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Here's Why Investors Believe that Funding Sick Start-ups too Can be a Smart Move

"Big companies have the strength of tech and human resources and a vast customer network that start-ups need"
Here's Why Investors Believe that Funding Sick Start-ups too Can be a Smart Move
Image credit: Shutterstock

2017 began on a sad note for start-ups, especially in India’s Silicon Valley Bangalore with many rolling down their shutters, failing to put up with the difficult times that have befallen them.

Many still are clutching at straws, trying to sail through “this one last time”.

India was witnessing a big boom till 2016, which reached its peak in 2015, with the blooming of new-age, innovative and tech-enabled start-ups. But, the ecosystem has always been unpredictable and volatile, where some entities grow exponentially and some are forced to roll down their shutters and some are caught in between — somehow managing to stay alive.   

Four years after bringing in a revolution in the retail sector with his e-commerce company Flipkart, IIT Delhi alumnus Sachin Bansal was forced to pull curtains down on DigiFlip, a section of his venture that sold computers and accessories.

So what happened to the Narendra Modi government’s ostensible campaigns like “Start Up India, Stand Up India’ and 19 exciting schemes that were supposed to shower founders of enterprises with bounty of facilities never conceptualized before?

Demonetization — What it Meant to Biz Community

In 2016 alone 200 odd start-ups had to die an unnatural death in a system that had once portrayed a rosy picture. All the hullaballoo and euphoria had suddenly given way to despair and darkness.

But, the problem lies somewhere else. Till November 8, 2016, India was one of the world’s fastest-growing economies, registering a growth rate of over 7%.

A senior IMF officer even claimed that until demonetization, there was “healthy consumption spending” in India, which pushed the overall growth.

The global economy had already started showing signs of slowdown. Against this backdrop, PM’s ostentatious demonetization move apparently increased the problems for the business community, which wondered what their ideal step should be.

How Start-up World Reacted

In the vibrant start-up world, experts saw it as a great gamble, which can make or break their fortunes. But since then the fate has been fixed and clear. Very few enterprises could actually be past masters at registering growth — some were biting the bullet while others were biting the dust.

How Investors Reacted

What must have been the investors’ role and move when start-ups were shutting shops? The open-hearted investors with loose purse strings turned thrifty overnight, setting more stringent conditions before extending a helping hand to a dying start-up.

But, investors have never openly blamed demonetization for their change of stance. They have always defended their prerogatives with the list of criteria that they have set for investments.

Nevertheless, their roles in start-ups are growing with time. The sudden resignation of Uber CEO Travis Kalanick underscores this statement. Kalanick put in his papers allegedly under pressure from investors, who are increasingly getting involved in shaping up the fortunes of small enterprises.

The several ventures are found to appoint professional executives as chief operating or business officers at the instruction of investors.  Entrepreneurs are left to deal with tougher market situations.

Entrepreneur India has contacted with four investors to analyze how they are helping dying start-ups and what criteria they set for them.

Prasad Vanga, Founder and CEO of Hyderabad-based Anthill Ventures, is of the opinion that investors often look for strategic deals. “Such deals add to our portfolios as well,” he says. Vanga considers it necessary to keep the entities alive. It will prompt another group of investors to pump in money at the next level.

Deepak Agarwal (AVP of Ideaspring Capital) and Vikram Gupta (Founder and Managing Partner of IvyCap Ventures Advisors Private Limited) are on the same page so far as the criteria for investing in a sick start-ups is concerned.

“Only investors who have an active plan to revive the business of a dying start-up should come forward to help lend support with a team that is aligned to create value. We invest in companies where we bring active support from our mentors from the IIT Alumni ecosystem since IIT Alumni Trust is our anchor investor,” says Gupta.

In addition, start-ups should be available at lower valuations for investors, adds Agarwal.

For Pratik Selarka, Investment Analyst at VentureEast, investing in dying start-ups is beneficial for both entrepreneurs and investors. While an entrepreneur gets another chance to build a sustainable business, investors may cash in on the opportunity to make good returns as the entry valuation is low.

What Kind of Help Start-ups Need

Resource sharing is one major help that investors provide to start-ups. “Big companies have the strength of tech and human resources and a vast customer network that start-ups need. Some big firms have even started incubators/accelerators to serve this purpose,” says Selarka.

Indian corporate giants should come out of their rigid mindset of building all their products in-house and rather start acquiring tech ventures, he adds

Such investments actually add innovation to the business models of small enterprises through a variable rather than a fixed cost structure, Gupta asserts.

Parameters

Gupta clarifies that a complete understanding of the business is an absolute necessity to add value to it. “You should have a good team that will save the ‘sinking ship’, in addition to adequate funds.” He stresses that it is equally important to have an exit plan in place before engaging with a dying enterprise.

Selarka advises investors to follow their instincts and study the changes in the market that will help start-ups become successful again. “Every investor has his/her own reason to back loss-making ventures. We look at the scalability quotient of an idea. VCs don’t make profit,” Vanga adds.   

Precautions

“Perform a detailed assessment of the future projects of a business before investing in it,” says Gupta. Investors must have a clear understanding of the competition and a product’s ability to sustain that, he adds. It goes without saying that market forces play an important role in business, and analyzing the market size of specific products or services is important before investing in a start-up, says Selarka. Investors should always count on the liabilities that a deal with a failing start-up brings before signing it, says Agarwal. All of them were unanimous on one factor — founders’ vision should align with investors. 

Investors’ Role Post Buyout

Vanga terms the investor as a facilitator and founder as the key person who has to do the business. One most important factor is the owner of a venture must be open to ideas and guidance that an investor provides. An investor’s role varies from individual to individual, says Gupta. “If acquisition has happened for acquiring an asset or an IP, profitability may not be an immediately criteria,” he adds.

In case of sick ventures, an investor usually tries to involve in day-to-day operations to ensure they are doing the right thing, says Agarwal.    

Deadline for Earning Profits

All four are of the opinion that there could not be any fixed deadline for earning profits from ailing firms. However, Vanga says investors mostly don’t expect any handsome return and they are never making profits. But even if they do, it is never before 10-12 years.

He, however, clarifies that seed investors and angel investors fix five years after which they start expecting the fruits of their investment. “As an investor, you are really lucky if you get some returns in 3-4 years,” he adds.

Agarwal prefers to set specific goals like cost-cutting for a certain number of months to make sure the enterprise he has adopted is moving in the right direction.

How Crucial it is for Economy

It must be noted that start-ups have generated employment in the country. These days, young professionals are found to prefer working with start-ups rather than big companies. Gupta opines that investment in failing start-ups is positive as it is gradually becoming one of the biggest contributors to the Indian economy. Agarwal says the trend is crucial as many good companies die because their timing may not have been right. “If we pump money into sick enterprises, which have potential to do good, they will scale and benefit the overall economy,” he adds.