Those interested in investing in startups should invest what they are willing to lose
The last 18 months have seen some of the craziest times when it comes to investing in startups in India. I am hardly a formal investor or an institution of any means and yet, I get as many as 20 emails a week from entrepreneurs asking if I would invest in their businesses.
These entrepreneurs are, for the most part, building companies that were established market spaces in the US and China. There was no notion of product-market fit: These were businesses that were known to be large in China and the US, and now they are being imported to and adapted for India. For example, an Uber has worked in the US so let’s bring it to India. This is what I refer to in my book The Golden Tap as the ‘this-of-that’ strategy. The entrepreneurs would quickly find angel investors and venture capitalists (VCs) and say that we will be the first funded and make sure that in this race we will emerge the farthest ahead so that we have the best shot at raising the next round from global investors like Tiger Global and Softbank.
So it became this copy-paste model and built high momentum really quick—20 people will enter that race of which 10 will raise VC money of which two will raise global fund money; those two are the winners.
This frenzy has led to what some may say an ‘unhealthy race’ where a large number of entrepreneurs are only focussed on raising money and not on growing the business.
I’ll illustrate this with two examples of companies that I invested in.
In one instance, there was an entrepreneur building a company for hyperlocal delivery. This was a young person out of Flipkart (along with a few colleagues) and a bunch of angels who are also my friends met him. They dissected the business for 2-3 hours and concluded that it had good potential as “we see local deliveries going up in India quite a bit”. At that time, the hyperlocal space had not heated up and so, there was this belief that this is a good space to be in.
One of the angel investors in the group was an analyst at a VC firm and he was talking to his boss, who said, ‘Why don’t you bring him to us as we also do early stage investments?’ As a result, the VC intercepted the deal before the angels could make an offer—in 24 hours, the VC closed a round of Rs 4 crore while the person was looking for Rs 1 crore.
And then the VC said they would handpick a few angels and give them a chance to put in a few lakhs. I was one of the few ‘chosen angels’, so I made an investment.
I didn’t hear from the entrepreneur for four months and the next thing I heard was that those Rs 4 crore were over. He’d spent all the money in building capacity. He was third in India [in his vertical] but since he’d not been able to raise another round of money (while the top two had been able to), he’d have to close down.
The entrepreneur moved on to the next thing. The company was ‘acquired’ by another hyperlocal company but none of the shareholders saw any money or stock. In hindsight, I should have met the entrepreneur and assessed how he was thinking about the business. Instead I felt comforted that there was a VC involved. That proved to be a false comfort.
This is representative to what happened to a lot of companies (and investors) in the last few months. They weren’t able to raise the next round and since they were building a business that was basically all about momentum, it became very hard for them to sustain.
This investment left me feeling remorseful, as this was not the way I usually invest. Here there was a bit of greed and, also, fear that got into me— the greed of investing in the next big thing and the fear of missing out. It is a bit like investing in real estate. You buy thinking this area could appreciate due to, say, a highway coming up, and when others move in, you look to sell on the momentum. For many investors, it doesn’t work out like that.
I almost always invest in companies run by people I have worked with in the past or have known for very long. These are all businesses that I would have loved to build but since I can’t build 20 businesses, I do the next best thing—I invest in them. For better or for worse, I have been happy with that and if things don’t go well, I don’t feel bad as I am into the person or the idea.
Another company that I have invested in is a food delivery company started by a repeat entrepreneur who is level-headed and not interested only in the valuation. He started this company well before the momentum in the food delivery space had begun. When the sector became hot, he raised VC money at a sane valuation.
In the summer of 2015, the meetings used to have this, ‘Hey, we just raised money and so what stories do we need to tell and what numbers do we need to raise in the next round?’ This company was not an exception to that trend. There was a lot of interest in the ‘next round’ [from most companies]. But at the end of August, the China market crash happened followed by the Nasdaq going down by 10 percent. That was a huge event for the Indian market. That is when a bunch of global funds decided to take it easy. Angels also slowed down as a result.
The company decided to take it easy and do some work and reach milestones, thinking they would later raise funds at a larger valuation. Now the focus was on unit economics and not just growth.
The entrepreneur started taking tough decisions. And instead of making food from lots of different chefs, he created vertical kitchens through cold storage and a lot of tech and only delivered to pin codes where it was economical. In December, the company posted its first profitable month.
I am invested in 25 companies now. The ones, regardless of whether they are doing well or not, I am happy about are where the entrepreneur is committed and passionate and continues to make a difference. The ones I am upset about are where I made a decision out of fear and greed. That would be one in five companies.
I would be surprised if out of 25, more than five return money, and this is something those looking to invest in startups need to be very careful about. Only invest what you are willing to lose.
The best deals come from entrepreneurs who are not looking for money. You have to get your way in and say please take my money. It is about meeting a lot of people and getting connected to entrepreneurs.
My suggestion would be to keep it informal and look at closed networks. Use these events (Nasscom, yourstory.in, TiE) to get into the networks.
Mostly though, if you see a business you’d want to build but can’t, you can do the next best thing—invest in it.
As told to Samar Srivastava
KASHYAP DEORAH is the author of The Golden Tap. He recently set up his fourth company, Hypertrack