HOW ARE E-COMMERCE COMPANIES VALUED?
Till recently it was the news of ever increasing and now the freezing and sometimes melting away of valuations of e-commerce companies that has been grabbing everyone’s attention.
It is fascinating yet confusing for most of us that how are these companies chosen and valued? Whether these startups were really deserving or were these overvalued is a matter of perspective but is equally perplexing.
Founder & Managing Director, Wazir Advisors, Harminder Sahni illustrates five broad parameters on the basis of which investors select the startups to invest in and also arrive at an agreeable valuation.
These parameters are mostly qualitative and are converted to quantitative factors later to run the valuation models to justify any level of valuation.
Hotness of the sector
If the sector like food-tech or fin-tech or ed-tech is being looked at by all others then there is a rush to take a position in some or the other company. In such an environment, all other parameters take a back seat and with increased competition the need for money or pressure to burn the money increases and so does the valuation to raise more and more funds. Entrepreneurs of a certain kind are not driven by the passion for what they wish to do but are solely driven by what is hot and how soon it will get funded. My personal take is that such dispassionate promoters as well as investors will find it difficult to create real
companies with sustainable business models. They may be able to make an exit by offloading it to another investor but the company may not be able to stand the test of time.
If a startup can show that they are copying an international success, say a Unicorn like BnB, then the chances of getting funded and that too at obscene valuations becomes much easier. Most of the investors are always looking at what worked in the US and are willing to fund copycats in emerging markets like India. Best of Indian brains, be it on financial side or on the technology side have been busy promoting and funding such businesses like OLA, Flipkart and Paytm, who are copying Uber, Amazon and Paypal respectively.
On the flip side, there is a serious dearth of capital to support ideas that are original and thus are riskier. Such ideas do not normally pass the muster of even junior most level persons in a private equity (PE) office.
However, I would not advocate that entrepreneurs copy models that were successes elsewhere but instead should try to find models that will work in the Indian environment and for Indian customers.
Blessings of marquee angels
With every passing day, angels are becoming more and more important in the overall startup ecosystem. Successful angels who have invested in and exited from some startups are seen by PE funds as the filters to weed out men from boys. Having a set of such angel
investors goes a long way in securing series A or pre series A funding. The reason for this is quite obvious. The amount of startup activity in India has accelerated quite rapidly in a short time and the fund managers just don’t have the capacity and, sometimes, competence to sift through this chaos. Angels perform this role of selection by putting their money where their mouth is and are rightfully taken seriously.
Lately, celebrity angels are being offered very attractive valuations by some startups solely for grabbing attention. This has started to create unnecessary doubts with regards to undeserving startups getting funded without proper diligence.
Pedigree is not only limited to IIT and IIM but now extends to serial entrepreneurs who have successfully started and exited startups. It is assumed that those who have done it once are certainly wiser and smarter and capable of replaying the magic.
People with the right qualifications and startup experience are valued much higher than real upstarts and, God help them if they are not from a certain group of institutions! But if all the boxes are ticked, then the chances of funding and that too at good valuation are extremely bright. Not that one cannot get funded without pedigree but having one certainly helps.
I wish and hope that this will change over time as more and more entrepreneurs from lesser known institutions come forward with bright ideas and make success of those.
Eagerness to create the next big thing
Somewhere, like everything else it also becomes personal and people are driven by personal success, recognition and glory. The big hype around Unicorns and world changing ideas push entrepreneurs as well as investors into starting and funding ideas that may not pass the test of any logic. The eagerness to be the next Facebook or Alibaba pushes these people to support ambiguous business ideas which even they accept, that they are unable to figure out fully. But that is assumed to be the nature of future big things in their infancy, that no one can see but some still believe.
The valuation of such businesses are a leap of faith and thus hard to put into a formula.
On one hand I am very uncomfortable with the urge of creating big things and solving big problems with someone else’s money but I am also an advocate of funding ideas that may have the potential to achieve something exceptional. This is a tricky one and my rational take is to look for passion as well as or may be more than that the competence of the team to do what they are claiming to do. Great ideas and intent are necessary but not sufficient to create great companies.
About the Author: Harminder Sahni is the Founder & Managing Director of Wazir Advisors. The views and ideas expressed in this article are his own.