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Firm truths: Investing in start-ups is almost a science

business Updated: Aug 29, 2015 23:58 IST
Suveen Sinha
Suveen Sinha
Hindustan Times
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The fellow on the phone sounded dejected. He is the co-founder of an up-and-coming start-up in Bangalore, but has a problem socialising.

“Whenever I meet someone and say I have started a company of my own, they give me a look that says, ‘oh, yes, why not! There is so much money going around’.” That makes him feel like a money vending machine.

His discomfiture may not last long, going by a spate of reports in print and digital publications that say less money is flowing towards start-ups now, and it is taking longer to come through. These reports also suggest that investors are waking up to the prospect of a valuation bubble. That when the bubble bursts, it will leave quite a debris of fallen start-ups.

The reports point to several signs. They say a famous start-up has been talking to investor for months to raise more money but has not made much headway. That another has raised a round at a valuation either the same or lower than that in the previous round. They say investors are taking much longer to sign cheques, unlike last year when a deal could be closed in just a couple of weeks. They highlight the high rate at which online market places burn cash as they cajole sellers to give deeper discounts. Yet another report says valuations of Indian start-ups are being scrutinised because of the fall in market capitalisation of new age ventures in the US and China.

Really? Where is this talk going? Let’s ignore comparisons of privately funded Indian start-ups with e-commerce companies listed on stock exchanges in the US and China. They belong to different worlds. And investors in stock markets are a different species from those who put in money in the early stages of a start-up.

Early investors in a new company come in not for the promise of profits it exhibits, but because they think it will one day change the world. That is the reason why, as the FT pointed out, the fledgling Tesla Motors is valued at about half as much as the stalwart BMW, although BMW sells 35 times as many vehicles. If the promise of changing the world is fulfilled, profits will come in a deluge.

That is the rationale – or lack of it, some would say – for investing in start-ups. It is established that seven out of 10 – some say nine -- will fail. But the three that work – all right, one -- will make you very rich. What’s more, they will leave you happy and satisfied. That is the way of the start-up world. It you are too soft for it, don’t come in.

That does not mean it is the refuge of the irrationally exuberant. If you talk to the investors who take early bets on start-ups, they will tell you it is a science. Ravi Kiran thinks of VentureNursery, which he co-founded three years ago, as having the same rigour as a top-flight business school. As many as 400 start-ups, he says, apply for each of its 90-day accelerator programmes. Only two are selected. At the end of the programme, they make a presentation before VentureNursery’s members, who decide whether the start-up is ready to graduate and seek venture funding. It is a stiff examination. Not all pass.

There are other methods that investors follow. But all of them are very particular about a few criteria before signing a cheque. Everyone looks carefully at the team, market, business model, sustainable differentiation, deal, and pricing.

There are variations within this framework. Some investors invest more in the market, others more in the team irrespective of the market. A third category does a mix of the two. The head of a highly successful VC says he is more biased towards the team but he has to believe in the market. And he likes his founders to be missionary and visionary than mercenary. Missionaries and visionaries attract the best talent.

Finally, all investors look for entrepreneurs who build to last, not build to sell.

By this time, you may be wondering if this is entirely science. Maybe not. But if you wanted to go entirely by science, you would not put your money on Tesla. For you, there is always BMW.