Why More Is So Less For Indian Entrepreneurs
"The more the investors show interest in you, better the bargain you can strike"
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The disparity between the stakes of entrepreneurs of the two ecosystems (as shown in the graphics below) isn't quite a revelation. The most glaring instance is Jeff Bezos's impressive stake of around 17 per cent in Amazon over 23 years versus someone like Radhika Aggarwal and Sanjay Sethi of ShopClues squandering away almost all of it in just six years. So, the more Indian entrepreneurs chase growth, the lesser equity they hold. Comparisons like these are not of apples to oranges, as many may find it. So what's wrong with our young tech czars?
Equity dilution at every round of fundraising is certain but how much should be diluted - is perhaps something that Indian entrepreneurs care less for. For example, six-year-old hyper-local marketplace, Zopper, has raised around four rounds so far, latest one being $20 million from Tiger Global Management and Nirvana Venture Advisors in 2015. And Neeraj Jain, its CEO and CoFounder, had a realization in hindsight. "Whatever we have raised, I think we have diluted a bit too much."
On The Losing End
While Jain didn't disclose the numbers but he points out couple of reasons for that. First, from the demand and supply perspective of the two ecosystems, there is a lack of investors in India in comparison to the US. That's because more the investors, better are the chances to find the right one at lower equity. Second, how many term sheets you have got on the table? The more the investors show interest in you, better the bargain you can strike.
Then there is value creation that the Valley entrepreneurs understand and Indian entrepreneurs misread it as valuation. The value that the US companies (mentioned in the graphics) have created is ubiquitous. So in the seven to 10-year time horizon from idea to IPO, if you are not able to create much value for your investors then investors will acquire that value by increasing their stake in the business. For instance, Facebook went public in just eight years after its launch in 2004. Even better was Snapchat's time to IPO – six years.
A typical growth scenario in the Valley looks something like this – You get INR 10 for a valuation of INR 100 in exchange for a 10 per cent stake. You grow the company to INR 1,000 valuation in three years and during the next fundraise; investors only seek increase of five per cent to their stake as you created value for everyone. Now here's India scenario – in three years you are able to grow the venture to only INR 200 valuation, so investors would increase the value of their stake from 10 to 25 per cent in the next round. So the equity keeps shrinking at a faster pace.
This doesn't pinch at the early or even mid stage of the business. As it goes higher and the business model and the path to profitability don't seem to converge even as loads of capital infusion happens in multiple rounds, it causes serious damage to entrepreneur's stake.
Kanwal Rekhi, Managing Director at Inventus Capital Partners, who has seen the best of both the ecosystems explains this with an example. "Google started in 1998 raised only $25.1 million in venture capital and profitably went public in 2004. On the other hand, Flipkart was burning $50 million per month in 2016 and they are still burning $20-30 million per month. Facebook a decade later raised $2.3 billion, a lot more before going public. But they did so depending on a very profitable business model. Compare this to bleeding and negative unit economics businesses by companies like Snapdeal. You can imagine how the dilution would be. Why should they get rewarded for a business model that takes forever to get built."
But Rekhi admits that these bad habits are everywhere and not just in India.
What's also noticeable is that Valley companies have evolved themselves into multiple companies under a parent company such Amazon Prime, Amazon Web Services, Pantry, Amazon Business etc., unlike Indian companies.
Global management thinker Anil K Gupta says, "Amazon started out as online retailer, but if you look at their cloud computing, they are ahead of Microsoft, IBM, Google, etc. Bezos has said that his goal is to make Amazon the world's most customercentric company and not the most customer centric online retailer. We still don't see the same ethos in India or China."
As entrepreneurs stuck on valuation to either remain in the unicorn club or enter it, investors too hedge their investments. "Tiger Global gave $10 billion valuation to Flipkart but asked for 2x liquidation preference. At the time of exit, Tiger will get 2x of his money no matter how much stake the entrepreneurs have," adds Rekhi.
Low On Convertibles
Another reason why equity dilution is more in India is because of low usage of convertibles notes typically at the angel or seed rounds. Investors don't want to invest in convertibles because the upside in the convertible is limited. Devendra Agrawal, Founder and CEO at boutique investment bank - Dexter Capital Advisors explains this with an example - Based on data from VCC Edge, initially, Ola had raised angel funding of INR 53 lac at 15.4 per cent stake dilution in April 2011. It was valued at INR 2.93 crore pre-money and INR 3.47 crore post-money valuation. Subsequently, it had raised Series A funding of INR 20.25 crore at 40 per cent stake dilution from Tiger Global in March 2012. This valued Ola at INR 30.37 crore pre-money and INR 50.63 crore post-money valuation.
However, if Aggarwal and Ankit Bhati (Co-founder, Ola) would have issued convertible notes at let's say 25 per cent discount to the Series A round assuming there was no cap – the pre-money valuation for angel investors would have been Rs 22.78 crore. Since the amount invested by angel investors was Rs 53 lac, which means the stake dilution would have been just around 2.3 per cent (0.53/23.32) and the founding duo would have retained around 13.1 per cent stake. Beyond all this, what entrepreneurs should also be conscious of - is how much they want to raise and at what valuation. They should be able to choose the right term sheet among what's available.
This would mean that if there are three investors interested, the entrepreneur must try to have all of them around the same time. "The entrepreneur must understand the approach to the next round as the questions will be different so that you don't look desperate for funding," says Agrawal. More importantly, if there is only one investor then entrepreneurs must communicate that you need to have enough equity in the business to feel motivated. "If you lose interest in the business because of low equity then everyone is at a loss," concludes Jain.
(This article was first published in the October issue of Entrepreneur Magazine. To subscribe, click here)