How startup stakeholders tend to forget the fundamentals during euphoric times

Globally, startups are going through a severe funding winter. India is no exception to the trend. However, fund houses are hopeful that startup ecosystem is resilient enough to overcome the odds.

In a conversation with the Bizz Buzz, Partner at private equity fund, Siana Capital Management, Dinesh Goel said the key learnings from the crisis are focus on profitability, and fundamental unit economics among others. He, however, said that investors, startups and general public tend to forget the key learnings during euphoric times. The key learnings from the current downcycle are that startups have to focus on fundamentals of the business with profitability as their biggest priority than chasing growth at all cost. Similarly, dependence on multiple rounds of fund raising has to be curtailed. The fund house, which has invested in eight companies from its first fund, is in the process of raising the second fund. It is hopeful of closing the second fund by the end of this year or early next year.

What are your views on the ongoing funding winter seen in the startup ecosystem? When do you see a revival in fund flows?

Yes, we are going through a downcycle as far as the startup funding is concerned. It’s a buyer’s market – funding lead times have elongated, valuation multiples have dropped significantly and investors are quite selective on the ventures they want to fund. That said, these are typical cycles that markets go through every few years. We will see a spate of shutdowns, layoffs due to downsizing and consolidation of companies. It’s not actually bad for the ecosystem at a macro level as it will cleanse the froth.

It’s difficult to predict when the markets will turn due to an interplay of multitude of factors. But we do hope that the scenario will change sometime in 2024, another four quarters or so.

As you have pointed out, there was euphoria in the startup space with every quarter or six months, we were witnessing new funding rounds for many startups. What kind of lessons the startup ecosystem and the investors’ community can draw from the current funding winter?

In my view, the most important lesson here is the need to focus on the business fundamentals. Investors must evaluate and fund companies on the basis of their growth and profitability potential. At the end of the day, the business that doesn’t earn cash profit remains dependent on regular injections of capital and hence vulnerable to funding downcycles. Over funding the companies at inflated valuations that happens when there’s excessive capital available germinates the seeds of troublein future. For most businesses, valuations don’t go up so sharply every four-six months that they are funded at which is a common characteristic of euphoric times.

Unfortunately, the lessons learnt take a back seat when the pendulum swings to the other side. This is reflective of human emotions and behaviour. Howard Marks of Oaktree has talked many times about the swings in the market that offer opportunities for discerning investors – we can see this applies to private markets too.

Do you see that profitability will be under sharp focus for times to come?

Profitability is in focus at the moment as a critical parameter and ideally should be in focus at all times except for very early stage funding when the product market fit is yet to be established. Barring some allowance for stage and strategy of the companies, both unit economics and overall profitability are critical for sustainability of the business. It is, however, easily forgotten during the bull cycle of investing. In upcycle, lens may change again with emotions like FOMO and greed starting to play over riding role again in decision making.

Many new age companies have gone public in the last two years with successful listing. Do you feel that the exit route of PE and VC investors gets squeezed due to performance of these stocks in the bourses?

Public markets are and will remain an important exit option for businesses with long term growth potential, albeit valuations will fluctuate as per market sentiment from time to time. Successful IPOs of new age companies over the last couple of years on Indian bourses have endorsed the same. There’s a much needed uptick in the investor confidence in their ability to exit businesses both via public listing as well as strategic and secondary sales with the increase in exit transactions. I expect a continued flow of new age companies opting to become public companies in the coming years while other exit options will also see a marked increase in volumes. This is good for the overall startup and investing ecosystem as a vibrant exit environment is critical to attract greater amount of risk capital. This has, historically, been a concern for investors in Indian startups that exits are rare and difficult even for the companies which are relatively doing well. So, its nice to see this becoming less of an issue going forward.

What is the investment philosophy of Siana Capital Management? Can you throw some light on this aspect?

We focus on new products/platforms built by entrepreneurs with the use of advanced technology and/or sciences that are relevant to both India as well as international markets. We are also consciously an active investor in our style. We prefer to lead investing rounds, work closely with founders and management team to help them with their strategic decisions from time to time and navigate the business towards sustainable growth and creation of significant value for all stakeholders.

Since we started investing from our first fund in 2019, this investment thesis has attracted much more attention and hence gained greater traction amongst the investors in India. Funds dedicated to such an investment philosophy still remain few and far.

Additionally, we also place emphasis on measuring and improving the ESG quotient of our portfolio companies. Innovative products that we back should also benefit society or environment in a positive way apart from achieving commercial success.

How many funds are currently operated by Siana Capital? Are you planning to raise any new fund for investment?

We have now almost deployed our first fund and are currently in the process of raising our second fund. Investment thesis broadly remains the same across the funds and we should soon start investing from the second fund. We have a strong pipeline of investment opportunities at various stages for new investments encompassing an interesting mix of SaaS, Robotics, Life Sciences and Cybersecurity. This is a good time for investors in the market as pointed out earlier.

How is the performance of investee companies so far? Are those performing well in the current environment?

Our portfolio, for the most part, has proven to be highly resilient. We have now weathered the full cycle of covid crisis followed by the geopolitical crisis and funding slow down. In fact, many of our companies continue to show solid growth and have also raised follow on funding rounds since our investment.