Why are non-profitable startups still getting funded?

Welcome, Thank you for landing here 🙂

Don’t worry, I’ll make this article very crisp & clear, not cumbersome like the Mondays 🙂

So, let’s dive into this..

The Amount of funding a startup gets depends on its Value and the  percentage of stake it wants to sell. For example if a startup is valued at $100 million, a 20% stake sale will fetch it $20 million.

Startup-Investment-Alternate-Capital

Thus Funding = Value of Start-up * Percentage of stake sold.

How is a startup valued?

A startup is valued on its ability to generate Cash Flows in the Future. Cash Flows means Profits after Taxation. Future cash flows are discounted to arrive at their present Value.

Thus Value= Sum of Discounted Cash Flows.

So, when you evaluate Start-ups, evaluate it on their Future and NOT present or past. If a start-up has the ability to generate Cash Flows in the Future, it will have Value.

Now to answer about specific Start-ups, here are some: –

Ola/Uber: – The inherent question Investors ask while Funding a start-up is:-

Does it have Mass Appeal? What happens if everyone starts using the Product? Also, when a start-up makes things convenient for you, it tries to make itself your habit.

When there was no Ola/Uber, we used to go down, ask several cabs/rickshaws, get rejected by quite a lot of them (I guess convincing Rickshaws in the suburbs of Mumbai is more difficult than convincing your crush for a date with you). But enter Ola, we can now book a Cab sitting at home or office and then only get down when they arrive. Thus it makes it convenient for us to do so plus the added advantage is that they are Cashless and they are Air-conditioned. So, we tend to form a habit of them, which is exactly what they want.

What did Investors think for the First time while Investing in Uber?

What if everyone starts using this Product? What if it expands to cities all over the World?

Fast forward to Today and it operates in 68 Countries! and probably 500 cities!

Link: https://www.uber.com/cities

I hope now you do understand why Uber and Ola get Funded. But, this answers only the question of the First funding.

Why is there a Follow up funding?

The answer is simple. Follow up funding is done when you want to expand to new horizons/cities or when you still want Cash to acquire customers and fund your SHORT-TERM losses.

Imagine being Travis Kalanick (CEO of Uber). You see a lot of Potential in India. So what do you do? Arrange for a follow up funding round to enter India (Remember Rs 600/- worth of a ride when you sign up for the First time and also when you recommend it to a friend.)

Zomato:-

Zomato’s revenues and EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) for the Last 4 years.

 

Revenue has grown 216% from Last year and Losses have also increased by 229%. But if you see the bigger picture Zomato has its presence in 22 countries including India! Also, in India it has a monopoly in Restaurant Search although there are others like Tinyowl, Foodpanda thus making it more probable for it to succeed. Further, it earns from Advertisements, Listings, Online Ordering, Consultancy (Advising Restaurants where to open their new branch through Data Analysis)

I ll like to again stress on the point that don’t see a Losses as a Determining factor to Funding instead see Value.

Flipkart:-

This is by far the most-complicated start-up to analyse but the Fundamentals remain the same. Flipkart is trying to build a habit of buying Online into Indians. Investors too are funding this. Online retail sales today accounts to only 1% of the Entire retail sales in India. If it were to increase to even 7-8% (which is present in USA) then it would mean a jump of 800% in the revenues of E-tailers in India. This is what investors are hoping of.

Make my trip:

I recently spoke to a person having his own Tours and Travelling Business in Jaipur. I asked him about the competition from sites like makemytrip Yatra etc. He said that people in India are still reluctant to use Credit cards online and thus quite a few just use these websites as bargaining tools but eventually book the tickets via a Travel agent or a Tour operator. Slowly, this mentality is changing and more and more people are using their credit cards online.

Infact, make my trip has been reducing its Losses in the past five years.

Link: MakeMyTrip Annual Income Statement 2015, 2014

So coming back to my point, A startup is valued on its ability to generate Cash Flows in the Future. Try to see potential and not Losses when valuing or understanding start-ups.

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I hope this helps. You could comment if you need further clarifications. Happy to help.

Disclaimer:-

I am no expert in Start-up valuations. 🙂

 

(P.S- A big thanks to my friend “Sumit Nayak”, a certified equity research analyst and a finance prodigy for giving his valuable insights on this topic. :))

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