Startup Funding & Valuation: On a Consolidation Path

Aakash Gupta
7028580424
Email: um16373@stu.xub.edu.in

It looked like the first blood drawn towards the ongoing speculation and prediction of an
upcoming Startup Bubble, when Morgan Stanley marked down its investment by 27% in the
Indias largest ecommerce market player Flipkart which currently has over 45% share of the
Indian ecommerce market and is now valued a little over $11 billion down from $15.2 billion.
Flipkart which has so far raised $3.4 billion and its top investors include Tiger Global, Naspers,
GIC of Singapore, Qatar Investment Authority and Yuri Milner's DST, may look for a down
round (when the company's share is valued lower than what was ascribed by earlier investors)
unless it has enough cash in the bank to fend off an increasingly aggressive Amazon.
Flipkart has been in similar situation before, when funding for tech startups dried up in 2011-12.
It was then bailed out by existing investors Tiger Global and Accel Partners. HSBC cut the
valuation of restaurant discovery and review portal Zomato to $500 million, Indian media
reported on May 9 which had been valued at $1 billion after its eighth round of funding last year.
Devaluation of the biggest ecommerce player in India has also created barrier for the rivals to get
further funds. According to a report in Mint newspaper, Snapdeal has held talks with several new
investors who have refused to invest at its current valuation of $6.5 billion, pointing to the
general belief that the pressure on market leader is bound to create similar issues for other
competitors as well.
The danger of the startup bubble is not only limited to the Indian context but has also engulfed
the entire world. High-profile investor Fidelity has valued down more than a dozen of its
investments in tech start-ups like Dropbox and Zenefits, Fortune reports. Fidelity portfolio
companies with stable valuations included, Uber, WeWork and Snapchat.

In the past, at least 145 private companies including 8 companies in India (Flipkart, Ola, InMobi,
Quikr, MuSigma, Snapdeal, Zomato, and Paytm) have won valuations exceeding $1 billion,
which are referred to as Unicorns. With free flow of venture investments in recent past,
executives at many of these companies went on spending spree to outgrow rivals, recruiting
unmatchable talent or for other reasons.

Today, they stand amidst a difficult choice: cut costs drastically to become self-sustaining, or
seek additional funds. Indian e-commerce players such as Flipkart and Snapdeal witnessed heavy
rounds of capital infusion starting 2014 till end last year as the scale of their business grew
exponentially. This has changed in the last eight to ten months with investors questioning soaring
valuations and putting stress on the companies to improve unit economics.

One of the major reasons for the recent devaluation of the ecommerce companies account for the
fact that they have had huge valuations without generation of revenue and a proper profit
generating business model. Flipkart and other players work on the deep discounting model. All
of them have burnt enormous amount of cash by offering deep discounts and have propelled
massive advertisement campaigns to lure the customers. The argument put forth by them is that
once they acquire customers, which are expected to be loyal, they can gradually increase the
prices and do away with the discounts. However, when putting this argument, these firms do not
account for the fact that customer loyalty is very difficult metric to achieve.

Today, customers have a large number of options available with them, with many firms offering
real time comparison of the products price available across various sites. Consumers are most
likely to go with the company offering the lowest price. Amazon with its deep pockets from its
other businesses is eating into the market share of Flipkart and has recently overtaken Snapdeal
to become the second largest ecommerce company in India. The investors, who are now
pressurizing these firms to break-even, were funding them based on Gross Merchandise Value
(GMV)-driven valuations. The firms ran after GMVs and the easiest way to get the right GMV
was discounting.

Despite the billions of dollars invested in recent years, most of these startups are yet to turn
profitable and investments in them are largely based on speculative future earnings. Investors
are not looking objectively at the sector. They are just seeing a few success stories and ignoring
the failures, just like they did in the dot-com era, said Paras Adenwala, investment consultant at
Capital Portfolio Advisors in Mumbai. This discount led model isnt viable for investors. Until
companies start working on generating profit or at least stop making losses and part ways with
this discounting model, the devaluation is likely to continue. After all, the investors need to
ensure that they get a return on their investment.

Growth, scale, funding, skyrocketing valuations, GMV, and other vanity metrics are fancy terms
which are often flaunted by startups. While investors are backing several me-too startups which
prioritize scale over getting right and viable business, startups are now exploring ways to spruceup the bottom-line. In order to stay afloat, many startups have started looking beyond the
valuations and growth parameters to stay competitive.
As funding gets hard to come by, it becomes essential for a startup to cut costs, usually by
trimming the workforce, bowing to pressure from investors to trim flab and restructure
operations. Major players like Snapdeal, restaurant discovery, food ordering platform Zomato
and online auto classifieds CarDekho have already let go their employees in order to seek
healthier balance sheets. "It's inevitable," said Sunit Mehra, managing partner at executive search
firm Hunt Partners. "In 2014-15, there was huge ramp-up (in hiring) that wasn't done in a
planned manner. A lot of numbers got added just for the sake of adding them."
"These are definitely testing times for the startup ecosystem," said Aditya Rao, chief executive of
services startup LocalOye. "2016 is the year where everyone is trying to re-evaluate their
strategies and put a strong focus on revenues and margins more than anything else." The Tiger
Global Management- and Lightspeed Venture Partners-backed firm laid off about 60 employees
in November, giving them about three months' salary towards severance.
Startups "are being forced to bring down their operating expenses drastically and look to be
profitable at the gross margin level," said Anil Kumar, chief executive of RedSeer Management
Consulting, an advisory firm that tracks online businesses in India.

Snapdeal, which is backed by SoftBank, Foxconn and Alibaba Group, put about 200 employees
at its call center on a so-called performance improvement plan that has led to several staff
exits. In December, Rocket Internet-backed Foodpanda India laid off more than 300 employees,
who accounted for about 15% of its total workforce at the time. Two months earlier, Zomato,
which counts Sequoia Capital and Temasek among its backers, too, laid off around 300
employees, a bulk of them in the United States.
With funding dried up, firms struggling to survive and increase in layoffs across startups, many
speculate the building of the Tech Bubble 2.0 and see the startup bubble burst as an inevitable
phenomena in the near future. Venture capitalist Bill Gurley of Benchmark described this
phenomenon at length in a recent blog post, in which he alleged that dirty term sheets allow
some companies to continue raising money at higher valuations by promising bigger payoffs to
new investors at the expense of older investors. That ultimately could render worthless shares
held by employees and even some founders.

Capital-intensive startups that benefited from easy venture-capital financing are arguably the
most vulnerable to the new funding climate. Empirically, there are so many unicorns that many
of them have to pop, said Jason Lemkin, a venture capitalist formerly with Storm Ventures.
Two hundred and some-odd unicorns won't yield that many billion-dollar companies.
Hundreds of layoffs at several Indian start-ups have sparked fears the bubble is starting to burst
for the country's startups, amid claims by analysts that many of them are overvalued. "The
valuation bubble is bursting. The valuations had reached levels where they were ridiculous and
could not be justified at any level," said Arvind Singhal, chairman of management consulting
firm Technopak.
However, not all is doomed. Many investors feel that layoffs are the need of the hour for startups
that have hired recklessly in the past based on investor backing. Gone are the days when
entrepreneurs attracted investment on unviable and projected metrics. Going forward, founders,
investors, employees, and the media should be prepared for such layoffs as the time for attracting
easy risk capital looks difficult for early/growth stage ventures. The key learnings for startups in

this context are, hire diligently, keep a hawk eye on the burn rate, and make strong business
fundamentals that are not dependent on the investors' mercy.

Another view followed that Flipkart's valuation markdown will help stop the discount-driven
customer acquisition model followed by most e-commerce companies and that there will be
increased focus on finding new metrics of growth. "Flipkart and Snapdeal founders have been
over the last few days talking about logistics, building infrastructure and payments. They know
they are not in a position to grow by discounts alone. These companies have enough data to see
how many customers made a repeat purchase without discounts to understand more about
consumer behaviour," says Satish Meena of Forrester Research. From here on, expect further
consolidation in the coming quarters as investors will want to combine their bets. With that will
begin a second phase of building businesses by India's fast-growing consumer internet
companies.
The deep discounting model seems to be abandoned as companies look to survive the funding
crunch and as a result may not be able to provide discounts to buyers on their platforms anymore.
Additionally, startups will look forward towards getting profitable rather than burning cash
behind scaling and growth. Startup devaluations can be a blessing in disguise, in the sense that
it makes the company leadership take a closer hard look at the current monetization model, reevaluate any fragilities and make strategic and tactical adjustments accordingly, Anindya
Ghose, director of New York Universitys Center for Business Analytics said.
Devaluation is never the end of the road for a startup, it is just a bend around the curve. The
startup just needs to introspect and see what they need to do differently to be able to grow
consistently and create maximum value for their customers and potential investors. While the
funding amount certainly takes a hit after devaluation, the founder should not shy away from
raising lesser funds than expected, because if they use the money judiciously and focus on doing
the right things at the right time, the result will be for all to see and itll only be a matter of time
till they prove their real worth to the stakeholders and get their valuation back in order.
This way they can create more value for the current set of investors and raise the next round of
funds at the expected value. The only thumb rule they need to remember is that they can never

chase a certain valuation. If they focus on the right aspects of the business, the valuation will
automatically take care of itself.
While the early signs of valuation-devaluation cycle lead us to speculate a startup bubble burst in
the near future, it is still early to predict an actual bubble burst specially when the market is
showing signs of recovery through positive course correction in terms of investment, cost
cutting, restructuring of the balance sheets and creating and nurturing a profitable business
revenue model which yields actual profits and not just mere promises. These steps have shown a
return path for the struggling startups to revamp their business and become competitive enough
to survive and grow. Focus on positive and real value creation through innovation rather than
following the already successful business models of other firms will help in the long run to
prevent any negative speculations about the startup environment and will help foster new ideas
and businesses to simultaneously grow and create value for the society as a whole.

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