Start-ups – The impact on our economy.

Start-ups – The impact on our economy.

About to BloomStart-ups have become the word of mouth of almost every person in town, at least in Bangalore which has become the hub of activity for new ideas. Students coming out of college come with a dream, ‘work for a couple of months, along with that work to become a start-up entrepreneur’. With so much activity, thoughts and money flowing into this segment, how good is this Start-up culture for our economy?

In the past 2 decades tech employees had the advantage of getting paid more than they could dream off, apart from the luxuries and indulgences which they experienced, which brought our economy fame & money along with cultural shift, they still had a lot of money un-used, which got poured into real estate, people bought 3 homes, more number of cars. Culture had such a dramatic shift that it is said in some segments of our country, the “K” in BHK is being taken off, apartments are sold as 2BH, 3BH etc., because cooking has become a past thought, eating out is the way of life today.

Now with real estate taking a back seat, where phenomenal returns are also a past history, the excess money that got saved by these Hi-flying tech employees has now got channelled itself into the economy in form of Start-up funding. The start-up industry is so lucrative, that few of them among the lots of thoughts and ideas that are in the market and would come in the future is going to become a Google or a Facebook, which makes the wealthy individuals take a bigger bet even at risks that does not have any fundamentals. Each one offering to fund at higher and higher valuations which none would have dreamt off.

Most of the start-ups today are loss making, for example – one of the top stories of India, Flipkart has declared a loss of 2000 plus crores in FY 2015 on sales of 10000 plus crores, and they are still boasting that they have tripled their turnover from 2800 crores last year, while the losses too have nearly tripled in the same period. Why so much losses and whose money is it that is making its rounds here?

The losses are mainly due to discounts allowed on product sales to capture market share & employee cost. If this company has lost 2700 crores in the last 2 years, how are they going to recover these loses, what is their capital? If the losses continue at the same pace, next year the total loss should be 15000 crores.

Why is this done?

To have analytics numbers that shows they are market leaders and when the company launches its IPO, poor investors will throng to buy the company’s stock. And why is this required?

Only then can the wealthy investors who have pumped in money into the company with very high dreams, make big profits.

It is a like this, I am a fool to make an investment into a loss making company, while I am confident that I will find an even bigger fool to whom I will offload and make my profits. The final losers will be the general public who are expected to invest into the IPO’s of these businesses.

Employee cost is another area where these start-ups are exorbitantly high, every student joining his or her higher education, when asked about their ambition, have only one company in their mind, “FLIPKART”.

The fight to have the best talent has become so severe that employees are getting paid in crores along with super lenient employment rules; they get paid holidays for every other silly reason. How can they be productive for the company? That is the requirement now, just that I need to have the best talent, keep them so happy that, if they just stay with the company, the competitor will lose his edge to become more competitive. Same like killing the brick and mortar businesses through massive discounts, this employee hoarding is one more method.

There are so many similar businesses offering the same services and still get funded. Most of them, many users have begun to complain of poor quality in their services. Pepper Tap, Swiggy, Tiny Owl and many others have already been in the news for poor quality of products and services.

The next target on sales for Flipkart is 10 billion dollars for FY16, which will be 65000 crores. One of India’s top FMCG company ITC, a century old company having presence in various segments of the economy, having brands that have prominent place in the country’s population has a turnover of close to 40000 Crores and is reporting a profit of close to 10000 crores. This company is 100 years old. If 2016 sales is going to be 65K crores for Flipkart, even at a modest 1 multiple growth it should have a sales number of 130K crores in 2017, which means every citizen of India buys product worth a Rupee from Flipkart, can this be a reality?

And this numbers are only for Flipkart, while there so many similar businesses looking to have equivalent growth or at least that is what the investors in them are expecting them to do.

All of it shows one clear sign; it is bad that we have got the hint of it so early in a period where Indian economy is pegged to be the world’s best destination for investment at the moment. The start-up bubble is going to get burst far earlier that it is anticipated to.

 

Let’s look at why the start-up funding is required? The thought of start-up funding is to support a business that is just in a thought stage, which requires huge funds before it can even launch its products or services, while it does not have a good revenue of its own yet, to payback for the financial support. Due to which the business cannot get funded by the banks in the traditional way and no bank will fund a loss making company. To get such kind of financial support the investor is given a small stake in the company, so that, he stays in wait till the business begins to generate revenues and the company gets listed through an IPO, where the investor gets his exit route by offloading his holdings in the company to the new investors. In some cases the new investor comes in the form of another venture capitalist, who pays a higher price and buys the same stake from the existing investor. Whatever is the level of entry the final exit route for these investors is through the Equity markets?

Now, it gets a little clear, as to why there is so much awareness getting created about the start-up companies in the form of discounts, publicity and sponsorships. Only then will the name be registered in the minds of common investors, who by then will be craving to have a share of this investment frenzy. Off late I have been getting one out of every 20 investment suggestion requests on how a small investor can participate in the OLA or a Big Basket.

At present it is not at all easy for the common man to invest in start-ups, while soon when the IPO is launched all these aspiring investors will throng to get a pie and that is good enough for the company to issue its shares at a mind boggling premium.

 

Promoters or in these cases the founder or the conceiver of the idea, how much does he make from his idea finally.

The other day it was published on the newspapers that Big Basket has got 800 Crores of funding, this follows the recent 300 crore funding the company had received. With some number crunching it is assumed that the original promoters or founders will have about 20-25% of the equity in the company after about 3 or 4 rounds of funding. In Flipkart it is said that the Bansals hold 7.50% stake in the company. All the rest of the stake is sold at lower valuations, while the advantage they have again is the hefty salaries the founders get after giving away their stake in the company.

A start-up conceives the idea, sells 30% of the company without even knowing how much he is worth, further to that if the idea looks to be interesting, funding keeps happening and he keeps losing stake, he never gets any benefit from the funds that comes in, while his salary and investor commitment makes him stick to the company.

A question I got to answer recently from an aspiring startup….

“How do you decide how many shares to offer in a company, and how do you determine the price per share?

 

Can you please tell me what to do in this case?

 

If a company has 1mn Rs (INR) as paid up capital. Now if this company is getting fund from foreign let’s say $100,000. Now, how to price per share. What other things I should keep my eye on. If you can point me to the right direction that would be of great help.”

 

At the end of the tunnel if the public issue of the company gets blown out, finished, the founder has peanuts from the company. The sad part is that the founders of these start-up companies don’t invest their earnings in a different asset. All the big salaries they earn are again pumped into funding similar start-ups down the line. How many of these businesses will reach the end of the tunnel is anybody’s guess.

 

The present start-up mind-set.

The other day I happened to be in a conference organized by one of the start-ups. The program was to promote a training product for new entrepreneurs. The program will teach about how to become a successful entrepreneur in 15 weeks and it charges 50k for the course. Even if 100 aspiring entrepreneurs take up the course, the company makes 50 lakhs, and from there even if they grow 10X, which is a normal reach these businesses have at least in the beginning, they are looking at about 5 plus crores of business. Whether they make profit or not in this business, these statistics will be good enough to sell the company for a couple of 100 crores and exit. Once the start-up euphoria dies, this business will also go down, while who cares, the founders or the investors who took the initial stake make a killing.

In that conference during the question hour, a girl asked this question. “How early can a start-up make its exit?”

The moderator asked, “Of all the reasons, why do you want to exit your business? Is that the reason for which you want to become an entrepreneur?”

Then the girl says, “At least that is what the serial entrepreneurs want, exit at the earliest.”

Then the next question from the moderator, “Who is this serial entrepreneur? I have heard only about serial killers, who kill every other day. Do these serial entrepreneurs too, do the same, kill businesses?”

Looks like it is true to some extent, kill the business and move on to the new one? In reality they are killing businesses. They fund some one’s idea, take it to a high level and get out, then go out finding another such opportunity. How many great opportunities can a fund find on a regular basis? For the fund that looks for early and smart exits it will for sure find opportunities on a regular basis because it is said that India will have about 11500 start-ups by the turn of the decade, of which about 2-3% will reach the IPO Stage. So, for the later investor, there is going to be only about 20 to 30 companies that will give good growth on the capital invested, which are those companies? At present those companies may or may have not even been conceived.

After a business gets funded, the founder becomes a slave; he does not have any other task in his life, no family, no vacation and at times even no time to take care of himself, apart from slogging it out to meet the super-fast valuations the investors want from the company. Just about the time the founder losses all his stuff on the ideas about the business the investor takes exit by off-loading his stake to an investor who comes in at an even higher valuation. The new investor comes in with expectations to crush the founders even further, of their ideas. Where the steam left is much lower and the business goes down. Already there are many cases of new start-ups finding it difficult to get next level of funding and are closing down operations.

 

One of the Venture capital firm’s head had recently disclosed about the prevailing thought among the new entrepreneurs. A real experience she had recently.

 

A student just out of college comes up with an idea and approaches a VC for funding and requests to have $ 1 million, when he was told that his idea could not be funded. His reaction is that, “Ok, I will find a new idea that can be funded.”

People are approaching the idea of funding in a different manner and not in the real sense of having a business. They think that they can pop up ideas on the go, get the funding, sell the business and look for a new idea. There is no passion on the idea to make it a big business, they just want to come up with an idea that they think is the pain point in the economy, find an investor who can fund the idea, sell the business to them and move out to get a fresh idea. Is that so easy to get an idea, make it into a business and get out making a killing out of the idea? It never was and will not be so anytime in the future.

The benefits this start-up culture will bring to our country.

At present India is the number one investment destination, the most sort after by all the investment communities around the globe. Start-up is one of the lucrative activities which are expected to be worth pushing huge capital. The benefits from this frenzy are tremendous. Whether the investors will make it big or not is unknown for now, while there is going to be a lot of opportunity for the citizens of India from this Start-up euphoria in the country.

Some areas which can benefit are employment, a real lot of employment opportunities are going to be generated and the salaries are going to be unrealistic for the talented ones, money flow will be high. Media will get tremendous business due to advertisements and promotions, infrastructure will grow rapidly and above all the Indian citizen will benefit the most. Commercial as well as residential real estate will sky rocket as there will be a lot of disposable income in the hands of the public and the companies will gobble office space. Assume that each of the business gets a minimum funding of 100 Crores, 11500 companies would mean that we will have about 12 lakh crores of funds moving in India in the next 5 years. It is 2.50 times the total sales of Indian Oil Corporation, the company with the highest revenue in our country. Taken by the numbers that these companies loose in the form of discounts to capture market share, which is at 20% now, it means the Indian public has a chance to get 2.40 lakh crores of money. The distribution of funds is going to be very big; our economy will thrive due to this flow of funds. As most of these investments will be in the technology space, the country will become a super developed one by the turn of the decade.

If a person has to be smart, he should just consume all the discounts and be pretty sure to not invest into the IPO’s of these loss making IMG_2672businesses once they hit the markets. Need not worry about the losses these business are going to make once the bubble gets burst, after all whose money is it. It is the excess money that the ultra-wealthy investors who have become rich overnight not knowing where to park the money, that is being thrown into our economy in the name of capturing market share and building numbers in the thought that they can fool the common investor through the IPO and make a killing.

By the turn of the decade when the bubble is burst, India will be super rich as all of its infrastructure will be world class and its people having a wonderful life, while the losers will be the super-rich who will not mind the losses because after all it is the money that is in real excess for them. We will be witness to one of the classic cases of wealth distribution happening in the next five years. Enjoy the run and get rich.

 

About Author

Ramesh Sigamani

Ramesh Sigamani

With over 3 decades of experience in capital market investments, Ramesh Sigamani is a trusted Financial Planner par excellence. He works personally with individuals and corporates to build a strong investment portfolio that stands firm against market volatilities and delivers time & time again.

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