True Story: Chat between an entrepreneur and an investor

The conversation I am about to narrate took place at a coffee shop I go to regularly. I’m a big fan of working in coffee shops, especially those that can actually serve up a nice cuppa. So not talking about Starbucks here obvs…

About two weeks ago, I was listening to some peppy house with my headphones on and working away, when two men converged to a table right in front of me and began a very animated conversation.

I couldn’t ignore the frantic hand gesturing just beyond my laptop screen, so I decided to engage in a recent preoccupation of mine: inconspicuous eavesdropping. With all the startup mania in India’s silicon valley of Bengaluru, this occasionally results in some great entertainment.

Thankfully, the moment that I decided to take a break was when the conversation got really interesting. So I got up for a stroll, came back and flopped on a couch very close to their table. I pretended to write stuff in my diary. What I was actually doing was noting as much of the conversation as possible.

In less than a minute, I figured one of these guys was the co-founder of a tech startup, and the other was part of a firm that has invested in the startup.

So here goes, from where I picked it up:

Entrepreneur: {Imagine a THICK south Indian accent}“…see, I can’t promise anything, but I am sure we can work on the valuation”.

Investor: {In classic American twang} “Absolutely, you will have to, there is no way my guys will put in more money unless we see an increase in valuation, but at the same time, it has to be sensible”.

Entrepreneur: “ Definitely, see, this is not the kind of business that can be valued on the basis of your usual metrics. So, you know, revenue and cash flow and all is not applicable…we have to look at it from a broader perspective”

— — — — — — — — — — — — —a long silence — — — — — — — — — — —

Investor: “So what do you propose then? The last round was at a $2.4 million valuation, so we’re looking at making at least 5x by the time the next round comes in…”

Entrepreneur: “See, I have spoken to Madhu and Sachin and the guys, and they think we should raise the next round at $30 — $35 million valuation. Also, that is the only way we will be able to get the big guys interested to put money in at a later stage.”

(Me: Big guys? Who are these ‘big guys’?)

Investor: “OK, so how are we going to sell the story? You are proposing a jump in valuation from $2m to $35 million, so what’s changed to justify a 20x increase in valuation?”

Entrepreneur: “See, we’ve seen good growth in users, and the engagement we have since the last funding round is AMAZING. So simbly to say that not much has changed is not the way to look at it. We are building a brand here. Brands take time to build. When you first put money in, you said you wanted to see vision. We have shown solid vision. And solid execution. I am sure you agree.”

Investor: “Yeah vision is OK, but that needs to result into some form of tangible metric which justifies the money that you are asking for. We’ll have a detailed look at the numbers tomorrow when Stu and Jamie are in, but what’s been the growth in revenue since last year?

— — Waiter interrupts, asks if they’d like anything more. Goes on to describe the awesome, new strawberry cheesecake ice-cream milkshake on offer. VC shakes his head, Indian guy considers for a few seconds, clearly tempted but finally bobs his head, the way that Indians are famous for saying ‘no’…

Entrepreneur: “See, revenue growth has not matched growth in users, but as I said, this is not a business that can be valued on the basis of revenue. You need to take a broader perspective than just that…”.

Investor: hesitates for a moment, changes position in his seat, and then says, “I…I…can see where you’re coming from, but it’s all about the story. So, umm, let’s think about this for a moment. Umm, what’s the growth story here? If we put in money at the valuation you are talking about, then the company has to be on track for a $80m valuation in 3 years time. Is that going to happen? I am not so sure…”

Entrepreneur: “See, we are going as per our initial estimates. If this is not resulting in revenues, we will need to alter our pricing. Currently, we were selling an upgrade at $15 per month, and we feel this is too high. I feel we should grow to 2 million users and until then, keep upgrades very cheap. Investors are putting too much pressure on us to keep upgrades at a high price.”

Investor: “Hmmm, so how many users are we at this point?”

Entrepreneur: “About 85,000. Most are from US and Europe. We want to build a huge user base in India, but this won’t happen at $15 per month. It is too expensive.”

Investor: “85k users isn’t exactly a lot is it? And you’re saying that’s worth $35 million?!”

Entrepreneur: “Actually, see, users is the only metric that will result in revenue going forward, so we need to push that number. If people are not signing up, then we have a problem. The product is great. You know that. I know that. The market is big. There are already a lot of copycats, which shows…”

…gets interrupted by a visibly upset investor…

Investor: “OK, I tell you what, Ravi, let’s park this conversation here. I get your points, but we have to be sensible. Credibility is the biggest thing in this business. I don’t want to be known as the guy who bummed it up chasing a nonsensical valuation. We’re meeting tomorrow anyways, with the other guys here, so we’ll figure something out.”

— — — — — — — — — — — — — X — — — — — — — — — — — — —

That was where they decided to call it quits for the day and began to pack their bags.

I found it interesting that the founder was pushing so hard for a second round, at an insane valuation, for what seems like not very many users.

Without knowing details about their business, it is pointless coming to any sweeping conclusions. But what got me perked up was the amount of trust both these guys had in the future.

They were both betting that tomorrow would be much better than today.

They were both betting that tomorrow they’d magically have users who would pay for the product.

They both seemed to have a slight disregard for the amount of money at stake, and whether it was going to be put to good use.

At the end of the day, we all live with a lot of trust in the future. We accept cash as payment because we trust it will be worth at least as much tomorrow. We buy cars, houses, things, all with the hope that they will exist, and possibly increase in value tomorrow. We ‘buy’ an education, because we believe that it will provide us with a ‘return’ at some point in the future.

Stakeholders in the start-up ecosystem probably take this line of thought to an extreme. More often than not, they are wrong. But that doesn’t stop some of them from having a go at it again. And again. And again.

I have heard conversations such as this one many times before. At least in my neck of the woods, founders and investors seem to be playing a game. It’s sort of a funny game, and doesn’t fit in well at all with the stuff I studied as a Finance major. Since when did revenues not matter? They’re all betting on each other to take them to a greener patch of grass, without much regard for the consequences. And they don’t mind playing with other people’s money to achieve their goals.

I once worked at an edtech startup and remember a conversation I had with the founder. I asked him what valuation he had raised the last round at, and without any hesitation he said ‘in the region of $25 million’. This company had under 20,000 users so I probed him some more. You know, just to make sure if my 2% stake really was worth half a million dollars! On my insistence for another (more digestable) figure, he settled with ‘it must be $2.5 million then’.

It’s like what Gary Vee said on one of his episodes:

“There’s this one 23 year old founder I am backing who has told me he doesn’t give a shit if he loses all my money. He thinks he will acquire enough skills to get himself a second shot at it if this fails. And I’m a big, fucking loser to back this kid. But hey, I don’t want to look back and think I missed out”.

Sooner or later, the same shit as 2008 is going to happen. Perhaps not in sub-prime, as that doesn’t exist in India. But I can see something similar hitting the startup scene…

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Cheers!