Investing in Early Stage Companies in India

Recently I ordered take out from a restaurant in Mumbai.  I was passing by the restaurant and stopped to place an order.  On my way out, I asked the restaurant manager which food delivery app shall I use the next time I wanted to place an order from the restaurant and his response was that many of his customers order from Zomato.  He also added that a certain Bollywood star is a regular dine-in customer at his restaurant and has rated the restaurant positively on Zomato which is a strong testament to the quality of food they serve.

Given that there are multiple food delivery apps in the country vying for the customers wallet, some offering fast delivery and some offering the best discounts,  the popularity of Zomato for food ordering highlights the power of the community that it has built over the years.  Customers that have been using Zomato for dine-in recommendations can now use the same app/experience for food delivery.  And new customers to food ordering can benefit from the community reviews on Zomato before they decide to place an order from a restaurant.

Delivery times for any food ordering platform needs to be reliable/predictable and with Zomato's partnership with Runnr, their food delivery service should be best in class.  As the food ordering space matures in India, will integrated dine in and dine out platforms prevail over pure food ordering platforms by being able leverage reward benefits (ie rewards for dine out can be redeemed at dine in), and the multiplier effect of the community reviews (ie. dine in reviews can influence dine out decisions)?

"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!