Uncovering tech startups holds important lessons

Times are changing. The situation is aptly explained by paraphrasing a line attributed to Vladimir Lenin: “There are months when nothing happens; and there are months in which years happen.”

Just a few months ago everything was fine. Fresh money was being raised. Initial public offerings (IPOs) were happening or being talked about. Billion dollar valuations creating new unicorns happened every week. The media pandered to start-up entrepreneurs. And politicians used them to tell us that India’s economic story was going great.

Suddenly everything seems to have changed. The easy money that flowed into the sector thanks to rich world central banks creating money out of thin air has slowed. The number of unicorns is decreasing. Today, IPOs at extreme valuations don’t stand a chance. The media is asking questions.

There are several lessons we can learn. Technology entrepreneurs draw on the marketing lesson offered by the success of several international firms. As Al Ries and Laura Lies write in The Fall of Advertising and the Rise of PR: “All recent marketing successes have been PR successes… To name a few: Starbucks, The Body Shop, Amazon.com, Yahoo!, eBay, Palm , Google, Linus, PlayStation, Harry Potter, Botox, Red Bull, Microsoft, Intel and BlackBerry.” India’s tech startups took advantage of this insight and sold their supposed “success” stories to the news media and social media.

The news media, always looking for heroes, bought their stories and took them to the mass market. As Phil Rosenzweig says in The Halo Effect: “Our most compelling stories often put people at the center of events. When times are good, we lavish praise and create heroes.”

This has turned many start-up entrepreneurs into public heroes. The views they have on everything from the state of the nation to investing money are somehow considered important. This ignores the fundamental aspect of life that human experience is in very narrow domains.

These entrepreneurs caught the attention of ordinary Indians. A major reason for this lies in the fact that their stories are presented to the world with great simplicity, almost saying that if they can do it, so can you. As Rosenzweig writes, “The test of a good story is not its accountability to the facts, but its ability to provide a satisfactory explanation of events.”

In this sense, the stories of these new age heroes did not take into account aspects like being in the right place at the right time or the fact that there is so much easy money floating around waiting to be invested. We were told that the “success” of these entrepreneurs was due to their individual competence and hard work.

Also, the hope that these firms will make some money someday is presented as a business model and rarely questioned. One analyst even went to the extent of forecasting earnings till 2041 to justify Zomato’s extreme IPO price.

But that was all yesterday. In his book What Goes Up, Eric J. Weiner quoted fund manager Jerry Tsai as saying, “The problem with getting a little bit of good publicity is that when things go wrong, they like to kill you on the way down. The media likes to build things up so they can tear them down.” Or as Rosenzweig puts it, “When things go wrong, we blame and create villains.”

Although this disruption has yet to begin, the media is reporting layoffs at startups and also questioning the regulatory arbitrage that some of these firms have indulged in. In fact, about two decades ago, the media did a great job of exposing the excesses of the dot-com bubble after it burst. Something similar happened after the subprime crisis broke out. The media has done a great job of explaining the why, what and how of this financial crisis.

The biggest lesson here is that just because something has been around for a while doesn’t necessarily make it work. Tech startups mostly had a cash-burn model where they offered goods and services at a discount to build scale. Their income and losses increased at the same rate; VCs have funded these losses so far. They cannot continue to do so as money is no longer as cheap as it was.

In conclusion, there are three ways startup entrepreneurs can make money. The first is to sell to other entrepreneurs. Many of them managed to do this. The second is to go public with an IPO and offload some of their stake to ultra-bullish retail investors. That also happened. Now is the time for the third and only sustainable way. Startups must ensure that their revenues are greater than their costs.

This leaves us with two lessons. First, the era in which access to easy money was dismissed as the purview of entrepreneurs is now over. And secondly, a high valuation does not mean that the business will be profitable one day.

Vivek Kaul is the author of Bad Money.

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