Almost every tech unicorn in India is a loss-making business. Yet we keep on hearing that they are raising millions of dollars in every funding round.
Why do these Tech Startups require so much funding? And why are even venture capitalists investing in them even after making so many losses?
First of all, banks don’t give loans to loss-making companies. That option is not available for tech startups that are prioritizing scalability. Then they need to look for VC funds.
Startups don’t require to directly pay venture capitalists over a period of time. But they need to give a share of their company in return for that money.
Why Do Tech Startups Raise So Much Funding?
The answer is simple – Tech Startups raise such high amounts of funding because they are primarily driven by technology, especially the Internet. Internet businesses have too much leverage of being asset-light models.
A non-tech startup can at most raise 1x to 3x of its revenue while a tech startup can easily raise 5x-12x of its revenue. Of course, exceptions are there and it depends on a lot of factors. But that’s how it works.
Almost every investor or VC wants to invest in tech startups because they can grow massive and scale globally. There are no risks of goods rotting in the inventories or blue collared force of laborers to manage.
There is too much risk in offline businesses. Mechanical hazards, physical hazards, chemical hazards, ergonomic hazards, physiological hazards, and many more things to deal with.
Almost every Internet company works with some fixed assets, subscriptions of software, and some highly skilled programmers. That’s the backbone of most tech companies.
Tech companies never fail. It’s the expectations that don’t fulfill. It’s easy to pivot an internet-based tech startup and build something from scratch using the same data and experience. This is almost impossible for traditional non-tech businesses.
Since we are talking about data, every tech startup has a massive advantage of holding a data mine. They can use the whole data for their own improvements or just provide analytical services to other companies in the same industry.
- Uber & Ola don’t own any cabs
- Zomato & Swiggy don’t own any restaurants
- Oyo & Airbnb don’t have their physical properties
- Facebook and YouTube are not generating content
- Netflix and Amazon Prime don’t need to maintain theatres
- Amazon & Flipkart don’t manufacture and stock goods in inventories
Every Internet startup is purely working on data and scaled globally. This is another major reason why tech startups raise so much funding.
Every failed tech startup can literally use its data mine to survive in the market by providing data analysis and consultation as a solution.
In a nutshell – the risks are low, scalability is high and data is the new oil.
This is the whole reason why investors and venture capitalists want to invest in tech startups and not in traditional offline businesses.
But Why Raising Funds So Rapidly?
No. It’s surely not justified to host multiple funding rounds and increase the valuation.
It seems that media houses and PR teams no more care about profits and sustainability. Pick any news publication and you will barely find any headlines covering bootstrapped businesses.
It’s all about funding and revenue.
I will explain why it happens.
It’s a Rat Race in the Startup Ecosystem
If you are a startup owner, you ought to be extremely careful with the decision if you really want to raise funds. Do you really need VC money to grow? If not, it does not make sense to even enter the funding game.
Once you raise your first funding, you will be forced to raise more funds.
Consider yourself as a startup owner. If you get some funds from an investor, you promised some great returns to that investor, obviously!
Since a startup is a private company and no trading of shares is done in real-time, there is no way to find the real-time valuation of a startup.
So, how will you find the valuation of your startup and assure your investor that you are growing in numbers? By raising more funds! That is the only way to evaluate progress and valuation.
Valuation is something that is decided by multiple factors and not just revenue or profits. We will talk about it in some other blog post.
It might look like you don’t need to return the money but it is expected that you need to give returns. It’s social pressure on an entrepreneur.
To show the returns to existing investors and hype up the branding in the market, founders tend to keep raising funds. This automatically implies that the next round will come up with a higher valuation.
Here’s a Catch – You Need To Finish Those Funds Before Raising Again
Before raising funds in the next round, you need to finish all the funds from the previous round. It doesn’t matter how. If a startup is using those funds to improve products and technology then it is still fine.
But the easiest way to deplete those funds is by heavy spending on marketing. There are no limits to spending on marketing. This is sophisticatedly called a customer acquisition strategy. In reality, this is just a way to burn money for the next round.
Some startups keep on acquiring other small startups. The EdTech industry is a prime example of this.
This is also a reason why funded startups pay high amounts of salaries to their employees. They have money to burn and they invest that in getting better talent and retaining them.
Why Are Investors Okay With Startups Operating in Losses?
I had a discussion with one of my friends where he mentioned that retail wholesalers make crores of Rupees in revenue every month. I saw someone fighting in the Facebook comment section that a panipuri seller makes profits yet nobody gives him investments.
Guess what? These businesses cannot be scaled to multi-million dollar businesses overnight. Hence, nobody wants to invest in such businesses.
Raising funds is not as easy as it sounds. It takes months and months to convince investors to raise funds. Each and every aspect of a startup is thoroughly checked with too many questions and answers.
Obviously, nobody invests blindly.
Even if a tech startup is in losses, the future predictions and trajectory curves are shown to convince the investors. It’s not an easy job.
There are also possibilities that the investors really trust the founders and company to keep investing till it gets profitable in the future. The ultimate goal is to acquire as many customers as possible.
Ultimate Goal of Any Tech Startup is to Acquire the Highest Market Share
Unlike traditional businesses, tech startups have the power to target old customers again and again.
A restaurant is very popular and decides to launch a new business. How will they tell their old customers? They can’t.
But if Zomato launches a new business, they can cleverly announce it by targeting their customers.
Profitability can come once the major market is acquired and marketing spend is reduced.
The primary goal is to acquire so much of the market that it becomes almost impossible for any newcomer to acquire the market share.
This approach can never be used in traditional businesses. So, the trend of raising funds for loss-making businesses is only possible in tech startups.
Investors are in the business of entering and exiting businesses. They are not in the business of building businesses.– Ankur Warikoo, Founder of Nearbuy.com
Investors and VCs very well understand that almost 90% of the startups fail and very few startups survive and give great returns. But those who win, eventually recover all their losses from other failed startups.
Every startup has an exit strategy. It can be one of the following –
- Listing as a public company
- Selling to some other company
- Merging with some other company
When any of these events take place, the valuation of the company is considered and investors take an exit after booking huge profits.
Eventually, this valuation game helps those investors in long run.
Is This High Valuation Game Good or Bad?
It’s too early to say. Internet-based Tech Startups just started booming in India.
Traditional investors who work on fundamentals before investing often check the balance sheets and profits before investing. If they find so many losses, they label such startups as worthless startups.
They have a valid point too.
On the other side, people like me are highly optimistic about the future of the startup ecosystem in India. We tend to believe that technology has a massive power to revolutionize the business game. I already mentioned the reasons why I feel so.
Markets in new era with a domestic listing of tech startups: SEBI Chairman Ajay Tyagi
And I agree with this statement.
If the overall tech startup community grows with time, it will empower other aspiring entrepreneurs to build more startups in the future. It will create an awareness to take traditional businesses online. Covid-19 has already accelerated that process.
This will create more opportunities for digital marketers like me 😉
Also, tech startups can create more jobs. Governments can’t create many jobs, but startups can!