Remember
when South African media giant Naspers acquired bus ticketing platform
redBus at a $100 million (Rs 620 crore) valuation in June 2013? It was a
seminal deal -- a badge of honour -- especially as very few VC-backed
internet companies had achieved such valuation. But 18 months later,
$100 million is considered loose change.
Now, an increasing number of startups are aspiring for Rs 1,000 crore ($160 million) valuations, which would catapult them to the unicorn club of $1 billion (Rs 6,200 crore) global internet startups. Being a part of the Rs 1,000-crore club makes them stand out from competitors, giving them a leg-up in raising even more funding, hiring in a talent-scarce market, and getting more press.
Fueling this are top venture capital investors and hedge funds flush with capital driving up valuations in a market where financial metrics are becoming less important by the day, often stupefying market experts.
Restaurant search platform Zomato is in talks for a $100 million funding round that would value it at $1 billion, a mere four months after it raised $60 million at a $660-million valuation. Flipkart is in the market to raise fresh capital at a valuation of $15 billion a month after it raised $700 million, valuing it at about $11.25 billion.
Flipkart and Zomato headline an unprecedented valuation swell that has swept both startups and VC investors.
Now, Ola, Zomato and Paytm are set to join Flipkart, Mu Sigma and Snapdeal in the club of billion-dollar Indian startups. By most accounts, these staggering valuations, often involving 4- or 5-year-old startups running sizable losses, have little to do with calculations based on hard numbers. "Startup valuation is a kind of voodoo art," Rehan Yar Khan, founder of Mumbai-based Orios Venture Partners, quipped recently on the sidelines of a networking event when a wealth management executive quizzed him on the subject.
Khan, known for early bets on startups such as Ola and Druva, was only half joking. Venture capitalists like him are the primary source of capital for startups and set the baseline for valuations.
"Valuations are determined on the basis of what we (VCs) think could be the potential return multiple on an investment in 5-6 years. The present day valuation is back-calculated down from that target return multiple," said a Mumbai-based investor with a Silicon Valley firm.
Fanning Valuations
Once an investor has set his target return multiple, he back-calculates on the basis of how much capital the startup will need to reach that multiple and what his shareholding will be when it achieves that multiple. Much of this so-called back calculation comes into play during Series A funding and becomes more pronounced in later rounds.
To be sure, investors also take into account factors such as how a startup compares with similar businesses overseas, in markets like the US or China, and then discount for the market size in India. The numbers can vary based on factors such as the entrepreneur and the team. For instance, a 25-year-old IIT graduate founder can do wonders for a startup's valuation.
Founders, too, are to blamed for inflated valuations. During a meeting last week with an entrepreneur who had recently joined the billion-dollar club, when the conversation turned to the recent entry of hedge funds into India's startup ecosystem, the entrepreneur abruptly said, "We will be in fundraising mode soon and will raise $500 million. There's a queue of investors from hedge funds to sovereign wealth funds."
But shopping funding rounds through the media, social media and investment banking channels has become the norm, often succeeding in fanning valuations.
The valuation of consumer internet companies, led by e-commerce ventures, has baffled several market observers and financial consultants. How can an online retailer losing tens of millions of dollars every month be worth more than the combined market capitalization of all the listed retail businesses in the country? Also, how do huge valuation chasms arise between close competitors?
For instance, online retailer Snapdeal raised nearly $1 billion last year at a valuation of about $1.9 billion, while larger rival Flipkart was able to attract nearly $2 billion in funding and is valued at over $11 billion. Similarly, cab aggregator Ola raised about $250 million last year at a valuation of about $650 million, but rival TaxiForSure could manage only $30-40 million at a valuation of less than $100 million. Now, Ola is close to acquiring TaxiForSure as the latter is said to be running out of capital.
Hunting in packs
One reason for the vast mismatch in valuations is that most startup funding deals are not intermediated. "VCs are almost as active as a banker" in introducing their portfolio companies to potential investors, according to an investment banker. The general practice among VCs is to invest in packs or club co-investment partnerships, which makes venture valuations more of an art, subject to softer aspects such as the law of demand and supply rather than financial metrics.
"You develop comfort with certain investors because you back similar types of entrepreneurs, are bullish on the same sectors and are comfortable working with them," said a Bangalore-based investor. The internet sector is a good example of how VCs hunt in packs.
Tiger Global has made over 10 co-investment deals with Accel Partners India and four with Helion Venture Partners. Helion and Accel Partners have made half a dozen investments together. Not quite cartel-like behaviour, but close enough.
This is unlike private equity deals and mergers and acquisitions in sectors such as IT services, pharma/healthcare and consumer goods, where the terms are derived based on a company's earnings before interest, taxes, depreciation and amortization (EBITDA), or price-earnings (P/E) multiples.
Many investors in startups also negotiate deals based on the shareholding they want in a company. Japan's Softbank is known for its 30-35% stake requirement in its target companies and has this shareholding in all its India portfolio companies -- InMobi, Housing.com, Snapdeal and Ola.
Ultimately, deals boil down to a VC's conviction in a startup, leading to faster closures. "When you are investing in Flipkart, it does not really matter if you are putting capital at a $7 billion or $11 billion valuation as you have to be convinced that the company will be worth $60 billion," said another Mumbai-based VC investor. VCs, too, realize that such an environment will not last forever, and there could be some slowdown in the future. But till then, as one VC put it, "Everybody is riding the wave."
Now, an increasing number of startups are aspiring for Rs 1,000 crore ($160 million) valuations, which would catapult them to the unicorn club of $1 billion (Rs 6,200 crore) global internet startups. Being a part of the Rs 1,000-crore club makes them stand out from competitors, giving them a leg-up in raising even more funding, hiring in a talent-scarce market, and getting more press.
Fueling this are top venture capital investors and hedge funds flush with capital driving up valuations in a market where financial metrics are becoming less important by the day, often stupefying market experts.
Restaurant search platform Zomato is in talks for a $100 million funding round that would value it at $1 billion, a mere four months after it raised $60 million at a $660-million valuation. Flipkart is in the market to raise fresh capital at a valuation of $15 billion a month after it raised $700 million, valuing it at about $11.25 billion.
Flipkart and Zomato headline an unprecedented valuation swell that has swept both startups and VC investors.
Now, Ola, Zomato and Paytm are set to join Flipkart, Mu Sigma and Snapdeal in the club of billion-dollar Indian startups. By most accounts, these staggering valuations, often involving 4- or 5-year-old startups running sizable losses, have little to do with calculations based on hard numbers. "Startup valuation is a kind of voodoo art," Rehan Yar Khan, founder of Mumbai-based Orios Venture Partners, quipped recently on the sidelines of a networking event when a wealth management executive quizzed him on the subject.
Khan, known for early bets on startups such as Ola and Druva, was only half joking. Venture capitalists like him are the primary source of capital for startups and set the baseline for valuations.
"Valuations are determined on the basis of what we (VCs) think could be the potential return multiple on an investment in 5-6 years. The present day valuation is back-calculated down from that target return multiple," said a Mumbai-based investor with a Silicon Valley firm.
Fanning Valuations
Once an investor has set his target return multiple, he back-calculates on the basis of how much capital the startup will need to reach that multiple and what his shareholding will be when it achieves that multiple. Much of this so-called back calculation comes into play during Series A funding and becomes more pronounced in later rounds.
To be sure, investors also take into account factors such as how a startup compares with similar businesses overseas, in markets like the US or China, and then discount for the market size in India. The numbers can vary based on factors such as the entrepreneur and the team. For instance, a 25-year-old IIT graduate founder can do wonders for a startup's valuation.
Founders, too, are to blamed for inflated valuations. During a meeting last week with an entrepreneur who had recently joined the billion-dollar club, when the conversation turned to the recent entry of hedge funds into India's startup ecosystem, the entrepreneur abruptly said, "We will be in fundraising mode soon and will raise $500 million. There's a queue of investors from hedge funds to sovereign wealth funds."
But shopping funding rounds through the media, social media and investment banking channels has become the norm, often succeeding in fanning valuations.
The valuation of consumer internet companies, led by e-commerce ventures, has baffled several market observers and financial consultants. How can an online retailer losing tens of millions of dollars every month be worth more than the combined market capitalization of all the listed retail businesses in the country? Also, how do huge valuation chasms arise between close competitors?
For instance, online retailer Snapdeal raised nearly $1 billion last year at a valuation of about $1.9 billion, while larger rival Flipkart was able to attract nearly $2 billion in funding and is valued at over $11 billion. Similarly, cab aggregator Ola raised about $250 million last year at a valuation of about $650 million, but rival TaxiForSure could manage only $30-40 million at a valuation of less than $100 million. Now, Ola is close to acquiring TaxiForSure as the latter is said to be running out of capital.
Hunting in packs
One reason for the vast mismatch in valuations is that most startup funding deals are not intermediated. "VCs are almost as active as a banker" in introducing their portfolio companies to potential investors, according to an investment banker. The general practice among VCs is to invest in packs or club co-investment partnerships, which makes venture valuations more of an art, subject to softer aspects such as the law of demand and supply rather than financial metrics.
"You develop comfort with certain investors because you back similar types of entrepreneurs, are bullish on the same sectors and are comfortable working with them," said a Bangalore-based investor. The internet sector is a good example of how VCs hunt in packs.
Tiger Global has made over 10 co-investment deals with Accel Partners India and four with Helion Venture Partners. Helion and Accel Partners have made half a dozen investments together. Not quite cartel-like behaviour, but close enough.
This is unlike private equity deals and mergers and acquisitions in sectors such as IT services, pharma/healthcare and consumer goods, where the terms are derived based on a company's earnings before interest, taxes, depreciation and amortization (EBITDA), or price-earnings (P/E) multiples.
Many investors in startups also negotiate deals based on the shareholding they want in a company. Japan's Softbank is known for its 30-35% stake requirement in its target companies and has this shareholding in all its India portfolio companies -- InMobi, Housing.com, Snapdeal and Ola.
Ultimately, deals boil down to a VC's conviction in a startup, leading to faster closures. "When you are investing in Flipkart, it does not really matter if you are putting capital at a $7 billion or $11 billion valuation as you have to be convinced that the company will be worth $60 billion," said another Mumbai-based VC investor. VCs, too, realize that such an environment will not last forever, and there could be some slowdown in the future. But till then, as one VC put it, "Everybody is riding the wave."
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