In today’s Finshots, we look at how the era of easy money in startups may have created a problem in the world of angel investing.
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The Story
It’s another day and we have yet another Indian startup that has allegedly fudged their numbers.
This time it’s Mojocare, a Bengaluru-based wellness startup that began life in 2020. They fired 80% of their employees out of the blue! Their venture capital investors say that the Mojocare team fudged the books. And some reports claim that the founders even diverted money into companies run by their own relatives.
Now it seems that Mojocare has admitted to some stuff and denied the others. Basically a “Yes, we fudged numbers, But, no, we didn’t steal money,” kind of situation.
The unfortunate reality is that we’ve had too many allegations coming in from Indian startups in the past year alone — BharatPe, Trell, Bikayi, GoMechanic…and now Mojocare too.
And the rise and fall roughly look the same always —
- Sell a fanciful story featuring India’s 1.4 billion population and raise money at insane valuations because everyone wants to invest in the next big thing.
- Burn cash chasing growth and customers.
- Draw high salaries for self even if the startup is making massive losses. And cash out some of your equity for a big payday.
- When the growth doesn’t materialize, fake the sales because you can’t afford to look like a failure now.
- But when the tide turns, investors turn more cautious. They turn off the money tap. And this receding tide reveals who was swimming naked.
But there’s another problem in the making here. And it’s something that early stage investor Shrishti Sahu pointed out — a problem when these same startup founders turn into angel investors.
See, founders don’t often pump their own capital when starting up. Instead, they go out and tell stories to VCs and raise money. And once the money hits the bank account, they take it as a sign of validation of their business prowess. A stamp that they’ll be successful even if deep inside they know that their company is built on shaky foundations.
And once that belief sets in, they want to take the next logical step. Became an angel investor. They want to advise other startups on how to run the show. After all, they can proudly say they know a thing or two about startups after raising money from the big VCs, no?
And if writing ‘Founder’ on LinkedIn is Level #1 of the status game, writing ‘Angel Investor’ in their bio is level #2. It elevates you in the game.
Now here’s the issue — all these angel investments are actually just VC-subsidised money.
Just think about it. How many of these founders actually run profitable startups? For instance, here’s a bunch of angel investors in Mojocare listed out by Business Today:
“Vineet Jain (MD, Times Group), Kunal Shah (Founder, CRED), Ankit Nagori (Founder, Curefoods), Adrian Auon (Founder and CEO, Forward), Sajid Rahman (Founder and CEO, Telenor Health), Ravi Bhushan (Founder and CEO, Brightchamps), and Vivekananda HR (CEO and Founder, Bounce).”
We’re not going to pick names and say that ‘angel investor X is a founder of loss making company Y’. We bet you can figure it out for yourself.
So, this is what typically happens — Startup founders raise VC money -> use this to pay themselves a fat cat salary -> Maybe do a secondary and sell some of their equity for cash -> And then invest this very same money into other startups and call themselves angels.
As the Financial Times points out, “In San Francisco, this [startup founders investing in other startups] is a form of charity. It keeps the whole ecosystem working.”
It seems like it’s the same story in India. And this cozy startup ecosystem has its own problem.
What do we mean?
Well, guess who’s another angel investor in Mojocare…Kushal Karwa.
And if that name doesn’t ring any bells, well, he’s also one of the co-founders of GoMechanic. You know, the tech-based auto service startup that was accused of manipulating the books and siphoning funds in January.
Coincidence? We don’t know.
And you can bet that VCs aren’t blind to such things. They will turn cautious. They’ll dial back on the pace of investments. And it seems like it’s already happening. VCs in India had a whopping $23 billion in cash on the sidelines by the end of 2022. Or what’s called ‘dry powder’ in startup lingo. For context, in the years prior to that, VCs generally kept $15 billion that could be deployed at a moment’s notice.
They may eye founders more suspiciously and look for red flags. They’ll tighten the screws.
Apparently, some VCs are saying, “Look, we need our capital back at the end of 4 years. Plus a 25% annual return. Otherwise, give us the rights to your personal assets. Your house and car too.”
Others are demanding special treatment. They want to be first in line for a payout whenever the company gets sold. And they want twice the money they’d initially invested. That means, the founders only stand a chance to make any money for themselves if they’re able to payout this 2x return to the VC. If not, the founders get nothing. For perspective, VC’s generally demand just the initial capital and not 2x.
There are even VCs who’re now laying down the gauntlet and trying to curb those high salaries. And saying that founders can’t sell their own shares for 4 years. Which means they can’t really turn angel investors either.
But imagine a founder who’s desperate for cash. If these are the kinds of offers on the table, they’ll definitely be tempted to take it up. And the problem is that it’s terms like these that might nudge them into fudging numbers. Because they have to sell a fanciful story to a greater fool and give their initial investors what was promised.
It’s a vicious cycle. And this could derail the Indian startup space.
Now we just want to make one thing clear. We aren’t painting all founders with the same brush. We know how hard it can be to build a company. Many founders toil for years on a meagre salary or even nothing. Just to create something worthwhile. So when they finally get VC validation and money, it’s kind of a reward for all those years of struggle. But we can’t deny that the dark side exists. Where some founders are just looking to strike while the iron is hot. Make a quick buck and live a lavish life. And that’s the problem everyone's worried about.
Until then…
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