26 Aug 2015 20:15 IST

Are we staring at a start-up bubble burst?

There is a lot to be worried, as crores get pumped into ventures without much thought to sustainability

Sustainability is to the corporate world what the elusive El Dorado was to explorers. One look at the list of Fortune 500 companies from over a decade or two confirms this.

At least traditionally, managements of companies agonised and worried about not being able to sustain their superior performance. But today, neither the new age start-ups nor the VC/PE firms that back them up seem to have similar fears.

We are riding a huge wave of PE/VC-led investment and funding of start-ups and tech companies. This kind of growth is an unprecedented phenomenon. While such overwhelming support to young entrepreneurs with unique business ideas certainly warrants support and help, the way the valuations and funding is conducted leaves one wondering if there’s a need to worry.

Assumptions and reality

Recently, one of the leading Indian e-commerce companies announced its results for the financial year that just ended. It declared a loss of close to ₹10,000 crore on a revenue of about ₹18,000 crore.

Within a few weeks after this, it received a further infusion of capital. This was after an astronomical valuation of close to ₹1,00,000 crore.

One of my friends, who runs a tech firm, shared an anecdote with me. Not so long ago, he had an interesting situation to deal with. His Income Tax officer wanted to treat the share premium his company received, on a recent funds infusion, as a form of equity: as “income” and not as share premium. Treated as income, this share premium is taxable. The basis for this, according to the officer, was that the firm has been making losses, so he couldn’t get his head around the fact as to why anybody would invest in equity of such a firm, and that too at a premium!

That is a logical assumption, but the reality is quite different.

Today, VC/PE firms invest based on how fast you can scale and grow the top line. In most instances, they don’t even bother to ask promoters about when the company will break-even or start generating profits. The assumption is that once you scale up and gain a relevant market position, you can change gears and make the company profitable. Till such time, it is okay to sell your stuff at a price much less than the cost. While there is some logic to this way of thinking, what is a worrying trend is that they completely ignore questions related to the business’ viability and sustainability.

Steroid-led performance

This is, in some sense, akin to steroid-led performance in the athletic world. Not only is it unsustainable in the long run, but has disastrous consequences in terms of health of the individuals.

Take a look at recent photos of Ben Johnson, the sprinter who hit headlines during the Seoul Olympics. He looks like he has aged a 100 years! A similar fate awaits these steroid-fed companies, in my view. Systems, processes, people and culture are the DNA of the firm. As much as you won’t fast track your child’s growth using steroids, you should carefully nurture and build your organisation. In a hurry to get the money multiplied several times in five to seven years time, the start-ups are pumped with Vitamin ‘M’ (read Steroid).

The consequences of such strategies are not difficult to foresee. You will see corporations come and go. For every one Amazon (which has for decades, not displayed positive cash flow), you will find many wannabe Amazons fading away quietly and never to be heard of again. And nobody touches a failed start-up again.

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