Systematic flaws and lack of vision leading to turmoil in startups

Infosys founder N.R. Narayana Murthy recently blamed venture capital (VC) funds and investors for their aggressive focus on growth over profitability. The veteran technology entrepreneur said that the ‘growth-at-any-cost’ mindset of startups was the outcome of VC firms’ behaviour. Terming the current investment model of VC firms similar to that of ponzi schemes, he said, “I would hold venture capitalists responsible. They propounded the theory that only the top line is important and not the bottom line. I think that is completely wrong. In many ways, it looks like a Ponzi scheme.”

No doubt, there is truth behind the tech veteran’s words. VC and PE funds keep on investing on any venture till there is growth in the top line. It’s like from one round to another round, the risk gets transferred while valuation of the startups keeps rising. At the end, when growth dries up, the last fund gets caught if the startup has not been able to go public. In case the startup gets listed, then the entire risk gets transferred to the general public. Indian bourses have seen the fate of many new-age companies’ scrips after their listing on the exchanges. Investors are not willing to give the risk premium based only on growth. Therefore, Murthy’s words seem logical in many respects.

However, there are also other extreme arguments to this logic. Firstly, India as a country faces inherent dearth of risk capital. Traditional financial institutions are not willing to bet on new ventures owing to their age-old evaluation methods. So, before the advent of PE and VC funds, raising risk capital for a new-age company was a herculean task. No wonder, entrepreneurial culture of Indian economy on a wide scale is a recent phenomenon. Earlier, only people from well-to-do families or with certain links would go into business. With the advent of technology and funding availability from PE and VC funds, many more have joined the race now.

Individuals passing out from premier educational institutions are taking the entrepreneurial plunge today. This is leading to meritocracy. There is no denial that the US as an economy is so successful today as it has actively funded new ideas with the risk capital those require. Secondly, the success rate of startups is not high even globally. Though statistics vary, around 70-80 per cent of all startups fail to survive. Therefore, blaming VC and PE funds for the current state of affairs is not fair. Moreover, only PE and VC funds are not to be blamed for the growth at all cost mindset of startups. Founders of many startups are also to be held responsible for such state of affairs. Many founders are only focussed on the valuation game than focussing on value addition aspect. This hurts long-term prospects of the business. Their short-sightedness has put them and employees in trouble during this funding winter. There are many aspects to the same theme. Only blaming certain set of investors for the current turmoil in the startup ecosystem is wrong. However, Murthy’s observation also plays a role. It is better to draw a balance between growth and profitability for long-term survival.