Are gross profits the key to bulletproofing your startup?

6 months ago, I wrote about the real cost of customer acquisition after visiting the offices of a prospective startup that we were evaluating. After writing the blog, I provided the founder with explicit feedback on why I was passing on the investment. I had laid out our rejection feedback mechanism a couple of years ago, and we continue to follow it at Artha even today.

Handling rejection is not easy. I was in sales for many years, and I still consider myself to be in sales as I sell the opportunity of investing in our fund to prospective investors. As a sales manager, I trained, managed, and fired thousands of salespeople for almost a decade. Therefore, I have directly or indirectly dealt with rejection, a lot.

Hence it does not surprise me when I get a range of reactions to our feedback emails from founders. Their responses range from the grateful and gracious to anger fuelled expletive-laden multi-pager emails, giving feedback to our feedback. I do remember that this founder fell into the former group.

I believe that my post is more relevant today than at the time I wrote it. In 2019 (it seems so long ago now), the early-stage investment market roared on the back of a surge in micro-angel investors & a flood of friends & family capital. These uninitiated investors, many of them investing directly into equities outside of mutual funds, for the first time. They were lured in by stories of the 100s of Xs someone they knew had made.

Unfortunately, their ambitions made them blind to runaway gross losses their investee startups were making, i.e., the direct cost of revenue exceeded the actual revenue brought in. In layman terms, it meant that for every ₹1 of income the startup earned, the direct cost of generating that income exceeded ₹1. Not a sound business situation in any market condition!

My team and I met many of these hyper funded startup founders. We tested their penchant for profitability, at least at the unit economic level, but those were different times. The founders commanded and received unbelievable valuations. My team and I sat and gaped on the side-lines as we saw our anti-portfolio list swell faster than the list of startups that were in our portfolio! I wondered if we were facing a new normal, like a valuation black hole where the laws of economics did not function.

Unbeknownst to the world, a novel virus was raising its ugly head some 4348 km away. In the flash of an eye, the funding flow stopped. Many founders were caught unprepared, and unfortunately, their cheap capital fuelled startups died a quick but painful death.

As investors have realized many times in the history of euphoric investing – it is a startup’s dharma to make a profit. One cannot run (or fund) a startup that makes losses, not for too long. A startup can be accused of buying revenues when its direct cost of bringing in the revenue exceeds the revenue brought in. In a cruel twist, a startup making a gross loss assigns a zero or negative value to the operations apparatus that keeps the doors open. It won’t take a valuation expert to tell you that if opening the doors is worth less than zero – it is profitable to shut those doors.

To clarify, I do not endorse a net-profit strategy for startups that want to grow and scale. However, profitability, at the unit economic level, is a must before a founder decides to chase growth. Fast-growing startups must invest in creating long-term assets (tangible or intangible) to manage hypergrowth because minor issues quickly become massive at scale. Therefore, even the best-managed fast-growing startups build capacity before productivity can catch up, leading to net losses.

A part of the cost of growth gets compensated by adding positive unit economics of every transaction, creating gross profits for the startup. The gap (if any) is filled by venture capital or private equity investors that want to capitalize on the startup’s growth potential.

Even in a harsh fundraising environment, a startup with gross profits can survive. The founders can cut non-critical investments & expenses, utilizing the gross profits to grow the business, even if it is slow growth. Only a gross profit-generating founder can choose to sacrifice growth for sustenance.

However, founders that attempt scaling despite unfavorable unit economics do not possess that luxury. They need a perennial source of capital to continue their revenue buying program. If there is any threat to their source of money, their startup will be in trouble, deep, deep trouble. Just how big is their issue, these founders and their investors are beginning to find that out now.

Moral of the story: gross profits are worth their weight in gold. 24-carat gold.

My Favourite Funding News from Last Week (w20)

There is a slow recovery in the funding of early-stage startups. We are still a long way away from the heydays of 2018-19, but the growing pace of activity in angel networks & early-stage funds are promising signs.

After shortlisting the early-stage deals for week 20 from Traxcn, Inc42, and YourStory, we picked out the following as the best funding picks for the last week:

 

Name: Vernacular.ai

Amount Raised: USD 5.1 mn led by Exfinity Ventures and Kalaari Capital

What does Vernacular.ai do?

Edited from Traxcn: Vernacular.ai is an AI platform to manage customer engagement and call center automation solutions. It provides multi-lingual chatbots for automating customer service operations of enterprises using natural language processing and deep learning. Natural language processing helps the bots to extract meaning, context, and entities of incoming messages, thereby enabling companies to interact and engage in any language with customers.

Deep learning helps in pre-training the bot with domain corpus and augmenting with enterprise-specific data to achieve maximum accuracy for the same. The bots developed using the platform can be deployed to multiple omnichannel platforms, including Facebook Messenger, Twitter, Website, Mobile, among others. Some of the supported languages include Hindi, Gujarati, English, to name a few. Clients include Vistaar, Shriram General Insurance, Exide Life Insurance, and Barbeque Nation.

Why do I like Vernacular.ai?

Voice AI has enormous applications in a world where customer service standards aren’t keeping up with the expectations of customers. Customers want to get personalized treatment and in a language that they are comfortable conversing in. As an early investor in vPhrase, I have seen the vast revenue potential of applying artificial intelligence for customer communication.

 

Name: Mintoak

Amount Raised: USD 2 mn led by Pravega Ventures

What does Mintoak do?

Edited from Traxcn: Mintoak offers a POS solution called DOV that enables merchants to accept digital payments. The solution involves a POS hardware device along with software solutions. Merchants can accept various types of card payments, such as magstripe, EMV, NFC, and secure PIN. It also enables the acceptance of UPI payments. Merchants can also accept payments without internet connectivity through their patent-pending technology that allows a POS to the transaction to be completed using the voice channel, thereby improving transaction completion rates. It also offers a consolidated view of all transactions handled by the device.

Why do I like Mintoak?

Except-Jio, most mobile operators operate on seriously inadequate infrastructure to handle the bandwidth demands of India fintech companies in urban centers. I shudder to imagine how vendors in Bharat, where the network infrastructure is weaker, would cope up. Mintoak attempts to use a data-light technology to process transactions, thereby decreasing costs and improving efficiency – an actual Bharat-focussed tech play.

 

Name: MetaMorphoSys

Amount Raised: Undisclosed amount led by Good Capital

What does MetaMorphoSys do?

Edited from Traxcn: MetaMorphoSys Technologies provides a software suite for the insurance industry. It offers solutions for product development, claims management, risk management, and more. It also features software for insurance quoting, sales & marketing, underwriting, and more.

Why do I like MetaMorphoSys?

Insure-tech will be one of the biggest beneficiaries of the post-COVID environment. A CRM focussed on increasing the sales & marketing ability of insurance agents will be a need-to-have utility. Hitting a ₹50 lakh monthly SaaS revenue will be the first port-of-validation for MetaMorphoSys!

My funding picks of last week (w18)

Fundraising activity continues to slow down; therefore, my team and I had a tough time shortlisting our favorite picks with just a handful of deals to choose from. After shortlisting all early-stage deals activity for week 18 from Traxcn, Inc42, and YourStory, we jointly picked out the following as the best funding picks for the last week:

 

Name: QuillBot

Amount Raised: $4 Mn in a round led by GSV Ventures and Sierra Ventures

What does QuillBot do?

Edited from Traxcn: Millions trust QuillBot’s full-sentence thesaurus to get creative suggestions, rewrite content, and get over writer’s block. QuillBot uses state-of-the-art AI to rewrite any sentence or article you give it.

Why do I like QuillBot?

My team and I are Grammarly power users processing tens of thousands of words for our investment notes, meeting minutes, emails, blogs, private chats, and more. I believe that there is space for a Grammarly competitor, especially one that understands the Indianized English – also, can Quillbot (or Grammarly) build a plugin for PowerPoint, please!

 

Name: YAP

Amount Raised: $4.5 Mn led by BEENEXT

What does YAP do?

Edited from Traxcn: YAP offers a white label program management platform. They also issue a Yap Tatkal wallet, which allows their clients to provide their customers physical or virtual prepaid cards linked to their products. They also offer a QR payment solution in the mobile wallet.

Why do I like YAP?

The lockdown caught the banks with their pants down due to unpreparedness to go digital. The post-lockdown scenario is bleak for physical banking, and banks must prepare themselves to fully service their customers from the palm of their hands. YAP is building APIs to bridge that gap hence one to look out for.

 

Name: Mindhouse

Amount Raised: ~$680K from BTB Ventures, GGV Capital, Aartieca Family Trust, and Angels

What does Mindhouse do?

Edited from Traxcn: Standalone mental fitness and wellness center brand

Why do I like Mindhouse?

The COVID19 virus reserves it’s worst for those with weakened immune systems. Therefore I expect that fitness (physical or mental) will be on the priority list of most in the post-virus era. Mindhouse attempts to enter the space that mind.fit is operating in. Will it succeed?

Flashback Friday: United Mobile Apps

United Mobile Apps (UMA) developed and published mobile applications software. The company issued software products for mobile devices with a focus on connection management, device management, and data synchronization. UMA marketed its products and services to original device manufacturers throughout India.

UMA had a vision of enabling access to all the User’s data ‘Everything – Everywhere.’ To implement this vision, UMA worked on a cross-platform software called Unify (U5) which had the following modules:

  • USync: Synchronize data from mobile device / laptop / PC
  • UManage: Manage the device remotely
  • UShare: Share the backed-up data

 

Year of Investment: 2012 Total funding raised USD 1.2 Million
2020 status: Shutdown Number of rounds 2
Co-investors: Blume Ventures, India Venture Partners & Mumbai Angels

 

Anirudh A Damani (aD) gives his insight behind this investment.

  1. Why did we invest in UMA?

aD: UMA was trying to optimize the mobile telephony infrastructure by utilizing the correct cellular network bands based on the type of data getting transmitted. So, their solution allows the network operator to use 4G for rich data applications, 3G for emails, 2G for voice calls, and GSM for SMS. The solution also allowed a seamless offloading to wi-fi for data sapping applications.

It was the perfect solution for an infrastructure challenged market like India with its notoriously poor network quality. I also liked the founding team, the right mix of engineers, and businesspeople for a complex infrastructure play.

 

  1. What were the risks involved with an investment in UMA?

aD: There were a couple of significant risks. First, the company must invest a considerable amount of money on R&D, an expense that it could not stop even if sales were slow – which was the second risk. The company had a long sales cycle and relied on the correct alignment of several external factors for its success.

 

  1. How long did you plan to invest in UMA?

aD: For a long time, I  had a conviction that UMA would be my first unicorn. I had planned to hold onto it forever as UMA’s business model would make it a cash cow. Unfortunately, unfavorable market conditions dashed my expectations.

 

  1. What was the primary reason behind dead pooling UMA’s investment?

aD: As I had said earlier, the company relied on external factors for its success, e.g., the quick rollout of 4G networks to be a viable solution for network operators. The network operators would then ask handset makers to install UMA’s chip in the handset and pay a royalty to UMA per device per month.

However, the 2G spectrum allocation scam in India led to a slow 4G rollout in India. Though unconnected to India, different regions around the world also witnessed a slowdown in rolling out 4G. This stalled the company in its tracks. The company tried pivoting to a new business line, which met with moderate success, and it needed additional rounds of capital to survive the delays but failed at raising a new round.

 

  1. Are you satisfied with the efforts of the founders?

aD: Absolutely! I believe that the founders gave it their all, and factors beyond their control led to their eventual demise. I continue to have a ton of respect for the founders, and I look forward to investing in them once again!

 

  1. What mistakes did UMA make, and what was your learning as an investor?

aD: It would be incorrect to blame the founders for making mistakes for situations beyond their control. The most significant learning for me was to ensure that the founders held (at least) 60% equity before raising a Series A round.

 

  1. Would you invest in a similar startup today?

aD: Absolutely!

 

 

My funding picks from last week (w05)

There were 15 deals in week 5 of 2020 that were available on Traxcn, Inc42, and YourStory,
I sat with our funding team, and after some enlighting discussions, I have shortlisted my picks to:

Name: InterviewBit
Amount Raised: $20 million
Investors: Tiger Global Management & Sequoia India
What does InterviewBit do?
Edited from Traxcn: InterviewBit is an online platform for tech interview preparation. The platform offers gamified lessons with video tutorials, primer problems, and guided solutions for programming, scripting, databases, system design, puzzles, etc. The platform also enables the candidates to get connected with the right companies worldwide based on skills and preferences.
Why do I like InterviewBit?
I like focussed vocational plays. Last year I had picked out GreyAtom as a funding pick as it provided an upskilling platform for data science and web development employees. Therefore picking it isn’t a surprise that InterviewBit got selected even though the $20 million round from Tiger & Sequoia is bigger than a typical Series A round in India.
InterviewBit solves an exciting problem of finding, interviewing, and evaluating tech talent, which is the Achilles heel of the best of Indian start-ups. The CAC for such plays is quite high, but considering the 18-35 lakh rupee salary bracket they target, the rewards may outweigh the costs.
Only request – can someone create a platform for finance and accounting employees! 😊

Name: AdonMo
Amount Raised: Rs. 21.4 crores
Investors: Bace Capital, Astarc & Mumbai Angels
What does AdonMo do?
Edited from Traxcn: Adonmo provides an in-transit cab advertising platform for advertisers to reach their target audience. It enables advertisers to place their ads on top of the cab and select the target location and relevant time slots to display advertisements and track their ads in real-time. It uses a proprietary computer vision and hyper-local technology to identify its viewers and advertise.
Why do I like AdonMo?
It was unbelievable that I had created a business plan to provide contextual ads based on geo-location on top of taxis during a 6-7 months stint in Kolkata in 2012 or 2013. I had reached out to taxi-top display manufacturers in China who could provide the hardware required for this service. These plays were very popular for advertisers in Africa as most homes did not have electricity – therefore, taxi-top displays were the primary distributors of advertising. But AdonMo is precisely doing what I could not i.e., EXECUTE on the idea.
I am excited about AdonMo as it disrupts the hold billboard owners have enjoyed for several decades. A moving billboard provides better and deeper reach to advertisers with exhaustive reporting and must work out to be of much better value than a billboard.

Name: YoloBus
Amount Raised: Rs. 4.28 crore
Investors: Undisclosed
What does YoloBus do?
Edited from Traxcn: Yolobus provides an online-based platform for booking intercity tickets. Users can book tickets by giving details like location, date, time, etc. It offers features like real-time tracking, in-cabin Wi-Fi, Toilet, Pantry, CCTV cameras, etc.
Why do I like YoloBus?
There are several intercity bus services. So what is interesting about just another intercity bus service?
There are several intercity bus ticket booking platforms – So what is interesting about just another intercity bus ticket booking platform?
India is home to the world’s largest and fastest-growing middle-class population. India’s growth pulled 271 million people out of poverty between 2006 and 2016. It is only a matter of time before India’s per capita income will cross $4000 with and a majority of the Indians will belong to the middle to upper-middle class i.e., aspirational class.
This vast majority of people will have a very different consumption basket and preferences compared to the sustenance living Indian, and services like YoloBus cater to a growing section of the Indian audience.
While Yolo may get considered a bit ahead of its time, if it can keep its costs of operation and customer acquisition in control and sustain – there is a big market for it to capture!
One question, though – why are the investors undisclosed? The first time for me to see a release in which the amount gets disclosed but not the investors!  

Navigating the Indian Seed Landscape

No one can doubt that the Indian PE/VC ecosystem is going through a golden run. The amount of money flowing into the ecosystem is breaking records –records set just the previous year! If I narrow the PE/VC down to just “start-ups” then Indian start-ups have raised $11.3 billion this year – up from $10.5 billion raised last year – the good times are truly here.

This massive influx of money and strong tailwinds make it seem as though raising capital is getting easier. But, with the number of start-ups growing as fast (if not faster) than the money supply, the real picture for a start-up raising money today is – disconcertingly different. The discussion of what metrics does it take to raise a round, what the different stage VCs focus on when you raise, etc. is a polarizing topic. One that I regularly have now with founders who are raising, founders who have raised and with funders of all stages – but there isn’t a silver bullet.

Therefore, when Yuki Kawamura shared Pear VC’s report, aptly titled, Navigating the New Seed Landscape, he could not have sent it at a more opportune time. Mar Hershenson, Managing Partner of Pear VC, created this report analyzing the US VC ecosystem but there are several parallels we can draw for our ecosystem here. For example:  

  • It confirms something that seed investors have long known, i.e., the time, amount and metrics required to raise a Series A round has increased, therefore;
    • The money needed to get a venture ready for Series A has also increased
    • Series A investors want to see positive unit economics and traction before putting in growth rounds
  • Traction has a direct correlation to valuation
  • Second time and successful founders get a premium valuation
  • Where you locate your start-up does affect its initial valuation

There are several other learnings in the report, but the one slide that stuck with me is:

Just replace the names of columns (from the left) with Seed, Pre-Series A (or Angel), Series A, and Public to translate this to our ecosystem’s lingo. However, the vertical order in those columns stays the same
  • A seed investor (like me) backs the team
  • The angel investor backs the traction, and
  • The Series A investor backs the market.

The report then gets into further details as to what your start-up must emphasize when you are raising a new round. It provides a founder the VC view on where your venture must be before attempting to raise that the Seed, Angel, or Series A round. I believe that this presentation is manna for founders. I Whatsapp’d it to my founders in the morning. Now I share it with you!

Two Graphs for the Indian Start-up Ecosystem to Celebrate and Fear

There are two graphs that will define how 2018 was for the start-up ecosystem in India.

This telling graph that I took from a CNBCTV18 article shows that the amount of money raised by Indian start-ups in 2018 exceeded the amount of money raised by companies on the stock exchange. It is a rare occasion to see investors pour more money into unlisted investments over listed ones. This can be attributed to the recent market volatility that has hit pause on the number of IPOs in the last 3-4 months. The IL&FS fiasco led to credit crunch and the uncertainty over the results of the Lok Sabha polls next year also acted as catalysts for dampening investor sentiments.

However, this is an important moment for our young start-up ecosystem and I will be the first person to state that the recent spate of $1 billion+ rounds is a harbinger of the good times that lie ahead.

However, these summed-up funding numbers are hiding a very important fact that the number of start-ups raising early stage rounds has dropped 39% from its 2016 peak and the amounts raised is down by 52% from its 2015 zenith. Apart from the large SoftBank led funding rounds, we have had a seriously down year.

A major reason for this slowdown in early-stage funding is the exit of many small cheque angel investors that were blindly pouring in capital into early-stage companies. These avoidable angels (as I would call them) barely spend a few hours with start-up founders during the period of their investment and expect disproportionate returns on the sweat and blood of founders alone, a rare occurrence. Now as many of these start-ups have finished their funding runway, haven’t reached their promised goals and therefore unable to raise new money; they are starting to shut down.

An early stage start-up shutting down is a normal occurrence but these types of angel investors have usually dabbled in mid-cap and small-cap stocks too and their portfolios had swelled up spectacularly until the volatility that eroded the gains, and the principals in many cases. Faced with this double whammy many small angels have stopped writing angel cheques or (thankfully!) sworn off angel investing altogether. The recently advertised angel tax fiasco only helped hasten this decision.

I categorically blame angel networks for mis-advertising this investment class to these investors. Using examples of how small cheques led to massive returns they signed up tons of wannabe (read: avoidable) angels without having explained to them the effort that went into helping those founding teams and – how many failures it took to get one success. The result of these lax policies is the vacuum of early stage capital we face today.

101/2018

What will you discuss if valuation is not a variable?

I spent most of my Sunday at IIT Bombay as one of the 14 investors in the Ten Minute Miillion event. In its 3rd edition the format is inspired by Shark Tank insomuch that a selected group of investors (and there is a beeline to be part of this panel) hear a 5 minute pitch and are given 5 minutes to do a Q&A with the founders. After which they make a decision to invest between 100k to 1.5 million rupees into the startup. All the investors display their bids on a placard and the organisers total up the bids to announce whether the startup has received enough bids to fulfill the 1.5 million investing round. If the startup gets bids below the 1.5 million minimum the round has failed and they do not get any money.The event is held during IIT Bombay’s E Summit and judging by the presence of well known angel investors, the excellent pitches to a room for 300 that was packed to overcapacity and they received raucous applause when a successful funding went through – it pointed out that this was definitely the place to be on Sunday at the E Summit.
To ensure that the deals committed to, go through, there are number of the investment cycle steps that were completed prior to the pitch namely, the valuation, the share-holders agreement, the amount of the raise and a basic level of DD. The only thing left for the founders and investors to do post the successful raise, is to complete the execution and to adhere to an honor code between the founder and investor to complete this process or risk being black-listed from next year’s edition.
Much of the investors on the panel have been in attendance at this event for the last 2 years, so there was a lot of learning on the best practices and the common pitfalls which an investor should be careful of.
The event went off very well. I saw 6 pitches, bid on 4 startups and 3 of them were successfully oversubscribed. The format is quick and the energy levels remained high throughout the 3.5 hours we were there. The stories from the event will be remembered for months to come and the 3 companies we are investing in are promising startups with excellent potential.
When the valuation is not a variable the quality of interaction between the founders and investors changed dramatically. The investors ask “smarter” & insightful questions to better understand the business and to better understand whether the team can deliver on its execution promise. The event also debunked a common misconception that investors are interested in low share prices and one can entice them by giving them low prices for shares. The words of Sage of Omaha, Warren Buffet, “Price is what you pay and value is what you get” rang true yesterday when on level playing field, all startups that had agreed to the same valuation and the same amount of raise, there were startups that failed in raising even 20% of the 1.5 million rupee mark!
In my personal experience, startups that put up high valuation expectations in their presentations, chop off their own feet by diverting the focus of the investor from “is this startup worth investing in?” to “is this startup worth that much?”. The first scenario it is future potential of the business that is under scrutiny but in the second scenario it is the performance of the startup/founder until today under investigation. For early stage companies the second scenario puts them at a significant disadvantage and it may make sense for early stage platforms to bring deals that have pre-agreed terms (like the kind that existed at VentureNursery) and focus the attention of the investor on the business than on the valuation.