Why investors like loss-making startups?

Last week I wrote about Indian achieving 100 unicorns’ status, quite a commendable thing for a developing country. India has become the third largest startup ecosystem after the US and China in sheer number of startups.

However, not everything is hunky-dory in the startup world. It’s like a storm-in- the-tea-cup situation. As per recent data, most of the unicorns are not profitable – 57 of the unicorns in deep loss, 18 of them are somewhat profitable and rest of them are registered in Singapore or the US, hence, their data is not available.

Zoho, InfoEdge, Zerodha, Five Star and Dream 11 are among the top five profitable companies. Zoho and Zerodha are still unlisted, whereas Infoedge is listed and Five Star is an NBFC. On the other side, hospitality major Oyo, Udaan and Flipkart are among the top three loss-making startups.

Situation is not so different in other countries. In the United States, some of the biggest startup companies are making significant loss or have never made any profits. However, investors do not care about it; startups are able to generate more funding from marquee investors and achieve newer valuation levels.

To understand why investors like loss-making startups, we must dive deeper into getting insights about user-growth vs revenue-growth. Investors expect startups to expand rapidly and acquire users even at a higher cost. Many startups spend a fortune to onboard a customer (sometime the onboarding cost is more than what customer would spend on the startup offering). This cost is termed as “customer acquisition cost”.

Higher customer acquisition is also cultural thing – American startups usually have more access to money; hence they launch with the boom, and they acquire thousands of customers within weeks. Europeans’ startups focus on product and profitability before building the customer base as they don’t have similar funding available as their American counterparts. In India, money from investors comes late but when it comes, it brings pressure and targets for the startups to acquire customers.

Investors expect startups to tab into the large domestic market and onboard customers at whatever cost. In the process, startups lose focus and cost go spiral, resulting in the loss        

Being a large domestic market, one of the biggest advantages of India sometimes becomes a disadvantage of make it for the startups. Investors expect startups to tab into the large domestic market and onboard customers at whatever cost. In the process, startups lose focus and costs go spiraling upwards resulting in the loss.

In 2012, Facebook was criticised by the analysts for failing to meet the revenue growth expectations. Facebook by then had 1 billion users and was the largest social media in the world. However, Facebook was not making enough money. On the other hand, Amazon was going for revenue growth without adding many customers, hence, always remained profitable.

The sweet spot in the discussion is how to maintain the balance between user growth and revenue growth – it can be achieved simultaneously. It takes planning, detailed planning and little creativity to find the alignment between the various stakeholders (shareholders, customers, employees, and investors). It is ultimately the enduring vision of the entrepreneur to pivot the model as per the need of the market and remain competitive.

Article published in Blitz India https://blitzindiamedia.com/why-investors-like-loss-making-startups/