Welcome to the frenzy, where many regular investors are getting caught up in the excitement of Startup madness. They hope to make quick profits, but is this really what investing is all about? Or is it more like taking a chance, similar to playing the jackpot in a casino, where the house always wins?
The Context
Step to startup madness, a casino that often buzzes with excitement and boundless potential for many vested parties. Governments are big fans of them, venture capitalists can’t get enough, consumers bask in the royal treatment, and for those who supply the tools to propel them forward, it’s a jackpot waiting to happen.
The glamour of investing in the next big thing, the opportunity to be a part of a groundbreaking company’s journey from the bottom up – these dreams fuel the aspirations of many retail investors like you and me. However, this pursuit of startup success can come at a cost to retail investors.
In its simplest form, a startup is just a company in its early stages. Typically, founders provide the initial financing, and they may seek external investment before fully establishing the business. Funding can come from various sources, including family and friends, venture capitalists, crowdfunding, and loans. As the pressure to turn profit mounts, some smart entrepreneurs even consider taking their startups public through an Initial Public Offering (IPO), attracting retail investors to join the excitement, often to provide returns to seed investors and to support further growth.
Sounds a bit confusing, doesn’t it? Let’s simplify things by tearing down startups with the help of an entertaining fictional example.
Let’s Start A Start-up
Picture a modest vegetable vendor named Rocky. He kickstarts his small veggie stand with just a rickety cart perched on a street corner. Rocky’s initial game plan is quite simple: he buys vegetables at wholesale rates from the bustling Azadpur Mandi in Delhi and sells them to the locals.
As Rocky begins to draw more customers, it dawns on him that he can grow his business. To make this happen, he secures a loan, procures additional carts, and brings on a few helpers. His vegetable venture is taking off, and he dares to dream of an IPO (Initial Public Offering) for his brainchild, “Rocky’s Roaring Veggies.”
But here’s where the less savory aspects of startups creep into the picture. To keep pace with IPO demands and satisfy the appetites of his investors, Rocky starts taking shortcuts. He engages with less-than-savory suppliers for his vegetables, compromises on quality, and even cooks the books to present the business as more profitable than it truly is.
The “Rocky’s Roaring Veggies (RRV)” IPO becomes a screaming success, etching its name in households. Yet, beneath the glittering surface, the business grapples with a web of problems. What was once a humble vegetable stand now finds itself entangled in a web of deception and financial woes.
This fanciful example of a vegetable vendor’s journey to an IPO sheds light on how the pressure to scale up rapidly and meet investor expectations can lead to ethical compromises and reveal the darker side of the startup world.
For a retail investor like you and me, who lacks private venture awareness and is captivated by hype, hysteria, media attention, and the enticing advertisements that precede every YouTube video, it’s a guaranteed recipe for financial disaster. With no or controlled visibility to balance sheets and real numbers, the likelihood of uncovering “Rocky’s” reality is close to zero.
Who Benefits From Start-Up Madness
As per the Economic Survey Report 2022-2023, the Indian startup landscape has experienced a remarkable growth trajectory. In 2016, there were 452 startups, but by 2022, the number had surged to an impressive 84,012. These startups, duly recognized by the Department for Promotion of Industry and Internal Trade (DPIIT), have contributed to the creation of over 9 lakh direct jobs, reflecting a substantial 64% increase in 2022.
A noteworthy achievement is that as of October 2023, around 111 Indian startups have attained the coveted status of being in the “Unicorn Club,” indicating their valuation at or above $1 billion. Out of the total number of unicorns, 45 unicorns with a total valuation of $ 102.30 Billion were born in 2021 and 22 unicorns with a total valuation of $ 29.20 Billion were born in 2022.
This positions India as the third-largest hub for tech startups globally, marking a significant milestone in the entrepreneurial landscape.
Startups indeed play a pivotal role in the economic landscape, as they contribute to the dynamism of the financial sector through their commendable successes and, quite often, their setbacks. In both scenarios, substantial capital changes hands, making these ventures essential components of the economic engine. Moreover, startups make a substantial dent in unemployment figures, bolstering employment rates—a critical gauge of a thriving economy. However, from the perspective of retail investments, the story isn’t always as rosy.
The less illuminated side of this narrative reveals that a staggering 90% or nine out of ten startups meet their demise. The path these startups tread can often feel as slippery as a cucumber on a grater. Approximately 20% of them take a tumble within their initial two years, another 45% succumb within the first five years, and a whopping 65% find themselves in a real pickle within the first decade.
It’s a global phenomenon and, in countries like the United States, a much larger economy is witnessing an crazy upsurge in startups. At the current rate, it almost seems like every American will have their own startup within the next 25 years.
But the big question is, are all these startups investment-worthy for us retailers? This query prompts doubt, particularly when considering the vast range of startups emerging. Nevertheless, it’s intriguing to ponder why venture capitalists seem to be enthusiastically lapping virtually every venture in this space, much like a child with a scoop of ice cream.
Start-Up Madness and Venture Capitalists
Imagine you have some money to invest. If you have a little money, maybe ₹1 lakh, you might want to invest it in big and well-known companies. You’d do some research to find the best ones, make sure you don’t put all your money in one place, and keep an eye out for any problems. Now, let’s imagine you have a lot of money, like ₹100 crores, and you still want to invest it smartly. But here’s an interesting idea: why not invest like a venture capitalist? They get special benefits like paying less tax, getting tax credits, and other advantages.
In this case, you might start looking at small, promising new businesses, almost like they’re just starting. It’s a way to use your big pile of money to buy a big piece of these small companies.
For venture capitalists, what seems like startup madness is a bit like playing a strategic game of Monopoly where they carefully weigh the risks and rewards. They have brilliant minds on their team, often from top-tier institutions, who spend a significant amount of time planning variables. Their sole focus is on figuring out how to make money, even when some of the companies they invest in don’t perform as expected. In the end, their concerted effort translates into profits—a strategy that professional traders reading this would likely agree with.
However, for regular retail investor, it’s their hard-earned money on the line, that directly correlates with their dreams and aspirations.
Damage To Retail Investors
Venture capitalists often dive into early-stage investments, where startups display promising business models, even though revenue may be scant or non-existent. This scenario introduces a unique challenge in appraising these fledgling companies. In their pursuit of additional funding, both startups and venture capitalists occasionally turn to imaginative methods to inflate their valuations.
One such method involves bestowing sky-high values upon mystery patents or proprietary technology, even if these assets have yet to generate any income. It’s a tactic to enhance a startup’s perceived worth. Some startups opt for a comparative approach by comparing themselves to well-established, successful enterprises, asserting their potential to achieve market-leader status. In the business world, however, claims alone seldom translate into tangible profits.
As these overvalued startups eventually go public, they can distort stock market indices and benchmarks. This startup madness and distortion make it increasingly complex for investors to gauge the genuine health of the market. Moreover, excessive valuations can set the stage for bubbles to form, wherein startups are priced far above their actual value. When these bubbles eventually burst, investors can face substantial losses, potentially contributing to economic instability.
The startup madness is evident in a lineup of well-known names that, at first sight, seemed incredibly promising. Fortunately, they never made it to the stock market listings. Some names include Doodhwala, ShopX, Lido Learning, Tiny Owl, Pepper Tap, Local Banya, GoZoomo, Zebpay, Nearbuy, Flashdoor, Jabong, Truckmandi, Bounce, and Stayzilla. If you were a private equity investor in these companies, this article might have been quite disheartening for you.
However, if you were fortunate enough not to have invested in them, you can count your blessings for avoiding potential pitfalls. Feel free to explore these companies online for further insights.
Conversely, numerous companies have managed to secure their listing, with many more waiting in the wings. Although it wouldn’t be fair to single them out at this moment. As I’m keeping a watchful eye on these developments, I am sealing this write-up as a kind of time capsule. If you stay with us, it will be interesting to revisit these subjects in the future (2-5-10 start-up years) for potential case studies.
If you’re eager to explore this topic further, we’ve published an informative guide that explores the analysis of start-ups as they go public through IPOs. Just click here to open it in a new browser tab for your next read.
Conclusion
The startup culture plays a crucial role in economic growth, yet the start-up madness that leads to fictitious valuations and inflated market caps carries substantial risks. The excitement around overvaluation can lead to financial bubbles, misallocation of resources, and distortions in economic indicators. Retail investors need to maintain a grounded and pragmatic approach when assessing the valuations, reputation, and market caps of startups, ensuring the sustainability and true essence of their investments over the long term.
Sometimes, the best strategy in these situations is not to follow the crowd. Steer clear of developing narratives and base your decisions on solid research, focusing on companies with decades worth of strong financial performance and a proven track record in the market.
I’ll leave you with these thoughts for now. Feel free to share your perspective on the culture that promotes startup madness in the comments below.
Be sure to take a look at the suggested guide that teaches how to invest in an IPO with a step-by-step process.
🔔 Invest wisely!
