Startups – Beginning of a technological innovation or bubble

Whoever said “Everything begins with an idea” had no inkling that nearly all of them would be transformed into something. Let’s call this something “startups”; and yes, these startups made ideas happen! And in the present scenario, it seems thinking of ideas is as good as making them happen as is evident from the fact that about 137000 new businesses(data only for countries that participate in GEM) try to come into being each day worldwide. That number alone is enough to show us the picture of the startup trend across the globe. But how many of these last long enough to be big businesses? A very small percentage! With so many new startups coming into picture each day, it is difficult to find out which ones are truly innovative and can stand the test of time. 

Talking about India, the Indian start up world is beginning to take shape and is reminding analysts all over the world of the atmosphere of the Bay and the Silicon Valley that was prevalent during the 1970s and the 1990s. As of Oct 2015, we rank third (after US and UK) with over 4200 startups. Fuelled by a lot of factors such as hefty funding, evolving technology and a burgeoning domestic market this number is projected to be 11200 in 2020; which is certainly not a small number. However is this just a passing trend or are these startups here to stay is the big question. With many veterans differing in opinions, it is hard to tell for sure.

According to First Round Capital’s new “State of Startups Report”, a survey of more than 500 founders of Venture Capitalists backed companies, around 73% of the startup founders believe that they are in a technical bubble. Another finding from the report says that 80 percent of startup founders have reported they were able to raise the required capital to fund their growths in their last rounds, but virtually all of them say that it will be harder for them to do so in the years to come. Funding is the backbone of startups. Going by the report these startups will soon cease to exist.

 Funding – How much of it is justified?

Lack of future funding is not the only thing contributing to the bubble scare. Another caveat is that the funding sometimes is too much too soon. Most of the startups today are flushed with excess cash. This has given rise to financial imprudence. Earlier when it was difficult to raise money, startups were careful in spending money. However now the startups are spending more than needed and taking on unwarranted risks. Throwing money at overheads, marketing and remuneration has become the new investment strategy for startup growth. All of this has led to a vicious cycle of spending more and raising more. More cash burn is leading to spiraling valuations and under performance.

All this leads us to ponder over the question, “How much of this expenditure is justified?” Most of the startups today are busy raising as much money as possible. However, how much of it is being used to understand the customer needs, build a sustainable model or empathize with the problems being faced currently by the customers. For instance some online food companies have built strong apps and websites and have been spending on advertisements like there is no tomorrow. However, their internal processes are shockingly primitive till date. Is building a business model majorly on marketing and advertisement justified?

These startups should realize that at some point of time they have to build a real business and generate real profits and then seek more funding. Any startup with a hollow foundation cannot survive merely on the pillars of marketing. However today most of the startups are dependent on funding even for business-as-usual. Most of the e-commerce companies are currently running in losses and some of the startups are on ventilators from day one and showing no sign of recovery anytime soon. The jury is still out on when they will become profitable.

 Investor rush – Fear of missing out?

Despite all these issues, investors seem in some kind of panic and mad frenzy to invest in startups. They seem to be investing like never before.  No one wants to be left behind. This is evident by the entry of unconventional investors such as hedge funds in privately owned startups. The reason for this rush to invest in startups goes back to the deep recession times of 2008. After 2008, the investors who did not see much excitement in public markets started investing in startups expecting humongous returns when these startups open to IPO. The investors who made money through these startups invested more, thus turning the investment into a self-fulfilling prophecy. However there is no guarantee of great returns even by investing in startups. The mediocre post-IPO performance of former Unicorn companies such as Pure Storage and Box provides evidence of the fact that probably the chicken has come home to the roost.

According to a report by CB Insights, the access to the Unicorn club is becoming less and less exclusive with each passing day and the trend shows no sign of abating anytime soon. The trend is a disturbing one as there is no liquidity in the investment being poured in by investors. Unless the startups perform well, the investors are only set to lose. Investors seem to be investing in startups without even evaluating the sustainability of startups at times. Autopsy.io is a website which proves testimony to this fact. The website contains many failed startups launched with much fanfare. The reasons for failure seem to vary from ‘not being able to find the right market’ to ‘unsustainable business model’ to ‘lack of time spent on vision’ etc. Investors need to be prudent in exercising their judgment regarding which startup to fund and how much to fund.

Concerns are also being raised about the closed door decision making by promoters and the founders who are showing a lack of accountability to a large set of stakeholders including the investors. The investors have less control as against investing in listed companies. In case of hot startups, promoters are less willing to yield control or divulge even basic information rights to investors. This also raises concerns about the use to which the investors’ money is being put. All this is being justified in the name of allowing startups the requisite space.

Startups – Rat race or substance?

The funding being received by startups is not even justified in many cases. Many average Joes, bored of their routine jobs turn to startups, only to find themselves in a mess later. Most of them simply try to sell old wine in a new bottle by merely changing the packaging of existing ideas. Sometimes startups also end up aping models from the west without considering whether those models can be profitable in the Indian context. For instance, Grofers copied USA’s model and is trying to implement it here. However the internet penetration rate in India is grossly different from USA. Hence its sustainability here is a big question mark.

Moreover, a lot of startups exist today only because people want to be a part of the trend. After all, the bandwagon effect is for real! Such startups definitely contribute to the number of startups, but not to the ones that survive in the long run. The drive behind something you pursue is paramount. You could either be voluntarily involved in a unique business opportunity or you could be doing it only because of the lack of other sources of income. The former form the opportunity entrepreneurs and the latter, the necessity entrepreneurs. Necessity entrepreneurs rarely have the urge or motivation to pursue the business idea and thus find it difficult to put through in the long run.

The signs of this bubble going to burst are already coming into picture. Several booming companies are shutting their operations, shelving expansion plans, carrying out layoffs or looking to be acquired. Be it Zomato, the restaurant search app; Tiny Owl, the food delivery app or Housing.com, the real estate search portal- all of them are going through the same hitch. Housing.com faced another big trouble. It had raised US$100 million from Softbank at a US$400 million valuation. But when its existing investors decided to sell it out in October, it got sub-US$50 million offers. What went so wrong? The issue was believed to be the absence of a sustainable and scalable business model. As long as startups with weak business models continue to exist, so long the bubble scare will continue to exist.

Counter view – Startups are here to stay

However some people disregard the scare. They feel all this bubble talk is mere hype without much substance. According to ‘Internet World Stats’, the number of internet users has increased from 400 million in 1993 to around 3 billion in 2015. Moreover the mobile revolution is showing no signs of abating. According to the Hindu, India is all set to become one of the youngest nations by 2020. Around 64% of our population will be under 35. This population is more net savvy and also a major consumer. Thus the domestic demand will see a further upswing. All this is enabling more efficient and previously unthinkable business models. Uber, despite not owning any car is driving around 3 million people every day. Airbnb, without owning any accommodation was able to put up more than 30 million guests in 2015.

Customers have started looking more for convenience giving rise to hyper local startups such as Big Basket, WashKart etc. Not all of these startups are lacking in innovative ideas. Many cried bubble when Facebook was valued at $15 billion in 2007 and also when it acquired Instagram for $1 billion in 2012.There was also a bubble scare when Google bought YouTube for $1.65 billion in 2006. However today, YouTube is considered as one of the best possible acquisitions of all times. Instagram already has around one third more users than Twitter. According to a Citigroup report Instagram’s current valuation is around $35billion and Facebook has a market capitalization of around $231 billion.

The way forward

The investors need to be careful to separate the chaff from the wheat before investing. The startups too must exercise financial prudence after receiving funding. The investors must be taken on board and informed about how their money is being spent. It’s reasonable to burn cash initially in order to gain the market share, but how and when the model will turn profitable needs to be understood. Rather than spending the money only on marketing, the money should be used to work on the fundamental aspects of the business. If these factors are taken care of, then the startup trend would survive for years.

The answer to whether startups are bubble or technological innovation is hard to tell as of now. Although the bubble cries are louder, disregarding all the startups as part of the bubble would be too big a statement to make. The startups won’t be all gone. Avant-garde entrepreneurs are and will be making it big! However the trend of over valuations might reduce in the future. Currently there is at least some froth in the valuation market, if not excess. With the passage of time, however, the startups might start receiving only the funding that they deserve. Till then let’s wait to witness whether the bubble bursts or stays.

Source: Article shared by Shailja Gupta 

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