of the two leading free online horizontal classifieds in India and was instrumental in building out its leadership in the country. Both the leading companies are helmed by smart mature leaders and the battle between the two companies has been on for a few years now. I can see this battle continue in the short term given that both companies seem to have cash in the bank for now. However, eventually, in this business model, only one player can become a strong viable business, not two. Winner Takes All!

The value proposition of a free horizontal classifieds platform is simple - Maximum Liquidity.  Buyers want more sellers and sellers want more buyers.  This is a true network effects business (i.e. the value of the platform increases with more users using it).  Once there are a critical mass of sellers and buyers on the platform, it is very hard replicate the liquidity on the platform. More users will beget more users and the liquidity will continue to grow without scaling marketing significantly.  And when there is unparalleled liquidity, that is when monetisation avenues like fees for preferred placement of ads works as there is no other alternative to market to such a large audience online. And that's when you can build a potentially highly profitable business as the costs are mainly technology and maybe some reduced marketing as a result of the network effects.

In India, the challenge with the online free horizontal classifieds industry was that it was a two horse race from the beginning. Both companies raised adequate monies, built strong platforms, and invested heavily in marketing. Users came to both platforms. Since it was free, users experimented with both platforms. Both platforms built a decent seller base and buyer base. Both platforms are trying to build "unparalleled liquidity". However the existence of two strong free platforms doesn't allow either one to become a successful business. Once a platform significantly dominates in liquidity, it is able to reduce marketing costs and switch on monetisation aggressively. In order to differentiate to be able to monetize, one of these companies has launched vertical platforms (i.e. separate platform for auto, real estate, etc.). These are good growth initiatives, however they may not help them to win the horizontal classifieds war unless they are unparalleled leaders in liquidity. A vertical classifieds business competes on "best service" for a finite liquidity (you cannot compete in best service for a very large base of liquidity - it is too complex) versus a horizontal free classifieds that competes on "unparalleled liquidity" but potentially giving up on service.  There are strong independent players that compete in vertical marketplaces with focus and capital dedicated towards solving the "best service" problem. It is hard for a horizontal free classifieds who is fighting the  "unparalleled liquidity" battle to also fight the vertical battle of "best service". The danger of trying to do both is that resources may get spread too thin and both battles could be lost.  

I suspect some of the vertical strategies in India are driven by similar strategies in China. However, in China, the leader in free horizontal classifieds business acquired  a vertical classifieds only once clear leadership in liquidity was established. So monies were invested in building vertical services on top of horizontal leadership without fighting both battles simultaneously.

Hence I believe the future for free online classifieds in India will lie in one of the following outcomes :
a) Both horizontal platforms consolidate and create one platform 
b) One horizontal platform outlives the other with a stronger balance sheet
c) One horizontal platform stops competing in the free classifieds space and pivots to vertical or other adjacent businesses.

Wish both companies luck and hope they will be able to navigate through the competitive environment successfully. Interesting times ahead.  

There has been a lot of unnecessary recent negative press and social media chatter around a recent de-valuation in an Indian unicorn by an existing investor in the company. Valuation fluctuations are par for course in large fast growing private technology companies. Let me explain why.

Financial valuations in large fast growth private technology companies is part art and part science. It is generally driven by -

a) The promise of the rapidly changing future financial metrics of a company -  Most of these fast growth companies are addressing new markets that have not been addressed before, therefore there are many unknowns at the time of financing – market structures, competitive landscape, etc which are dynamic in nature. As the company evolves and markets mature, more clarity emerges or more opinion forms around future growth potential of the company.

b) Liquidity of large pools of capital - Global environment and financial cycles can affect investor sentiments and large capital flows in private companies, thereby potentially reducing the pool of further capital which could then affect valuations due to pure demand/supply economics

Valuation fluctuations are short term aberrations and don't really affect the entrepreneur or the investor. Smart entrepreneurs continue to focus on building long term value by focusing on differentiation, scalability and sustainability. They understand these fluctuations in a rapidly changing environment and manage their ambitions, teams and plans accordingly and use it to their advantage to drive efficiencies in their business.

India is going through a digital revolution and companies will continue to thrive and grow given our attractive demographics. Many investors I run into continue to say that “India is one of the few bright investment spots left”. Market leading companies will continue to attract investor interest at premium valuations. 

My Harvard Business School professor came to visit me a few weeks ago. At the end of the meeting, he asked me what I thought of a business that is into an Uber for hotel rooms in India. My immediate reaction was "I don't understand it", and his response was somewhat similar. We both laughed.

There has been a lot of hoopla around trying to create standardised hotel experiences in India akin to an Uber, partly driven by large investor funding news.  I have met many talented entrepreneurs trying to execute in this space for a few years now. While I have a very high regard for entrepreneurs being one myself, I scratch my head when I see businesses like this that is stretching the Uber for X analogy a bit too far.

Let me be more specific on this business. If someone told you can get a clean table with a good table cloth and new silverware and plates at a cheap food restaurant that is generally filthy , would your experience be any different in that restaurant?  Marginally at best.

Similar is the story of branded hotel experiences. Customers I speak to swear they would never take their spouse to some of these "branded" hotel properties,  the only reason they are staying there because it is cheap and they know they would get a clean bed, etc but really didn't have a great experience.  The reason they are not thrilled with the experience is because the room is "just one part" of the whole hotel experience. The hotel lobby, the corridor, the food, the location, rest of the infrastructure, the other guests, are all part of the experience.  Building a long term sustainable business of partially branding somebody else's sub-par property without controlling the entire property is a challenge.

Another problem with partially controlling somebody's business is that there is no full alignment with the hotel owner and customer. If a hotel owner gets a walk in customer, the room may go to that guest as he is a guaranteed customer. Again, if you are branding the experience, this hurts the brand.

The real long term value of branded hotel or restaurant experiences is if you own/control the entire property or restaurant  not part of it. That is what branded or restaurant chains do. Hard to scale these businesses fast given the challenges of real estate, labor, etc and they may not merit venture capital returns, but that is indeed a real business with real value.

My advice to entrepreneurs in the quest to launch "Uber of X"  businesses and specifically the Uber for Hotel Rooms is to really understand if they can deliver the service levels that an Uber is known for. They control the entire experience. In this case of Uber of Hotel Rooms, it is not feasible to provide that experience.