Inflation and the failing Indian Startups

We all know that Venture Capital is one the the most expensive form of capital that exists. Why is venture capital expensive? Simple concept of risk return ratio. Where the risk is high, the return is high.

VC’s fund organisations which are supposed to be on the brink of exponential growth to give them phenomenal returns. The most obvious inherent part of this equation is that these organisations are burning with risk of failure.

Let us now understand how Venture Capital functions.

Venture Capital Funds come under the asset class of high risk and high return. If you are an avid and a smart investor, you would invest your money in various asset classes. The image below sums up almost all asset classes that exist.

Each asset class is based on the inherent risk its proportionate return expectations.

Depending on your apetite of taking risk, you would invest in various asset classes. If you were me, a 23 year old just starting out and is out there to win the world with no care, you would invest in high risk assets.

This above are the people who we call LP’s (Limited Partners). If you invest in a fund like Sequoia Capital, Accel Partners etc, you are a LP who is expecting high returns.

Lets now couple this with inflation and expectations of returns.

Inflation rates of a India, USA, Switzerland and Germany from 2006 to 2016

Above are the inflation rates of a few first world and developed economies — USA, Switzerland and Germany as compared to the same in India.

Implications of a high inflation rate-

The government of the said countries provides you with a certain amount of interest for keeping money with the bank. In India, this money is kept with the RBI (Reserve Bank of India). The RBI in-turn gives these banks a certain interest rate which is considered to be “risk free”.

In India, for the last decade, expectations of returns for — doing nothing and keeping money in your bank was averaging to a staggering 8.93% as compared to USA’s 2.088%.

Now lets combine this with expectation of returns on high risk asset classes.

In the USA, a VC would consider his/her portfolio doing good when it gives it a return of around 35–40%. In India, that return has to be somewhere around 60–80%.

You read that right. 60–80% of YoY return is considered to be a good return cause of the expectation of growth in India.

This does a couple of things.

  1. Sprint — Organisations that take up Venture Capital in India, have literally no option but to sprint. Not run, but sprint. You know what happens when you have to sprint for miles together. You wear out.
  2. No scope for innovation — When a VC is pouring money in an startup, it expects all of its capital to be pumped into growth. Growth is good. But if the pressure of that growth is the only driving factor and that too at around 80%, all the focus is on the metrics of market acquisition and maximum money AS SOON AS POSSIBLE. This kills innovation. This kills scope of experimentation. This kills scope to pivot.

Although this is what happens all across the world, there is a massive difference in the orientation and expectations of a well performing VC fund in India as opposed to some other countries.

Solution?

Here is a couple.

  1. Wait before you sell — your equity is probably the most expensive commodity that exists. Wait before you raise venture capital. Reach some scale before you raise your first round.
  2. Growth, growth and growth — Take in venture capital funds only once you have reached the growth stage. Scalability and replicability. These are the golden words for you to raise VC money. Your organisation has reached the stage where you have crossed product-market fit and all you need to do is pour gasoline on this fire, that is when you raise VC money.
  3. Other forms of financing — Banks, NBFC’s are institutions that will give you some loans. Try and reach a certain stage and level in your organisations growth story.
  4. Strategic Partners / Smart Money — Very early on, you want to take someone in as a partner who adds more value to your organisation than just pouring in money. This does two things, one you have more hands on deck and the second alignment of vision. Founders often forget how important it is to get partners who are aligned with your vision to propel growth.

The inflation problem?

India has a lot in store and the inflation and repository rate is on its verge of going down. Lets wait to see the next set of mega-disrutive startups to come from India!

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