In today's Finshots we talk about the startup winter and see if this is the end of the cash burn era

The Story

5,600!

That’s the total number of people  who've been laid off from Indian startups in the past 5 months. From ed-tech company Vedantu to social commerce company Meesho. The job cuts have been brutal.

But why is this happening now?

Just last year, we were minting new unicorns (a billion-dollar company) every week. In fact, we had 42 new unicorns in 2021. A record!

And now, all of a sudden, the mood has turned.

What happened?

Well, many things actually. For starters, central banks have been pumping money in a bid to prop up economies. Economies that were battered by the pandemic. Some of this money helped people get by during the past years. But most of this money made its way into the financial ecosystem. And as investors began scouting for new opportunities across the globe, they found an enticing opportunity in India i.e. the burgeoning Indian startup ecosystem.

These people funnelled some of these monies to VCs or Venture Capitalists (money managers with a high-risk appetite) who in turn parked this money in startups that had the potential to grow exponentially. As a consequence, the Indian startup ecosystem became a tacit beneficiary.

To give you some context, VC firms poured $38.5 billion into Indian startups in 2021 — 3.8 times as much as they did in 2020!

And what did startups do with all that money? Spent it, of course! They went full throttle everywhere — marketing, sales, tech, you name it. They wanted customers quickly and they were willing to burn good money to get there. But what goes up must come down, no? And in 2022, the tide began to turn.

First, there was the war in Ukraine. Then, a slow rise in oil and gas prices. There were also supply-chain hiccups. Which in turn triggered a wave of inflation across the world. Central banks, spooked by runaway prices, decided to undo some of the damage. They choked off the money supply, hoping this would help tame prices. And while it’s anyone’s guess if this will in fact help curb inflation, there have been some unintended consequences.

With money in short supply, investors have had to reassess their priorities. Quick returns aren’t a concern anymore. Wealth protection is. And naturally, venture capitalists have lost their sheen. They’re struggling to raise new funds from people. And their investments aren’t doing all too well either.

Tiger Global’s tech portfolio suffered losses to the tune of $17 billion, while Softbank reported losses of $13 billion.

They’re now sending grim memos to founders. One  note from YCombinator (a startup accelerator) said, “If your plan is to raise money in the next 6–12 months, you might be raising at the peak of the downturn. Remember that your chances of success are extremely low even if your company is doing well. We recommend you change your plan.”

So in effect, entrepreneurs who were binging on cash are now being forced to cut spending fast. And this should explain the layoffs, the general doom and gloom surrounding startups and the uncertainty surrounding their future.

But this has also got some people thinking— “Why did VCs invest their funds so recklessly if they knew this was an inevitable outcome? Why do entrepreneurs continue to burn money when a path to profitability doesn’t exist?”

Well, to understand this, you have to understand how the ecosystem works.

Great entrepreneurs start as great storytellers. They can weave the most compelling narrative and get even the most reluctant Venture Capitalists on the cap table. But this assessment is only partially true. Sure, VCs love good storytellers. But they only like a very specific kind of story - the one where you tell them “the world is your oyster.”

Today you’re a ride-sharing platform. Tomorrow you can be a financial services company. Today you’re an online wallet. Tomorrow, you can be a bank. Today you’re a company whose annual revenue barely touches 1 Cr. Tomorrow you could be a unicorn.

These are the stories that VCs want to hear. It’s the only way their business model works. Even if you’re a company churning out 100 Cr in revenues with a 10 Cr PAT (profit after tax), the business isn’t enticing to a VC unless you can show them that a 1000 Cr revenue run-rate is within touching distance. You have to sell this narrative, even if you don’t believe it yourself.

And if you’re an entrepreneur that would much rather stay grounded and conservative, then you’ll have a tough time soliciting VC interest. You’ll most likely have to bootstrap your way to the top or find a very different kind of investor — not the stereotypical venture capital kind.

This in turn begets a dilemma. Deep down, most entrepreneurs know that this ultra-aggressive approach isn’t ideal. The “fail fast, learn fast” mantra makes for a good bumper sticker, but steering a bleeding startup towards “kingdom come” is an unenviable task. The media scrutiny, the customer complaints, mutiny within the C-Suite, mounting investor pressure — it can cripple you. And entrepreneurs aren’t entirely ignorant of this reality. If anything, they know this all too well. The only problem? “Bringing a stick to a gunfight” won’t exactly improve their outcomes either. In a world flush with cash, it’s hard to be the lone rebel and bootstrap your way to the top. So they do the only thing they can. They simply go along with this charade. They raise millions knowing that the market opportunity simply may not exist. They promise the moon knowing that it may just be a bit too fanciful.

It’s how we got to this point.

Nothing else explains how a company can burn through 100 crores, in under a year, without showing any material improvement in business fundamentals. Except for the fact that this is how you play this game. It’s the only way you can play this game.

The mass layoffs, the closures, the bankruptcy proceedings, and the public fallouts aren’t aberrations. They’re features — a consequence of deliberate design. So for people wondering if the party is ending - No, it’s not. It’s merely a temporary lull. When the dust settles, and survivors emerge, everybody will go for round 2. There’ll be more unicorns, more entrepreneurs, more cash burn, and more money than ever before.

The rules of Venture Capital don't change. They’re merely rephrased.

Until next time...

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