We all know that most of the startup founders run their business in their heads. They flip, chew, change and chop, as they wish in terms of strategy, numbers, decision and action. This makes decision making more nimble and agile. Instant decision making, more driven by instinct and emotions, works well in early stages.
As investors move from considering wooed by idea stage startups to actual traction or revenue based businesses, a key factor kicks in. Numbers. Numbers. Most founders tend to ignore numbers – this is perfectly understandable. Most are driven by an idea or a problem to solve, fuelled by passion. The younger lot, even from elite institutions, miss the fundamentals of what they learnt. Many an MBA has become that passionate founder, and have treated numbers with disdain.
Now, look at this from a point of an investor. Investors have followed general guidelines mostly driven by a herd mentality, especially following the marquee VC firms that have made the early moves that set the sector standards. This has eventually become an avalanche and then peaked at a stage.
Now cut to Q3 of 2016, the situation is completely different. There has been a sea-change in the investor mentality. The investors are now looking for startups that carry more upfront risk, revenue, paying customers and profitability. The indication is that post the ‘avalanche’, there is too much money for the founders on the table, and cash burn has gone to bonkers. Fiscal discipline is a lost cause.
But the founders seem not to realize this yet. Still enamoured by the gold rush of 2014 and 2015, they still cite how investments and high valuations in their sectors have happened. Part of our advice has been to discount comparative valuation, as when confronted with an investor, the entire castle falls apart.
Our efforts have succeeded only partially. The founders are impatient to crossover to the ‘greener side’ as early as possible. The probability of getting a right deal – which includes a reasonable investment on equitable terms, is completely dependent on how the numbers stake up. And the standard business parameters kick in. Even discounted cash flow parameters are now tempered to a large extent and validated through other methods of valuation. In private equity or venture capitalist transactions, the Central Bank of India, RBI, has in fact suggested, a 3 method-valuation to be signed off by a qualified financial professional.
This means that startups either themselves or with suitable professional advice should sit and make the financials. It is also an opportunity for them to plan numbers – both revenue, profits, sales and other numbers that essentially are business drivers. These numbers will give an opportunity to decide on an aggressive or a balanced growth. This also in working out an equitable valuation and therefore a more achievable term of reference. Finally, a clear plan to burn cash with proper controls will also emerge after such an exercise.
In the changed scenario, such an approach offers the best possible chance for a balanced deal between the investor and the startup.