Growth To Continue, But Valuations Investors Are Willing To Ascribe To That Growth Have Changed
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Valuations and funding are two key words that have been trending this year. With India’s prestigious unicorn Flipkart suffering two major markdowns, investors are now beginning to scrutinise funding more carefully.
This also sends out a strong message to entrepreneurs, that it’s not all rosy out there but it’s not a bed of thorns either. One needs to carefully analyse their business models and show unit economics and scalability to secure funding.
Entrepreneur Media asked Suresh Shanmugham, Co-founder and Managing Partner of Saama Capital, on how he thinks investors would approach this season and what should entrepreneurs consider before approaching an investor.
What are the main reasons for the fall in valuations of start ups?
When the angel investors see value in the propositions put up by the startup companies they back them with funds. About three years ago a new round of venture funding activities took off in India as angel investors saw great value in many Indian start-ups. Most of them also got funded liberally in their series A and B rounds, but the valuations became euphoric when the large hedge and pension funds joined the party.
With the benefits of the hindsight, now it appears that valuations were on the higher side for most of the startups. But you can’t blame the entrepreneurs or the investors for this as it was the function of the heady times when expectations were high and high valuations were ascribed to growth.
The crack in the spiral in valuations was triggered by the weakness in the China market starting back in August 2015. That was when the investor side of the table quickly realised that the market had shifted and aggressive valuations paid for high growth in companies were going to be significantly hit. It took the entrepreneurs longer to accept the market had changed. Many initially expected this was short-term downturn that would quickly revert to its prior trend.
Based on my experience in the US, I can say that there is a period of market outlook mismatch that needs to equilibrate. That takes about 6 to 9 months time to work down from the late stage companies to the early stage companies. We are well into that period now.
Will 2016 see more of VC and PE activities in India, and if so why?
India continues to be attractive as investment destination. More funds are coming and more money is being raised in India-focused funds. But that does not mean all this capital will be invested in 2016.
With the easing of valuations investors see much more risk to businesses because of the tighter private capital market to get the next round of funding. They also demand a lower price/higher return to compensate for the added risk. Growth in companies will continue but the valuations investors are willing to ascribe to that growth have changed. Demonstrating business viability through attractive unit economics (transaction level profitability ) is the focus now. The next step is getting to positive cash flow and then profitability.
What should be the strategy and key focus areas for investors in 2016?
With the valuations getting reset, the investors will be very strict in terms of where the money is being utilised. They will now work more closely with their portfolio companies trying to get their cost structure down and get follow-on fundings done. Surely, more time will be need to be spent working with the portfolio companies rather than investing in new companies. We will also focus on how to best utilise the resources, stretch it to the extent possible to survive, and achieve savings wherever possible. It’s all about becoming much smarter about how to use the cash.
Amid weak funding which are the domains that are likely to get funded more?
Investors should continue to focus on entrepreneurs who are committed to building valuable companies and sustainable businesses over the long haul in a more capital efficient and scalable manner. Saama’s investment approach places great emphasis on the entrepreneur, their passion, experience, ability to recruit talent which is critical to the success of any venture. Saama’s view is attractive investment opportunities can come from different sectors.
Saama does not focus on specific sectors but examines the fundamentals of the business and realistic valuations when exploring an investment opportunity. We look at markets and companies that have the potential to generate significant returns.
Impact of new FDI norms in e-commerce
It is still too early to tell. Everyone is taking note of what has been provided by the Government and is trying to understand what it means first, and then, what needs to be done from an implementation perspective. Since we are so early in the 2017 fiscal year, it will take time to get the clarity on these changes.