Tag: Valuation

India Startup Valuations, Corporate Governance, And Other Good Stuff: Notes From The Recent Trip

From valuations drastically coming down and hard questions around SaaS, to the unlock of INR LP capital and rise of deeptech – sharing candid notes from my recent India trip.

Just came back from one more of my quarterly trips to India. Based on meeting scores of founders, investors, and operators, here are a few interesting insights on the current state of the Indian startup ecosystem:

1/ 4-6 quarter lag between US and Indian private markets

There appeared to be investor consensus that the real shakedown in overfunded/ overvalued tech startups in India hasn’t really started yet. Most VCs believe that 2024 will be brutal for many of their portcos that are on the wrong side of things and are, therefore, expecting brutal downrounds and recaps.

Given that the US private market correction started sometime in mid’22 and is still ongoing (eg. Convoy, a digital freight brokerage last valued at ~$3.6Bn, recently shut down reportedly under stress from creditors), there seems to be a significant lag between the US and Indian private markets.

With US VCs expecting startup shutdowns to peak in 2024, assuming the above lag, we are potentially looking at a weak fundraising environment in India continuing deep into 2025.

For India-based founders, this underlines the importance of having enough runway to tide the next couple of years out.

2/ Current fundraising environment is worse than I thought

Over this trip, I heard of at least 10 deals falling through at the final legal documentation stage. Anecdotally, I could identify a couple of reasons:

  • Smaller funds are facing capital call challenges with LPs, given tough global macros and general pullback from venture as an asset class.
  • The bar for financial diligence has really gone up. Funds are willing to walk away if even a few issues crop up in the typical Big 4 fin DD. A common issue I heard is a founder signing a term sheet on the claim of say $1Mn ARR, and post-fin DD, true recurring revenue as per accounting standards turns out to be $200k. This is a deal-killing red flag!

3/ Valuations have significantly compressed

Based on triangulating numbers from convos with multiple investors, these are the generally prevailing valuation ranges for each financing stage right now in India.

Note:

(1) These numbers are highly anecdotal and will vary a lot case-by-case depending on sector, team, and traction. However, I validated these broad ranges from multiple Indian VCs.

(2) Am also including a comparison with current US benchmarks as per Carta.

Pre-Money Valuations (as of Oct’23)IndiaUS
Pre-seed$3-5Mn$5-10Mn
Seed$5-10Mn$10-25Mn
Series A$10-20Mn$25-70Mn

What’s striking to me is how compared to the US, the valuation ramp with each stage of maturity is relatively low in India.

4/ The rise of Rupee denominated capital in venture

I remember the Managing Partner of the VC firm I used to work for more than a decade back, having a strong thesis that similar to China, India’s venture ecosystem will truly be unlocked by the participation of domestic capital pools. On this trip, I saw encouraging green shoots of this view, with Family Offices like the Mariwalas and Hindujas allocating to venture capital both actively and passively.

One interesting trend here is how the younger, next-gen heirs to these family businesses want to play an active role in working alongside the new crop of Indian founders. I sensed a passion and excitement in their approach, which transcended from startups being mere wealth management or portfolio allocation decisions.

To me, unlocking INR LP capital is a hugely encouraging trend and one that will make the local innovation economy more resilient to geopolitics and global shocks.

5/ Deeptech becoming a mainstream venture theme

Deeptech seems to have transitioned from being a fringe venture theme for many years, to now being one of the core theses of all mainstream VCs. Peak XV’s latest Surge batch is dominated by AI and deeptech, Accel is running an Industry 5.0 program via its Atoms accelerator, deeptech specialists like Speciale Invest and Pi Ventures are busier than ever, and I heard of many investments in-process in the semiconductor space.

The cornerstone of my investing thesis is – “India started by exporting software services in the 90s-early 2000s. It then moved up the value chain to become the global hub for software products/ SaaS from the mid-2000s till 2020. Over the next 20 years, India will move even further up the value chain and export cutting-edge innovation to the world”.

This time, I saw strong signs of this thesis on the ground in India.

6/ Corporate governance clean-up in progress

It was clear that both founders and investors are owning up to the corporate governance mishaps over the last year. The problems have been recognized, accountability taken, causes diagnosed, and learnings accepted and assimilated. I heard many instances of deep clean-up happening within companies, right from the board to the lower operating levels.

I see this as a major growing-up moment for the Indian venture ecosystem as a whole, and post this clean-up, everyone will be better off for it. I expect a whole crop of young founders and venture investors to emerge battle-hardened from these experiences, and from here on, focus their energies on building generational companies.

7/ Hard questions being asked of application SaaS

Similar to the sentiment at Bessemer’s recent Cloud100: Rise of SaaS in India Brunch 2023** in SF, Indian VCs are now starting to ask some hard questions about competition and product differentiation to application SaaS startups.

The Zoho playbook worked in the early 2000s. The Freshworks playbook worked in the 2010s. In this rapidly changing, post-AI world, whether these old paradigms are still applicable needs to be questioned and discussed in an intellectually honest way.

**Key SaaS takeaways from this event here.

8/ Very early signs of the domestic B2B software opportunity

While the India cross-border SaaS opportunity is now well established, I am also hearing scattered anecdotes of startups going after large ACV, domestic B2B opportunities. While VCs continue to be generally bearish on domestic B2B software, founders have started taking note of the journeys of the likes of Perfios and Netcore. Some of these companies have shown that though it takes time, it’s possible to build large ($100Mn+ ARR) domestic software product businesses.

In fact, over the last year, I have seen several enterprise startups reach $3-10Mn ARR by serving large Indian customers. Maybe it’s time to be more open-minded and take a nuanced view of the domestic B2B software opportunity?

9/ Tech-enablement of legacy domestic verticals

Applying technology to improve the growth and efficiency of legacy verticals like construction, procurement, automotive parts, logistics etc. is emerging as a key business opportunity. While horizontal B2B commerce platforms like Udaan, OfBusiness, and Moglix are already mainstream, am also seeing the rise of a new set of more specialized, vertical platforms.

These are really large TAM opportunities given the amount of GMV that changes hands in the brick-and-mortar portions of the economy. As India grows from a $3.5Tn to a $10Tn economy, the tech-enablement opportunity in these broader spaces will grow even faster.

10/ Didn’t see a clear thesis on AI

While almost all Indian VCs are deploying in AI startups, I didn’t hear any clear thesis or POVs from most of them. Not to be too harsh on them as barring the emerging hyper scalers like OpenAI and Anthropic, the early stage AI scene is pretty fuzzy even in Silicon Valley. PS: check out my recent post ‘AI Musings #1 – How The Odds Are Stacking Up?‘.

11/ Promise of IPO’ing in India

I heard distinct excitement around the potential of late-stage startups doing IPOs in the Indian market. Over the last couple of years, Indian public markets have shown a strong appetite both for tech growth stocks as well as small to midcap SMB stocks.

I spoke to a founder who recently listed his tech services company at a relatively small scale. His experience in managing the compliance and related overheads of running a publicly listed company in India has been fairly smooth so far. In fact, he has enjoyed both interacting with and learning from well-prepared large institutional investors.

Similar to INR LP capital, unlocking domestic public markets for IPOs of new-age companies will be a huge boost and de-risker for the local innovation ecosystem.

Other memorable moments…

LetsVenture, my very first angel investment, completed 10 years. I still remember the first brainstorming session with the founders when it was just an idea on a blank sheet. The company has since emerged as the leading infrastructure layer for private market investing in India. I am in awe of the tenacity of Shanti Mohan (Co-founder and CEO), and how she has selflessly contributed and fought for organizing private market investing in India. PS: some special moments at the celebratory dinner with early backers – Subrata of Accel, Sharad Sharma of iSpirt, and others are here.

LetsVenture’s achievements over the last decade

I was also on a panel at LetsIgnite with one of my oldest friends Anirudh Singh (Avataar Ventures), alongside Vishesh Rajaram (Speciale Invest) and Uday Sodhi. It was an unfiltered discussion on everything from portfolio construction, diversification, and power laws to entry prices and exit approaches. It was also the first time I presented my investment strategy to any external audience, so this particular event will always stay close to my heart. PS: some key insights from the panel are here.

LetsIgnite’23 panel on venture portfolio construction

Towards the end of the trip, I partnered with my friend and collaborator Arjun Rao (Speciale Invest) to do a closed-door, no-holds-barred type session with select infrastructure SaaS founders in Bangalore. The main theme was the US-India corridor. I like to keep these sessions very raw, no-gyaan, only brassstacks around operating and financing challenges that US-India enterprise founders are dealing with daily. PS: some key takeaways from the session are here.

Closed-door session on US-India corridor, in partnership with Speciale Invest

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Why The Instacart IPO is More Significant Than You Think?

A Consumer Internet company, operating in the cut-throat Grocery vertical, going public in a tough macro environment, amidst a widespread venture downturn and without a prominent AI narrative – Instacart’s recent IPO contradicts every mainstream belief.

The long-awaited Instacart IPO finally happened on Tuesday, Sep 19. The offering price was $30 a share, valuing the company at ~$10Bn on a fully diluted basis. This was a significant mark-down from the $39Bn valuation that private market investors ascribed to the company in early 2021 at the peak of the post-Covid tech cycle.

Given this is the first IPO of a notable venture-backed company since Dec 2021, I would like to share some nuances that other analysts and media reports might have missed, and which strongly underline the significance of this event in the current venture downcycle:

1/ Consumer Internet IPOs are tougher to pull off – compared to asset-backed brick-and-mortar industries, as well as enterprise software, Consumer Internet companies find it harder to go public given their business models don’t lend themselves well to sustainable profitability.

While these companies do show growth and scalability, they suffer from high marketing costs. The underlying metric that’s commonly used for this is Customer Acquisition Cost (CAC). Consumer Internet companies have high CACs, driven mainly by costs of FAANG distribution channels and discounts/ promotions to entice customers.

Public markets essentially evaluate companies on profitability (starting with EBITDA, but ultimately on Earnings), leading to Free Cash Flow (FCF). That’s why the standard valuation methods for public companies are the Price/Earnings Ratio (P/E) and Discounted Cash Flow (DCF).

Given the low or non-existent profitability of Consumer Internet companies, it becomes hard to robustly value them. That’s why they get held to a higher bar in public markets, as we have seen with the likes of Uber and Airbnb in recent years.

In that regard, it’s much more commendable when the management teams of say Instacart or Robinhood pull off an IPO vs. a Monday.com or Freshworks, given the default odds are stacked against the former.

2/ Bonus points for delivering a new IPO story in a tough space like Grocery – Several aspects make Grocery incredibly challenging as a space. It’s highly competitive with large incumbents (Walmart, Whole Foods, Target, Kroger, Costco etc.) coexisting with regional, mid-sized chains (Trader Joe’s, Ralphs, Gus’s Supermarket etc.) and mom-and-pop stores (eg. ethnic grocery stores like Asian, Indian, Mediterranean etc.). These players compete in an environment that is a lethal combination of low growth and low margins.

Historical US Grocery Sales (Source: Aswath Damodaran)

If one were to think of a legacy vertical that can be fruitfully disrupted by tech, Grocery wouldn’t even make the shortlist of most analysts and investors. That Instacart pulled this off and on top of it, also delivered a liquidity event, is a humongous achievement.

Source: Aswath Damodaran

3/ A venture-backed IPO amidst super-tight macros – while fighting against the above odds, what makes this event even more significant is that it has been pulled off in a high-interest rate environment driven by a hawkish Fed, an IPO window that has been pretty much closed for typical venture-backed models since late 2021, and where late-stage private companies are hurting from inflated last-round valuations, weakening customer demand and lack of profitability (refer my post ‘When will the next venture bull run begin?‘).

To choose this environment to go public in shows real courage, and I congratulate the management team and shareholders for this brave call.

4/ Pulling off a non-AI IPO in 2023 – Instacart closely followed on the heels of the chip design company Arm’s IPO. Given AI is seeing a hype cycle right now, the outperformance of Arm’s IPO was expected. But kudos to Instacart for pulling off an online grocery IPO when the only thing investors seem to be wanting right now is AI.

5/ Setting strong precedence for prioritizing liquidity for employees – Interestingly, only ~8% of Instacart’s outstanding shares were floated in this IPO, with ~36% of those sold coming from existing shareholders. In the words of the company’s CEO:

“We felt that it was really important to give our employees liquidity. This IPO is not about raising money for us. It’s really about making sure that all employees can have liquidity on stocks that they work very hard for. We weren’t looking for a perfect market window.”

Fidji Simo, Instacart CEO

This is an amazing stance taken by the company. As someone who has both founded and worked in early-stage startups, I have seen how demotivating holding illiquid stock can be for employees. In fact, this has been one of the major ecosystem-wide downsides of tech startups staying private for longer during the ZIRP decade.

Instacart has demonstrated that rewarding employees via liquidity events is at least as important as generating returns for VCs on the cap table and that it is the responsibility of Boards and management teams to make it happen.

6/ Proving that entry price matters – WSJ recently wrote about how almost all growth-stage investors in Instacart are at a loss on the IPO offering price. An even more insightful analysis was put together by the ‘Dean of Valuation’ – Aswath Damodaran, Prof. at NYU.

Source: Putting the (Insta)cart before the (Grocery) horse: A COVID Favorite’s Reality Check! – by Aswath Damodaran

This analysis shows that at the offering price, only the Seed, Series A, and Series B investors are sitting on substantial profits that also beat the S&P500 benchmark returns during their respective hold periods. Series C onwards, none of the investors have beaten comparable benchmark returns, with the late-stage rounds in 2020 and 2021 sitting on substantial haircuts.

While a common VC narrative is that “irrespective of the price, the only thing that matters is getting into the best companies”, my own experience is contrary to this (I wrote about it in my post ‘An angel’s struggle with entry valuations‘).

The actual returns profile of various types of VCs and Growth Investors who invested in Instacart at different stages of maturity and valuations provides more evidence for this age-old wisdom of OG investors like Buffet, Munger, and Howard Marks.

Source: Random Thoughts on the Identification of Investment Opportunities, by Howard Marks (1994)

Sobering thoughts for Instacart’s way forward:

As an active participant in the venture ecosystem, while I am wholeheartedly celebrating Instacart’s IPO and the way it has overcome all the above odds, it’s important to acknowledge that the business faces significant risks going forward.

1/ Market share – will it be able to grow, or even retain market share, as traditional grocers expand their online shopping experiences?

2/ Topline metrics – Instacart’s AOV has been pretty much static at ~$100 over the last five years. Given grocery is a low-margin business, it will also find it hard to significantly increase its take rate from the current ~7.5% levels*.

Further, while Covid saw a massive spike in customers leveraging online grocery, it seems that the use case seems to be settling down at relatively lower levels of purchase frequency.

Given these dynamics, what are the levers at Instacart’s disposal to improve its cohort metrics?

*As a comparison, Airbnb and Doordash have much higher take rates at 14% and 11.79% respectively. These reflect the higher operating margin profiles of the underlying businesses (both hospitality and restaurants operate in the ~15% range).

3/ Bottom line metrics – Instacart’s Selling Cost (Marketing + Incentives and promotion) as % of Revenue has been steadily going up (from ~12% in 2020 to 24.50% in 2022).

Though its customer retention is strong, will the company be able to convince these customers to buy more frequently, as well as keep attracting new customers, without a commensurate increase in CAC?

4/ Talent – While it’s tempting to perceive an IPO event as the finish line, it’s rarely so. In fact, as Yahoo, Google and Facebook have shown in the past, exponentially more value gets created in the years post-IPO, compared to pre.

This especially applies to Instacart, where the IPO valuation is much lower than the last private round, and therefore, much work needs to be put in to generate returns for these late-stage investors. See the amount of post-IPO heavy lifting that the likes of Dara at Uber and Brian Chesky at Airbnb have had to do to create shareholder value.

From here on, Instacart will need to ‘grow up’ as a public company and attract a fresh set of talent that can design & execute its next phase of growth. Will it be able to create a culture and working environment that can help achieve this?

All in all, Instacart’s IPO being a milestone for Silicon Valley is beyond doubt, especially considering the tough macroeconomic and venture environment over the last year. But I can also say with equal confidence that a lot of value still remains to be captured by the company, and the next few years are going to be a tough execution grind for the management team.

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An angel’s struggle with entry valuations

Recently, I was in a shareholder’s meeting of a portfolio company. It has been a gut-wrenching last 3 years for the leadership. Unfortunately, the company’s market pretty much shut down during Covid. Significant liabilities built up & the team saw significant churn. To survive, the company had to raise a bridge at a major haircut.

During the meeting, the management team walked us through their journey of turning the business around from this dire situation. After the lockdown was over, customer demand got re-ignited. The company drastically cut costs, improved operating metrics to get revenue back on track, re-negotiated long-term vendor contracts, and cleared-off short-term liabilities, all while retaining the core manpower, many of whom had to take salary cuts.

As a result, the company is now PBT-profitable & growing through internal accruals. Btw this turnaround was achieved on a ~$13Mn revenue base. As an operator & ex-founder, I was blown away by this execution story & the team’s grit.

But then, I put my investor’s hat on – despite all this progress, early investors are deeply out-of-money & are likely to remain so for a while. During 2017-19, the company raised equity at aggressive valuations that were misaligned with both the maturity of the business as well as the underlying multiples the sector trades at. In boom times, startups get valued at hyper-growth tech multiples. However, as soon as the cycle resets, follow-on investors revert to valuing them on realistic sectoral comps.

The good news is, courtesy of the awesome restructuring efforts, the business is on a profitable growth path. But given the extent of divergence between our entry valuations & current market comps, it’s going to be a long road toward generating healthy returns for early investors. And even if we get there, the sheer time taken will negatively impact IRRs.

As an angel, this is the part I really struggle to get my head around – how important is the entry price? Bill Gurley says in this 20VC podcast with Harry Stebbings – “the market sets the price on a deal-by-deal basis but as an investor, you have to keep an eye out for the price you are paying at a portfolio level”. This becomes especially hard for angels, who typically have to adhere to the price set either by the founder (SAFEs) or an institutional lead. In this era of fragmented checks via syndicates, SPVs & RUVs, I frequently see valuations that aren’t correlated to the underlying risk in the business & smaller check investors unable to push back. Ultimately, everyone ends up toeing the line.

As an investor, I always have the option of not participating in a highly-priced round. But then enters the other side of the coin – power law ensures very few companies drive a majority of venture returns. Therefore, angel investing is the game of accessing the “best” companies, which often requires paying up to get in. An argument frequently made is “if the company ends up as an outlier, it doesn’t matter what price you got in at”. I get this line of thinking but an “outlier return” is very contextual. Eg. a 10x return potential over a 5-7 year period is very solid for an angel, though might not meet the deal hurdle for a large fund. There are cases in my own portfolio wherein early angels are sitting on a 5-10x unrealized return because we entered at sub-$10Mn valuations and frankly, the likelihood of a startup hitting a $50-100Mn valuation is significantly higher than becoming a unicorn.

Over a 20+ angel portfolio built over 8+ years, I still struggle with thinking about entry valuations the right way. Presently, am taking it deal-by-deal with the guiding North Star of discovering & backing the best founders I can find, while also accepting the reality that angels will usually be price-takers that are prone to macro sentiments & the whims of lead investors. As Bill Gurley advises, maintaining perspective & discipline around portfolio-wide avg. entry price seems to be a smart way to play a balanced game.

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Public vs private markets…and WeWork

Fred Wilson recently wrote a great post on how WeWork’s botched IPO exhibits the stark differences between public and private markets.

As a founder, my major takeaway from the post was that one needs to be crystal clear on the type of company one is building. That should reflect in how you build, take it to market, price, capitalize, grow and eventually exit. North Star Metric reflecting all these being (gross & operating) “margins”.

Fred’s post also offers some critical insights for tech investors. It’s imperative that investors understand what is really the “type” of business being evaluated — differentiation, pricing power, cost of customer acquisition, scalability etc, all ultimately getting reflected in gross & operating margins. Smart investor behavior dictates peeling the onion significantly on all these issues.

Any business solving a real problem for the world, and if executed on well, has “value”. It isn’t about Uber, WeWork or Peloton being good or bad. They are solving a problem and that’s why customers use them. The key is to value them appropriately, based on fundamentals.

As Graham/Buffet say — “any company can be a good buy at the right price”. That’s why people invest in junk bonds, distressed assets etc. The challenge is in figuring out this “right price” in private markets, where information availability is significantly lower. At these stages, there is no perfect pricing mechanism, no feedback loops, no liquidity to correct mistakes.

Unlike public markets, private markets are driven by a bunch of individuals and not “Mr Market”. They are full of irrationalities, driven by emotional drivers like FOMO, personal passions, vision-over-fundamentals etc. Private market valuations aren’t driven by sound financial theory like DCF, Comparables etc. There just isn’t enough data!!

Imagine as a VC, a solid founder coming to you with a disruptive vision but not much execution. Your instinct (“heart”) says this could be big. How do you value this company? In absence of data, your estimate of value will have no choice but to be driven by 1) your “heart”: conviction and how badly you want it, 2) “buy-sell” dynamics: how much are others willing to pay relative to you and 3) comps from past experience. Though sub-optimal, this isn’t particularly bad as, in absence of data, you need some basis to value these companies, so they get funded and execution continues. That’s how game-changing companies will be built.

To summarize,

  1. Valuing assets in public vs private markets is drastically different.
  2. Due to lack of data, private markets value companies based on emotion+past experience+buy-sell dynamics.
  3. Therefore, a valuation reset when IPOs happen should be expected more often than not.
  4. The best private market investors get it right more often, despite playing at the mercy of emotional drivers and market externalities.
  5. This public-private valuation contrast will always exist.
  6. Sustainable, well-run businesses will withstand, adapt & survive.