Zembla, Zenda, Xanadu:
All our dream-worlds may come true.
Fairy lands are fearsome too.
As I wander far from view
Read, and bring me home to you.
This is the dedication of Salman Rushdie’s famous, “Haroun and the Sea of Stories”, a phantasmagorical novel for children underscoring important themes like expression, censorship, creative genius, and the need for storytelling. The dedication itself is an acrostic, where first letter of each line ultimately ends up forming the name of his son, Zafar, to whom the book is dedicated.
Haroun and the Sea of Stories is a story of a young boy, Haroun, whose father, Rashid Khalifa, the famous storyteller loses what is his gift of the gab one day. The reason - his wife and Haroun’s mother, Soraya, runs away with their sketchy neighbour. Following which the invisible story tap that brings all the stories to their house gets disconnected by Iff the Water Genie. Haroun now travels all the way to “Kahani”, Earth’s second moon, where the secret “Sea of Stories”, the source of the story tap, is situated. On his quest to get the story tap started again, he explores an entirely different world of water genies, talking hoopoes, and most of all, the world of stories.
When Rushdie calls fairy lands fearsome, he couldn’t have been more right than ever. In a world fraught with War, post-pandemic economic hiccups, interest rate hikes and a general wave of uncertainty, one can only dare to imagine what the breadth of fearsome could hold. In the dream-world (as Rushdie calls it), the Rashid Khalifa’s are full of ideas, selling stories that inspire, earning a fortune for themselves and for those believing in these stories. Until one day, when the story-tap shut.
These Rashid Khalifa’s are no other than our startup founders, and the story-tap nothing else than the fortune that these stories create.
But who shut it? And why?
The state of the union
If you’re curious, or on the path to becoming wise, which is nothing but transformation of acquired information into sound judgement and the ability of making decisions, which for the most part turn out to be right; then you, my friend, would have at least once in your life asked, “bro what the F?”
If you’re a founder, or someone working in a startup, or someone who is simply interested in closely following this ecosystem (in India or otherwise), you would have heard of the “money tap shutting”. The money tap is nothing but the funds that startups raise from Venture Capitalists (VCs) or Private Equity firms. (We’ll primarily focus only on VCs for this stack though).
The money tap shutting is a big news (obviously) as with it shutting, it shuts out the new founders who are banking on the VCs for fueling their ideas with capital, or those who wanted more runway for their existing startups - a) to keep up the current scale of operations and grow further, and b) to keep their valuations intact - think a $5 Billion company not having enough funds, even a news of this kind can do more harm to their existing valuation than making losses for few years in a row.
The important thing to ask in such a market is, besides the obvious (unavailability of funds), what happens when that ever flowing money river dries down? AJVC very aptly describes this phenomenon as “when times are bad, skeletons start falling out of the closet.”
And this is exactly when you ask “that’s alright, but what’s the F this is all about”? To which I’d say, there’s not one, but 3 Fs that define the market character when the tides are tough - Failure, Frauds and Fear.
A) Failure - Among other things, success is also a function of tailwinds, and frankly, lots and lots of it. It’s easy to be a successful startup, when everyone around you wants you to be one, as if betting on your success implies theirs too - entertainment industry needs a Shark Tank equivalent for TRP, media wants a early seed success story to print, VCs need a 3x exit in next valuation, and would-be founders want a groundbreaking story of a hero founder to look up to.
Versus, when there are headwinds, and no matter how good an idea, markets would just push you to your very own p90th potential to sell not just a story, but one backed with numbers everyone else can believe in. Because even when nothing sells, numbers don’t stop adding up.
Well, stories that sold a lot in 2019 and couple years from it (the unicorn days), stopped making sense all of a sudden when the tides were bad. Here’s how it manifested itself in the recent years:
Failing startups, lack of PMF, broken business models, no sight of revenue, hard to create profit pools, are all signs of startup staring at the failure spectrum. Interestingly every successful startup would have, at one point in time, faced these challenges (hence, a spectrum). But when the market itself is bad, demonstrating these traits can be symptoms of a classic failure. While 2021 saw India birthing unicorns left, right and centre; years 2022 & 2023 have seen a paradigm shift in this trajectory from seeing some of these stars rise, to seeing them shut shop, all too soon. Bikayi, Sequoia and YC backed startup halved its workforce, and got pulled out of its $1B valuation deal, when it had to deplatform half of its merchant base because of them selling counterfeit products. Among other issues, their tech stack and customer support was seriously criticised by their users, from end user being unable to add products to cart to not knowing where to raise a ticket from, merchants clearly lost trust in them. Last year, Nandan Nilekani backed ShopX, a B2B e-commerce platform, shut down its operations after having filed for bankruptcy. ShopX had raised $56 million across multiple rounds, and had pivoted from just B2B (connecting brands with retailers) to a B2B2C model. The startup shut shop because of low margins and extremely high costs associated with sourcing & supply chain management for retailers. Things got even worse in ed-tech (an already saturated market now seeing consolidation) where startups such as Udayy, Lido, Super Learn, closed its operations. Lido is a story of over-dependence on funding rounds to meet even the company’s op-ex (operational expenses). A k-12 ed-tech startup, Lido has left many parents without any sight of refunds for the fees they had taken EMIs for. Udayy, another k-12 startup, pulled plug on its operations because of high CAC and lower retention rates, especially when schools reopened after the pandemic.
In times when businesses want to save the runway for growing profitable lines of business, big shots like Swiggy, Ola, Meesho and Unacademy among others, have invested in restructuring, i.e. cutting down their cash burning and unsuccessful LOBs. Swiggy shut down its meat marketplace, Ola & Meesho shut its food and grocery businesses, and Unacademy closed its primary and secondary school business.
Valuations going down, the important thing to ask is why do devaluations happen? Like public markets, private markets are also exposed to the laws of supply and demand. In a situation where startups have less incoming demand from VCs versus more supply (willingness to sell equity for raising extra capital), going through a series of devaluation is common. Keep in mind, not every startup gets devalued. Bad times are like catalysts for market participants to course-correct and get a fair value. For startups which had super high valuations, yet lack of numbers to back it up (actual sales, revenue, retained user base, CAC to CLTV math), it’s only fair for investors to go back to the drawing board and fix what they got. Meesho, a social commerce startup, got devalued by 10%. This got even worse for the likes of Swiggy and BYJU’s whose valuation got halved - Swiggy down from $10.7 billion to $5.5 billion, and BYJU's from $22 billion to $11.5 billion. Same is the situation for Ola, which got down by 35% to $4.8 billion, and fin-tech startup Pine Labs which had its valuation cut 40% to $3.1 billion. This also follows the trend in the public market, where the tech IPOs saw value erosion right after going public, i.e. shares tanking 25-75% from their initial listing price primarily because of poor financial performance coupled with global macro-economic headwinds.
Pending IPOs, good times coupled with good actors can create legends, whereas bad times even though coupled with great actors, can not even create stars, at least not immediately. The IPO business is very similar. If you’re going public, you need to know that the market is ready to accept you, or what’s more, put you on a pedestal (exactly what happened with the oversubscription of tech stocks in 2021). But when times are bad, meaning, inflationary pressures, interest rate hikes, and an uncertain, grappling-with-war economy; equity markets are not best equipped to make stars out of good actors. This makes you think that companies withdrawing their IPOs might not be doing it only because of self-introspection (which should ideally be the case), but they are also doing so because an IPO is a rite of passage in the life of a startup, and no founder would want to do it wrong.
Silver lining lies in the fact that as the market gets better, we will see a wave of tech IPOs coming in, even more fiercely than before, as raising in private markets has become difficult, making it big in the public market will be the next step in the logical progression for many of these blue-eyed startups. While 2021 saw about 11 tech companies getting listed (PayTM, Nykaa, Zomato, Nazara, Policy Bazaar etc), this went down to 3 in 2022 with Delhivery, Tracxn Technologies, and DroneAcharya going public. Presently, the count is only increasing for startups which have either withdrawn their IPOs or were asked to refile their DRHPs (Draft Red Herring Prospectus - the preliminary offer document to float an IPO prepared by Investment Banks). While this space picks up slowly, startups will work on getting their financial health right, and match up to their bloated valuations, in the interim.
B) Frauds - The 2nd F is well, Frauds. Throw a rock and you might hit a startup alleged with fraud, financial irregularities, or questionable audit practices. BYJUs’, BharatPe, Zilingo, Trell, Broker Network, Housing.com, GoMechanic, Phablecare, Mojocare, are some (some, really?) which made headlines, and for all the wrong reasons, of course. The modus operandi of all of these frauds is generally the same - founders splurging VC money on family or relatives in the name of business expense, audit and reporting discrepancies (ways of recognising revenues and losses), or financial irregularities (misreporting sales or key growth and revenue metrics).
BYJU’s which was recently raided by ED, is in a soup for a possible big-time audit lapse, Deloitte which recently resigned as BYJU’s auditor did so as the ed-tech major has been reported to not have prepared its financial statements since 2020-21. Unhappy parents with no sight of refunds is a common theme here as well. GoMechanic, Trell & Mojocare all Sequoia backed startups were reported to have governance lapses, auditing discrepancies and financial irregularities, to an extent where revenues were overinflated and funds divested in some cases. Ankiti Bose’s Zilingo, is an exceptional case in mismanagement, cash guzzling, toxic work culture and spat between founder and their key investor, Sequoia’s management. Across all stories, an underlying trend that comes out is that of investors being blithely unaware of the ongoings in their portfolio companies, and founders taking due diligence and governance all the more casually.
C) Fear - “Fairy lands are fearsome too”. Funding winter reminds one of the fact that every stakeholder in any dynamic has something to lose. The fear of losing what you have (moat, market share, share - anything) is what the present time is characterised by. Underlying reasons and after-effects of the current situation are as follows:
Layoffs, as per a MoneyControl report about 94 startups have laid off close to 26,000 employees since 2022. Some of this is direct impact of either the entire startup shutting down or a business vertical getting completely scrapped, while a lot of it may be strategic restructuring and pure cost-cutting initiative.
Lack of runway, with no sight of future funding or when the money tap may resume, startups are getting cognizant of the capital runway available to them for their operational expenses, capital and customer sustenance costs.
Compliance and regulation, this remains a grey area as even startups with an established PMF might have to pivot and find a safety net in conventional business models, due to uncertain government directives. Think, Slice and Uni which had to overnight forgo their PPI based credit lines, because of RBI’s guidelines with respect to Pre-Paid Instruments and Credit Loading. Since disruption is new for disruptors and those getting disrupted, it’s going to be a long way before the two find a common ground to complement each other, and draw the regulatory fine lines for the players to operate in.
Brand and brand image, fear is associating with someone who would tamper your brand name because of theirs. No one would want as less of this as VCs who are seen as the evangelists of growth and incubation. With the recent mishaps with Sequoia’s portfolio companies such as BharatPe, Zilingo, Trell, GoMechanic among others, Sequoia split into three entities, Sequoia US & Europe, China and Sequoia India, which would also look at its South East Asian portfolio and is being rebranded as Peak XV Ventures.
But what are the 3 Fs (Failure, Frauds, Fear) pointing to - why would something that peaked once, fall flat? Or does that sound familiar?
Introducing Iff the Water Genie & Walrus
And they are bubbling to ask a question bubbled up inside them about bubbles, only to ask “how much bubble is too much bubble?”
Iff the Water Genie is the caretaker of all things Sea of Stories, and works for Walrus, Head of P2C2E (Processes Too Complicated To Explain). While Walrus is in charge of all water subscriptions from the Sea of Stories, Iff the Water Genie connects and disconnects the invisible story tap connection from the subscribers’ house. These valuable creatures take care of P2C2E to ensure stories keep brimming the world, and that these story subscriptions continue seamlessly.
Real world is full of P2C2E’s. So many of them, that we can mistake correlation for causation and vice versa. For the money tap to have shut, it should have started somewhere in the first place. What is this tap, where does it come from, who shut it, and why?
PART 1: How does the money-tap work?
The answer ties back to the history of Venture Capital itself. The Venture Capital industry might be as old as 1946 when ARDC collected funds to invest in ventures of WW2 soldiers. But the modern day tech venture funding as we know it today, is a gift of Arthur Rock, who first coined the term ‘Venture Capital’ and was one of the first VCs in Intel, one of the world’s largest semiconductor company. But how did Intel come into existence? Or how did the semiconductor and VC industry both extremely necessary for this insane, exponential compounding of tech first come into place?
Would you believe me if I said not more than 10 humans in history alone could be majorly responsible for this.
There were 8 employees working under Shockley, at Shockley Semiconductor Laboratory. Unhappy with Shockley’s management style, this ‘traitorous 8’ left Shockley to start Fairchild Semiconductor Company under Businessman Fairchild’s aegis, whom they met through Arthur Rock. Fairchildren then went on to start Intel, AMD among many other hallmark enterprises. One of these 8 fairchildren (as they were called), took a slightly different path, and opened what was a Venture Capital firm called KPCB in 1972. Years later, one of the employees at Fairchild Semiconductor Company, Don Valentine took notice of the immense potential that the sector had and how badly it would be in need of money to build, innovate and disrupt. Which led to what we know as Sequoia Capital. (More on this here).
(Photograph showing the Fairchildren, or as they were known ‘the traitorous eight’.)
With this background, it becomes easier to answer a few questions.
Why Venture Capital? Because traditional financial institutions like banks would not fund ventures which only have ideas. Banks need collateral, assets and numbers which young startups, especially technology startups do not have simply given the nature of the business. Hence, need for a new financing type, called Venture Capital.
Where do VC’s get money from? VC’s get money from large institutional investors such as pension funds, insurance companies, financial firms, and university endowments, or even HNIs - all of which put a small percentage of their total funds into high-risk investments. These investors expect a return of 25-35% per year over the lifetime of the investment. And since these investments form a very small part of the institutional investors’ portfolios, it gives VCs a lot of latitude vis a vis investing in multiple companies across sectors & take big bets.
How do VC’s make money and what are their costs? First, VC business is not an expensive one. Besides operational and salary expenses (which forms the major portion though), there’s not a lot that goes out of the pocket. And how does VC firm pay its cost, or make money? A typical VC fund has a life of 10+2 years, with 2 years being extendable for best performing investments. Over the life of the fund, VCs typically charge a 2-3% management fees, and take a 20-30% share in profits. Let’s understand this through an example. A VC firm raises $100 million, and charges 2% management fees, with 20% profits sharing. This implies, over a life of 10 years, VCs will have $80 million to invest ($20 million being management fees across 10 years). The idea is to 4x or 5x this $80 million, i.e. increase the fund value to $400 million in 10 years, which yields 20% profits to VCs, i.e. 20%*$300 million = $60 million.
How do VC’s compound value? The above example tells us exactly what a VC needs to do in order to create value. But how do they do so? How does $80 million become $400 million in 10 years, i.e. almost a 20% CAGR. VCs invest in a breadth of firms but in selective industries - they choose industries which can be forgiving as a whole than a few select companies. Successful exits either on sale to PE firms or taking the startups public, i.e. IPO, helps them realize value.
PART 2: When the tap worked fine
Year 2020 was the year of Global Health Crisis.
Year 2021 was when India had 47 unicorns all in a year, and $42 billion pumped into venture funding.
What changed, what worked in this industry, when all else fell apart?
The pandemic gave a great thrust to technology companies as technology literally became the linchpin saviour of the modern world - think education, businesses, health, social - everything came online. While the industry itself had great opportunity, what it needed was capital, to which there was no dearth and here’s why.
Central Bank interest rates fell to 0, a move made by FED and central banks across the globe to keep the economy up actually resulted in capital becoming cheaper, implying lots of excess funds available to be deployed in growing markets. This led to many venture capitalists receiving surplus funds, with fund managers wanting to get these rid off of their hands as quickly as possible, in a hope of 3X-ing it in the next valuation or exit round, which were going to be many, in this timeframe.
China + 1, besides USA, China’s startup ecosystem is supremely robust and has yielded compounding returns to investors in the past. However, with the global pandemic, and inherent resistance to invest in China, especially at a time when firms were shuttering shop there, funds divested more easily to India than ever before.
Being prepared, while a lot of the above is global and macro, the funding bath in India was also a well deserved one. A 15-20 year old ecosystem, Indian startups had by 2021 revolutionised and challenged the status quo in many ways than one could imagine. The tailwinds brought in by the venture capital industry coupled with actual on-ground talent and innovation, acted as a fuel to fire - and rest is history.
PART 3: And then the tap shut
Well, at least for now it is.
Folks speculating whether this was a bubble and that the world went slightly overboard with the party? Sure. As a race, we are either innately optimistic or extremely pessimistic, and the sad thing is we can’t be both together. Had that been the case, we’d grow linearly, but we shift baselines in booms, and we hit rock bottoms in bursts, because we don’t hold on to our beliefs as much as we want to. For eg: If we fundamentally believed in the story told in 2021, we wouldn’t be seeing so many devaluations today, it would have been priced right in the beginning itself. But for that, we would have had to also believe in basics of cashflows, revenues and losses, which no one bothered asking when times were good.
Anyway, moral lectures saved for another day.
Why the tap has shut suddenly now is because the capital went where it came from. Also known as tourist capital, the capital pouring in primarily from US & China shut its tap slowly and all the way into 2023 as global headwinds painted the entire world differently just within months. Russia invaded Ukraine, creating a world wide inflationary pressure. To curb down inflation, FED increased the interest rates, followed by all major Central Banks globally. All of this meant - a) value erosion in equity markets, and b) expensive to raise capital and deploy the same in private markets.
This also points to another failure in our own ecosystem, we do not have a lot of India based Venture Funds, funded by institutional investors of India itself. Why do we need more of these and reduce dependence on tourist capital?
When rupee depreciates against dollar, which it is, India doesn’t remain attractive to foreign investors. This is because Indian startups earn revenue in rupees and report in USD, for a foreign investor, this is value erosion, as dollar value of the same revenue has gone down, thus reducing the overall Multiple on Capital Invested (MOCI).
As long as interest rates go down, global macro-economic situations remain uncertain, and inflationary pressure remains - the funding winter for startup is going to stay.
All said and done, even with all of the above, India has been resilient on all fronts, we locked in $25 billion in venture funding with 24 unicorns even in 2022. As dust settles, this ecosystem shall emerge shining, maybe more than ever.
For my ”money”
Were we in a tech bubble? Yes & No. Have we been extremely bullish? Yes & No. Is excess money bad? Yes & No.
No matter what the question, everything in the history of the world is as important to exist as for it to naught. And that’s the big irony. The years which just went by have accelerated innovation way more than we could imagine, yet the present times have taken us back to the drawing board to think first-principles first, and the years to come are going to make behemoths of those which braved this wave.
What’s next for startups and founders?
If you survive, endure, and grow in this time, you probably would be closer to where you wanted to be when you started out than ever. This is a great transformation wave for startups to course correct, realize that capital runways are finite and that cracking the profitability code in scarcity can yield more sustainable business models than ever. Founders need to realize that companies fail first because of mismanagement than because of business model. Transparency and consistency can go a long way - regular and independent audits, sharing quarterly MIS reports with investors are some great ways of keeping the business in check and ensuring that corrective action is taken well in advance.
Parallelly, businesses need to start questioning the carrying cost, putting hard limits at what a justified CAC should look like, getting more juice out of the retained user base and pulling the band-aid off of monetary products - monetising users needs to start some day, and that time is now. Learnings in this direction can help businesses evaluate things basis where their Pareto lies, and build on top of that.
For startups really in need of funds, debt funding, i.e. raising through convertible notes has become a really attractive option. Founders are able to raise funds without committing to any valuation. While this may not be the most attractive option for investors, startups which are sure of their repayment capacity and unable to raise in this market, this is a sought after avenue for them.
Not all is bad - this is also a time for industry wide consolidation. Saturated sectors will see M&As, which should primarily entail good exits for founders, acquisitions at decent discounts, consolidation of power with bigger firms, and better down stream impact on delivering bundle of value to users - think food-techs buying out grocery delivery platforms, or fin-techs acquiring NBFCs.
What’s next for those funding them?
Investors have long been passive in this game, long enough for them to be unaware of what was happening right under their nose. This passive incubation approach needs to evolve into a more active partnership - a deeply engaged relationship between the board and the management so as to avoid situations of expectation mismatch, and ensure that lapses, if any, are found and corrected timely.
VCs also need to push peddle on a razor sharp focus on getting the unit economics right and paving a path to profitability, yet have patience to understand that goldmines don’t get dug overnight. The business fundamentals 101 guide would ensure investors and founders make the best out of scarce resources, i.e. scrap verticals or kill products which do not align with the uber business goals, work on carving a niche where the moat lies, and have a robust execution which yields maximum productivity to the business.
To err is human, but learning from the course of history is superhuman. Not just VCs but the world has time and time fallen for the halo effect that charismatic founders with their awe-inspiring stories have. It’s important to question at times like these, whether the fundamentals sit right with the story? Whether the startup is too busy romanticising the idea of its own existence that it has lost touch with reality. Remember, a resilient founder having a good enough idea can do more given the right direction and synergy versus an abstruse founder with a too good to be true idea. Due diligence and independent audits become extremely critical for forming an unbiased view.
Last but not the least, every pre-bubble era is filled with instances of mass hysteria - people wanting to jump into the bandwagon because the party’s too good to miss. It’s only when the party’s over, that those who didn’t belong there in the first place have a mess to clean up. This might just be what FOMO investing feels like, it is a very real phenomena, and it couldn’t be more true than in the years which have just gone by. Keeping the investing playbook intact both in good times and bad, will ensure you end up leaving what you should have left anyway, and invest in underdogs when no one believed in them.
For all the Harouns reading this, wonder bird Hoopoes, water genies and sea of stories, are all as real as you and me. For without stories, there wouldn’t be hope, and without hope, what would we be living for, after all?
Psst. Stories are better when shared :) Share with those who’d not want to miss this!
(Special credits to
for doing justice to everything that happens on the other side - the VC story. Thanks for keeping it real.)The Bonus Section: Facts Delivered, Straight from Source
India has around 75,000 startups and 7.46 lakh jobs have been created by the Indian startup ecosystem so far.
In the Economic Survey 2021-22 released in January 2022, India was named the third-largest startup ecosystem in the world, after the US and China.
According to a study conducted by IBM Institute for Business Value – 91% of startups fail within the first five years and the most common reason is – lack of innovation. Innovation is the most important factor in deciding the success or failure of Indian startups.
As per a Tracxn report, Indian startup ecosystem saw a 72% decline in funding in H1 2023 compared to H1 2022, i.e. down from $19.7 billion to $5.5 billion.
According to the IIFL Fin-tech report, the number of startups that got funded remained flat for 3 straight years, from 2017 to 2019, only to pick up in 2020 and surging to an all-time high in 2021. While the year 2022 saw a steep decline in the number of funded startups, it was still at par to the pre Covid level. This suggests that actually more startups are being funded in the country despite the funding winter. However, the big cheques or late stage venture funding have reduced. The report stated that more than 60% of the total deals done in 2022 were in early stage (Seed to Series A), while the same was not more than 45% in 2021.
If the number of funded startups remain the same, what has declined then? Answer - Money pouring in. Cut to 2023, startup deals are at a 9-year low. In fact, according to VCCircle, one startup received funding every 10 hours during February. But last year, deals happened every 3 hours.